Optics All The Way: Budget 2017 has brought to fore the astute lawyer-politician in Arun Jaitley

India’s finance minister Arun Jaitley has lived up to his credentials as a lawyer-politician adroitly: he has presented a budget for 2017-18 that pleases everybody but satisfies very few.

The capital markets investor class, including the foreign portfolio investor (FPI), is certainly happy. The movement of the stock market index reflected joy at being left alone: at closing time, the 30-share benchmark sensitive index was up 485 points in a relief rally. Investors were pleased that a rumoured restructuring of long-term capital gains tax was avoided. FPIs, who bring liquidity to India’s shallow markets, were spared additional tax blushes under something called the “indirect transfer provision,” which required tax to be paid on transfer of shares overseas if the underlying assets are located in India.

In the end, budget 2017 seems to be more about being seen to be doing the right thing rather than doing it. Jaitley’s thrust can be summed up in his own words: “My overall approach…has been to spend more in rural areas, infrastructure and poverty alleviation and yet maintain the best standards of fiscal prudence. I have also kept in mind the need to continue with economic reforms, promote higher investments and accelerate growth.”

This requires walking a fine line and Jaitley has husbanded all the political smarts he could muster.

Delicately balanced

On one side, the impending state assembly elections (in Uttar Pradesh, Punjab, Goa, Manipur and Uttarakhand) which begin on Saturday (Feb. 04) was bound to cast a long shadow on his plans. On the other side, Jaitley had to present a political budget without breaching the election commission’s restrictions.

Jaitley also needed lots of political nous since the budget had to be drafted in the backdrop of some momentous changes: demonetisation (which has dealt a severe demand and supply shock to the economy), the planned move to goods and services tax (GST), political developments in leading developed countries which could lead to severe economic consequences for India and other emerging economies. In addition, the fiscal responsibility and budget management committee’s report tied his hands by advocating fiscal prudence, barring exceptional situations.

On sum, though, there are a lot of announcements and political grand-standing but little by way of on-the-ground impact. For example, total expenditure planned for 2017-18 is up only 6.57% over the Rs 20,14,407 crore actually spent during 2016-17. That barely covers the rate of inflation. What’s even more disappointing, capital expenditure is budgeted to go up by only 10.7%. The country needs public expenditure to kickstart economic growth, especially in the absence of any private sector investment. Strangely, even though Jaitley has acknowledged this in his budget speech, he has failed to walk the talk.

Revenue could be a legitimate constraint. Tax revenues are expected to grow by only 12.7%, while non-tax revenues are actually budgeted to drop. Total revenue, including capital receipts, is expected to rise only 9.7%. One reason for the conservative estimates could be the expected shift to GST from July. The demand compression arising out of demonetisation could be another reason.

Political imperatives

Despite these limitations, the electoral imperative seems to have forced Jaitley to make numerous announcements for farmers, rural areas and allied sectors. In this, Jaitley has chosen to follow the footsteps of his predecessors by announcing grand schemes and allocating large sums. For example, he announced a Rs10 lakh crore agricultural credit target, against Rs9 lakh crore in 2016-17.

It’s curious that successive finance ministers chose to make this proud proclamation in the budget document when the money will actually be lent by various agri-lending agencies, such as the National Bank for Agriculture and Rural Development. There’s another strange twist: while the government promises to bear the interest subsidy on these concessional loans, the money kept aside for meeting the interest subsidy bill remains unchanged from last year. If the loan volume is likely to go up by Rs1 lakh crore, surely the subsidy element should also rise correspondingly?

Jaitley’s made another strange claim: he maintained that the pace of construction of rural roads under the Pradhan Mantri Gram Sadak Yojana had reached 133 km per day during 2016-17. This fact sits uneasily with roads minister Nitin Gadkari’s admission a couple of months ago that his ministry was unable to meet the highway construction target of 40km every day.

The political framework also probably stayed the finance minister’s hand from slashing corporate tax rates further, as had been promised in last year’s budget. In a year when demonetisation has affected millions of livelihoods and the ruling Bharatiya Janata Party wants to win Uttar Pradesh elections, the optics of helping large corporates could be a recipe for electoral hara-kiri.

He has instead cut tax rates for micro, small, and medium-scale enterprises with annual turnover up to Rs50 crore. His contention: their effective tax rate is higher than large companies and it is these units which actually create employment at the grass-roots level.

Arun Jaitley’s budget for 2017-18 pushes the political messaging of demonetisation further. He has painted a multi-hued picture that appeals to the stock market investor, because a rising stock index is often mistaken for economic health. His brushstrokes also strive to attract voters in various states by not only promising employment and income opportunities but also by painting the government as pro-disenfranchised and anti-privileged.

