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Wednesday, March 01, 2006

Budget speech 2006

The budget speech was a disappointing display of socialism and industrial policy. For many years, we have been used to thinking that a budget speech should offer a vision of important economic reform. This one does not. It makes some important progress on tax policy. There's nothing else, other than a mile-long list of subsidy programs of one kind or the other. Even in finance, where MoF's dealings with RBI and SEBI are immune to the CPI(M), there isn't much progress to show.

The budget speech is first of all a political statement. The FM has to make a connection with as many MPs in the room as possible. I find it a useful thumb rule to ignore any expenditure program of below 0.1% of GDP (Rs.3,000 crore). These little expenses are crumbs tossed to this constituency or that. Once you have stripped off this verbiage, you'll have the core of the speech in your hands. (See the article by Ila Patnaik on the institutional function of the budget speech).

At a numerical level, a quick summary picture is the `budget at a glance' statement. I put it into a spreadsheet and computed some useful numbers.

The UPA seems to be gunning for big expenses on their `flagship schemes' such as Sarva Shiksha Abhiyan (SSA). As the numbers in the spreadsheet show, roughly 1% of GDP was added into "plan revenue expenditure" to fund these schemes. Business Standard has an editorial questioning the efficacy of SSA as a tool for getting education done. You might find my earlier piece, on a five-fold classification of policy choices on education, useful.

Let me highlight some interesting comments and responses on the speech. For starters, see the front-page article in Indian Express by Ila Patnaik, Surjit Bhalla's response in Business Standard, and the double edit in Business Standard. All these big picture responses are happier about the budget than I am.

Shankar Acharya is often gloomier than the mainstream, but on this one, I agree with him 100%. The Securities Transaction Tax (STT) was raised by 25%. All of financial sector reforms are about trying to improve liquidity, i.e. reduce costs of transacting. The progress of reducing transactions costs of the last 8 years has been undone by the STT. The STT at 12.5 basis points is huge. As an example, a $100,000 basket purchase of Nifty now runs up an impact cost of 8 basis points. Compared with this, a 12.5 basis point tax is a very material addition to the costs of transacting. It is really depressing seeing these kinds of taxes, which fly in the face of elementary good sense in public finance.

On 22 Feb, Vijay Kelkar had a piece in Indian Express on the Goods and Services Tax [FRBM Task Force Report]. The FM has announced that we will set course for the GST with a 4/2010 deadline. Even though 4/2010 sounds far away (it's four years out, and after the next elections), this could be a development of the first order. Kelkar has a front-page piece in Indian Express today on translating this goal into reality.

One new development this year is a statement about the cost of the various tax exemptions out there [pdf from MoF website]. Saubhik Chakravarti has an article in Indian Express on this. The value reported in the budget document is roughly thrice the size seen in the recent NIPFP paper by Amaresh Bagchi et. al. I think that the disclosure of this statement by MoF is a major development. It's the beginning of the end of the exemption racket. Earlier, exemptions were a non-transparent way for politicians to get transfers into their favourite constituency. Now everyone knows who is getting what subsidy. Technical improvements are needed on methodology, but it's a great start.

As Andy Mukherjee recently emphasised, a big question facing India is the evolution of capital controls. Will India move forward - easing capital controls? Or will India move backward, reversing some of the opening the capital account that had been done by governers Rangarajan and Jalan? I wrote a short piece in Business Standard on the announcements on capital controls - which seem to avoid the danger of sliding back into controls. I also touch upon the announcements on development of the corporate bond market.


  1. i attended the FICCI post-budget analysis at BSE where ajit ranade (aditya birla group) and others (mastek chief, kpmg tax people) were on the panel. Ajit raised an interesting point about the STT, saying that it is probably one of the more "transparent" taxes around. and since you have to increase tax/gdp anyway better do it via more "transparent" methods. i told him about your efficiency argument. he didnt really buy it.

  2. three things:

    1. a major positive which i learnt in that meet was the fact that pc talked about year-round-reforms. he has asked FICCI to submit proposals on how to make manuf sector grow @ 12% and says he might amend the finance bill sometime in the later months. "no need to creat much hoopla over february 28th, why not have reform policies all year round" !
    2. ppl suggested that as far as expenditure on infra was concerned, we may agree to exempt it from the 3% (or whatever the no. is) FRBM fiscal deficit constraint. not many were happy over spending rate on education (only 3.5% of gdp) and infra projects (a lot of numbers were given... but as you said.." the devil is all in the execution" :) )
    3. i think this was a typical 'continuity' budget. not very positive. not very negative. just right. i believe that those who say that we may have missed out on a big opportunity towards reforms for a 10% growth might not realize that we are in a democracy and the greatest growth rates of over 10% have only been observed in either the Lenin-Era or in China. A higher growth trajectory may just be wishful thinking. then again it might not be. :)

  3. A core principle of public finance is: You do not tax transactions. Long chains of specialised transactions are the essence of modern capitalism. Penalising transactions is synonymous with penalising efficiency.

    JRV has a good set of postings on the STT subject.


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