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Contractionary fiscal policy?
Ila Patnaik
Business Standard, March 19, 2003

The fiscal deficit is expected to be the same as last year, but expenditure growth will be slower

Yashwant Sinha’s last Budget, the Union Budget for 2002-03, was prepared in the midst of hopes that the Budget would give a boost to the economy.

The minister obliged. In the Budget he gave the economy higher government spending. This was meant to give an impetus to the economy. Higher spending aimed to counter the impact of September 11 and the slowdown in domestic industry and in exports.

But given the already large fiscal deficits of over 5 per cent, Sinha also planned an ambitious increase in tax collection. The budgeted fiscal deficit for 2002-03 was 5.3 per cent.

The increase in central government expenditure, which was estimated to grow at 13.2 per cent, was matched by an increase in taxes. As is often the case, government departments could not spend the budgeted amounts, and expenditure grew by only 11.5 per cent.

How far can the recovery in the industrial sector be attributed to higher spending by the government, will be difficult to say, as it always is.

Budgetary measures such as housing sops and infrastructure development are seen to be among the important steps that pushed up growth. No one will be able to conclusively say that it was the expansionary policy of the Budget that helped in reviving the economy.

The Budget for 2003-04 has been presented at a time when the economy is showing signs of a pick up. Is the current Budget also expansionary like last year’s, as the slow down in growth in not entirely over? Or, is the impetus to growth to come from supply-side factors such as tax cuts? A quick look at the figures suggest that Reaganomics influenced Jaswant Singh more than John Maynard Keynes.

What is noteworthy about Jaswant Singh’s Budget for 2003-04 is that while the fiscal deficit is expected to be about the same level (as a per cent of GDP) as last year, the growth in expenditures is much slower. And, that this slower growth in expenditure is matched by a slower growth in tax receipts.

Since most of the government’s non-plan spending such as interest payments and salaries are ‘committed’ expenditures, non-plan expenditure cannot be cut much and so it is estimated to grow at 9.6 per cent, as against 11 per cent last year.

But it is plan expenditure that will take the major cut. Plan expenditure that grew by 12.7 per cent last year, is to grow by only 6 per cent in 2003-04 !

Sinha’s targets for tax collections in Budget 2002-03 were quite ambitious. In one stroke he aimed to raise tax collections from 5.8 per cent of GDP to 6.8 per cent of GDP. Revised estimates suggest that this target was almost reached. Tax receipts in 2002-03 were 6.7 per cent of GDP!

In the Budget for 2002-03, it was estimated that tax revenue would grow by nearly 30 per cent. Revised estimates suggest that the growth of tax revenue fell short of the budgeted amount and grew by about 23 per cent.

This is not surprising considering that GDP growth, especially industrial growth, as well as inflation was lower than expected. Since tax receipts are being measured in nominal terms, the shortfall in real terms, or as a percent of GDP was not very serious.

In sharp contrast, Jaswant Singh’s Budget for 2003-04 estimates growth in tax receipts to be a mere 12.2 per cent. This lower growth, especially in the face of a higher expected growth of GDP in the current year, is quite remarkable.

Budget estimates, usually an exercise involving application of new tax rates to different sectors assuming certain growth rates of the sectors, is more of an accounting identity than the expression of the minister’s wishes.

Budget estimates on the revenue collection side often fall short of, rather than exceed, the minister’s expectations. If collections were to fall short this year as well, there would be a sharp crunch in the resources available with the government.

It is possible that this time the difference between budgeted and revised/actual numbers may be lower because targets are less ambitious. Actual tax receipts may not be much less than targeted collections.

But if the Budget has made modest expectations about improvements in enforcement and efficiency of tax collection so that Budget estimates match actuals, then also there is no denying that the growth in tax revenue would be much lower than the 23 per cent achieved last year.

Budgetary estimates for 2003-04 hope to achieve a fiscal deficit of 5.6 per cent of GDP compared to 5.9 per cent of GDP in the revised estimates for 2002-03.

When government spending and taxes rise by the same amount, a simple application of the the balanced budget multiplier suggests that GDP would rise by this amount.

Similarly, when both are cut, simple Keynesian analysis suggests that GDP would decline by that amount. In this case we are not talking in terms of actual cuts, but in terms of slower growth. This may be translated into cuts as a ratio to GDP when compared to the previous year’s Budget.

Total government spending is estimated to fall from 16.5 per cent of GDP in 2002-03 (revised estimates) to 16 per cent of GDP in 2003-04.

The impact of a slower growth in government spending, matched by a slower growth in tax receipts, would effectively be contractionary. In other words, Jaswant Singh’s Budget is contractionary compared to Yashwant Sinha’s Budget of 2002-03.

This may not be an entirely bad policy given that plan expenditure is often spent on inefficient schemes and a cut in growth of such spending may be a path to fiscal correction. Even though in the short-run this may mean a contraction of demand, if in the long-run it means that wasteful expenditure of public money is reduced, then higher taxes raised later can be better spent.

The impact of Jaswant Singh’s tax cuts on GDP growth depends on the success of supply-side economics as well as Singh’s ability to implement ambitious private-public partnerships in infrastructure that seem to be the strategy substituting growth of public sector investment in infrastructure. It appears that these schemes, still a bit enigmatic, are not part of the Budget.

However, if Mr Singh can come up with schemes where the private sector puts money into infrastructure, something it has been fighting shy of in the last few years, that raises demand and does not raise fiscal deficits, then who are we to complain!

(The author is at ICRIER. These are her personal views.)

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