Arindam Das-Gupta: Fiscal reform: Why not tackle the waste?

What to do about public waste?
Based on successful international experience, government budgeting and expenditure institutions for goods and services it produces (or public outputs) should be overhauled. This can enable better: identification and targeting; real economic cost-estimation; public and grassroots monitoring; and a scientific study of the contribution of public outputs to development outcomes. In turn, this could help accountability and cost reduction through improved internal control and external audit.

With current government budgeting and accounting, even rough estimates of economic unit costs are not possible. Further, only some public outputs are quantifiably identified. Yes, most ministries have annual “outcome budgets” and performance reports since 2005. These are, however, non-transparent and do not enable public performance, waste and unit costs to be assessed.

With no proper cost estimates, the government cannot recognise overspending or under-spending on any output nor assess waste and leakage.

Only a few of the Twelfth Finance Commission’s preliminary reform suggestions to reduce public waste have been implemented since 2004. Where initiated, there is no hurry to translate them into transparency and efficiency improvements on the ground. For example, the Government Accounting Standards Advisory Board (GASAB) mentions 10 to 12 years for crucial accounting reforms in their road map!

How good are the UPA’s proposed tax reforms?
The two major UPA revenue reforms are the planned Centre and State Goods and Services Taxes (GST) and the replacement of current direct tax laws by the Direct Taxes Code (DTC). The GST is high-risk given its emerging structure and inadequate preparation for its implementation (DTC weaknesses are not discussed here).

A widely accepted design thumb rule for developing countries is taxes with broad bases making low tax rates possible without revenue sacrifice. Low tax-rates reduce tax evasion and avoidance, while also reducing government revenue risk from each instance of non-compliance. How well does the emerging GST design accord with this rule, dubbed the BBLR by fiscal expert Richard Bird?

The three positives that accord with BBLR: Extending the base of the central excise from manufacturers to retailers under the GST; unifying currently separate taxation of goods and services; and for states, allowing state tax on services in addition to goods, after the necessary constitutional amendment.

Unfortunately, by giving registered GST dealers (that is businesses liable for GST) a 100 per cent credit for input taxes paid by their suppliers (or 100 per cent ITC), the GST itself violates BBLR.

There are two main arguments for the 100 per cent ITC. One, it removes cascading of taxes (cascading arises when tax is paid by buying businesses on taxes built into prices they pay on inputs). No cascading makes the effective tax rate per unit easy to estimate, and ensures a tax base no larger than the value-added by the business. Unfortunately, only applied tax economists are concerned about cascading and effective tax rates. Theoretical economists, including a Nobel Laureate, have pointed to cases where cascading taxes are “optimal” when markets deviate from the textbook ideal. At the other extreme, GST dealers lose no sleep over cascading or effective tax rates. Further, in reality GST dealers are large, with annual turnovers above a specified threshold. Real world GSTs are cascading with non-transparent effective tax rates in any case where small businesses not entitled to ITC are part of the supply chain.

The second argument is that opposed interests of input suppliers who pay GST, and input buyers who get the ITC, make the GST partly “self enforcing”, reducing tax evasion. This GST property has both theoretical and empirical support. However, even a tax with a, say, 20 per cent ITC would be self enforcing while having a base broader than the GST in line with BBLR.

So on inspection, the two arguments are grounded in quicksand.

Return now to the “positives”. A senior tax expert at the National Institute of Public Finance and Policy, New Delhi, recently pointed out that neither central nor state tax administrations will be adequately prepared for the large and unfamiliar GST bases as compared to taxes they currently collect. The Central excise administration may have many new wholesale and retail sectors GST dealers, sectors with which the excise department has no familiarity. State VAT administrations have no experience taxing services. To avoid serious revenue loss and dealer compliance costs, improved administrative preparation including reorganisation, business process reengineering, upgraded IT support, and staff training are needed. The planned unified IT portal for GST dealers, while useful, does not correct basic administration weaknesses.

Perhaps the GST is not such a bad reform after all. If it fails to deliver revenue and GDP growth via lower tax distortion, the Indian government may reorder its priorities to what they should have been in the first place: Cut waste and leakage through proper institutional reform.

(The author is Senior Professor and Head, Centre for Economic Research, Goa Institute of Management)