The above article was published in www.qz.com on February 2, 2017, and can also be read here

Demonetisation And Budgets: All In The Mind

Arun Jaitley will soon be presenting the 2017-18 budget and his well-laid plans may have to incorporate demonetisation-induced changes

It’s 690 seats this year; another 964 seats are up for grabs next year, with the general election to follow in 2019. This inescapable political imperative will weigh on finance minister Arun Jaitley’s mind when he drafts India’s economic policy. The battle for occupying popular mindspace over the past two months is now telescoping into a two-year battle. And if the vast majority of Indians feel confounded after Prime Minister Narendra Modi’s surgical excision of 86% of currency, they shouldn’t despair: They are in the distinguished company of Jaitley who, presumably, is equally disconcerted.

Jaitley will soon be presenting the 2017-18 budget and his well-laid plans may have to incorporate demonetisation-induced changes, over and above those included for introducing the goods and services tax (GST) system. What’s worse, with the GST start likely to be postponed, revenue projections may now have to be recast along traditional lines. Two huge changes in three months is more than just a rude disruption.

Two other elements add to the confusion. One, the railway budget will be merged with the Union budget this year in a meaningful break from a meaningless tradition. Also, the traditional expenditure reporting format under the broad heads of Plan and non-Plan expenditure will be jettisoned.

File photo of Finance Minister Arun Jaitley; Photo courtesy: Mint  

Standing for a moment in Jaitley’s shoes, what’s likely to be more worrying is how the economic slowdown affects revenue growth and how that shapes spending plans—especially committed social sector or infrastructure expenditure—that cannot be trimmed, leave alone eliminated. Jaitley has already promised higher government pump-priming to boost economic growth. Many new variables have cropped up in the meantime, further skewing the math. Modi contributed gamely during his 31 December speech with promises to increase social spending under both new and old schemes.

For example, new interest subventions on small housing loans and farm loans or increases in the number of rural houses built for the poor under the Pradhan Mantri Awas Yojana are some of the schemes which might expand both capital and revenue expenditure bills for 2017-18. It is clear that Jaitley has little option in slashing the outlay for social sector schemes, especially when demonetisation has eroded rural incomes and the ruling Bharatiya Janata Party is unable to dismount the election treadmill. Apart from state assembly elections for Uttar Pradesh, Punjab, Goa, Uttarakhand and Manipur in less than a month, next year will see elections in Tripura, Rajasthan, Madhya Pradesh, Karnataka, Chhattisgarh, Nagaland, Mizoram and Meghalaya.

With the political economy constraining deep spending cuts—at the most, outlays might be shuffled around under different schemes—revenue generation becomes imperative for meeting many of the grand spending plans. This is where rubber hits tarmac.

The demonetisation narrative focused on cornering tax evaders and, through legislative amendments, forcing assessees depositing unreported incomes to pay higher penal rates. This would require enhanced tax scrutiny and inevitably involve some element of persecution. But by stating that demonetisation was launched to punish currency hoarders, it subjected the majority to widespread suffering for the misdemeanours of a few. The messaging was subsequently imbued with nationalist overtones and repurposed to focus on moving India to a less cash economy.

Enter the good cop: News reports claimed that Jaitley had hinted at lower tax rates in a meeting with tax officers, citing how similar attempts earlier had met with success. News leaks from unidentified finance ministry sources also made similar claims.

Jaitley later seemed to deny his statement without actually denying it. There’s no text of Jaitley’s speech; only a summary is available, which has him stating there was an urgent need for a change of mindset: “India has to move towards a mindset of voluntary compliance…payment of legitimate taxes should be considered as part of the process and nobody should think that tax evasion is acceptable.”

This is where things get muddied up. By using the term “mindset”, Jaitley pivots seamlessly into the arcane world of behavioural economics. It is reassuring to note that Jaitley recognizes the importance of mindset in correcting tax compliance behaviour. But his public musings betray a contradiction. Initiating mindset change is a long-term project which involves altering social norms using a combination of psychological and social forces. The post-demonetisation regime instead uses a carrot-and-stick approach: simultaneously offering incentives (aka the Laffer curve) and disincentives (penalties).

The World Bank’s World Development Report 2015—titled “Mind, Society And Behavior”—states clearly that penalties or incentives have failed to improve tax compliance across the world. The UK government’s behavioural insights team, also known as the “nudge unit”, claims to have used behavioural sciences successfully to improve tax compliance in the UK and other countries. Jaitley will do well to remember that like liquor prohibition failed to stem alcoholism and related social problems, a one-time demonetization (or a subsequent penal regime) might not be enough to raise tax revenue on a sustainable basis. While the impact of behavioural sciences in influencing policy outcomes is still imprecise, one thing is clear: lasting changes in social norms require long-term investments.

The above article was first published in Mint newspaper on January 11 and can also be read here