A dream beginning

Source: By Surjit S Bhalla: The Financial Express

For an interim Budget, this was a breakthrough Budget. I have been closely involved with Budgets for the last 20+ years—as an outside observer and as an active participant in the debates on economic policy. When Chidambaram cut the top tax rate to 30% in 1997, I hailed it as a dream Budget. Today’s Interim Budget is even more of a dream Budget. Let me explain.

My concerns throughout have been the following: do not be a fundamentalist on the fiscal deficit, as most of my fellow economists, and all market participants, have been. For me, the two most important economic considerations for a policymaker are growth and inflation. From a tax and subsidy perspective, my belief has always been to separate price setting from equity.

Translated, that means that the market (sorry, my left-wing friends) should set prices; and by market, I mean both domestic and international. The government should achieve its equity objectives through direct benefit transfers. The intent and direction of the Interim Budget is attempting, and beginning, to meet these objectives.

For the last 40 years, India has followed a misguided policy for alleviating poverty or increasing food production. In India, we have a saying about the two different paths to touching your nose—either a straightforward way with which you actually achieve the objective; or in a round-about way (arm around your neck) where it is impossible to even come close to achieving the target.

We have followed the old-fashioned corrupt way—food procurement and food distribution via the Food Corporation of India to ration shops from which 75% of the population can access rice and wheat at Rs1 and Rs2 per kg respectively. Along the way, about 50% of the food that is meant to be distributed to the poor and lower middle-class disappears into thin air—i.e. into corrupt sinks. The amount of this corruption: Rs1 lakh crore.

By introducing a direct benefit transfer (DBT) to the poor farmer, the government appears to have taken the first steps towards dismantling the 40 year old corrupt policy of food procurement and distribution and a highly inequitable one as well. By raising the minimum support prices (MSP), as this and previous governments have done, only the rich, upper class farmers are really helped. The Modi government bought into the false policy of raising the MSPs to farmers as a way of solving the farmer income problem. They (the policymakers) have been taught the first important lesson of econ 101—supply and demand determines the price, not the diktat of a bureaucrat or a left-intellectual, however well-intentioned she might be.

Econ 001 will also teach you that the market setting of the price does not solve the desirable objective of a “fair” distribution of income.

That is where a negative income tax, first mooted by Milton Friedman in the late 1950s, comes in. DBT is one version of negative income tax. So, for all those politicians who think they have just discovered the principles behind basic income, please read your econ 001 history books. Indeed, the general concept of basic income was first articulated (and practiced and failed) in England in the late 18th century. Incidentally, the failure was due to DBT being tied to the price of bread! Approximately the same reason, why the MSP system is failing;

The DBT, as presently announced, is a transfer of Rs 6,000 a year to poor farmers (those cultivating less than 2 acres). The target is 120 million small farmers, and total expenditure therefore is Rs 75,000 crore a year. For an attempt to arrive at a basic income transfer policy for all poor residents of India, and poor defined as those consuming less than PPP$ 3.1 per person per day (approximately Rs1,800 at present prices). We recommend a transfer of Rs520 per month for the rural poor and Rs630 per month to the urban poor.

The second component of the new dream Budget is the policy on tax rebates for those earning less than Rs5 lakh a year. The policy is strictly one of tax rebate, not an increase in exemption limit. If an individual earns Rs5 lakh, she will have to file a return, state that she is earning Rs5 lakh, and owe Rs 12,500 in taxes. This is because there is a 5% tax rate for those earning between Rs2.5 and Rs5 lakh. This is then adjusted with the rebate of Rs 12,500 and so she owes zero tax. Why couldn’t the government have just raised the tax exemption limit to Rs5 lakh? Because then she wouldn’t be in the tax net, stupid! That is the brilliance of this policy—you get into the tax net, as you should, so that, when your incomes grow, you will contribute to the tax kitty.

Revenue considerations are important, as is equity. Rough, but reasonable, calculations suggest that the government will lose about Rs 25,000 crore of revenue in 2019-20. There will be approximately 25 million taxpayers in the Rs2.5-Rs5 lakh bracket, and with an average income close to Rs5 lakh, the government would have been owed about Rs 25,000 crore.

Total transfer by the government on account of DBT for the poor farmer and the lower middle class worker is approximately Rs1 lakh crore. Note that the spending on farmers is three times that of spending on the salaried worker. Note also that this Rs1 lakh crore is near identical to the present corruption loss of Rs1 lakh crore due to the operation of the PDS system.