Spoiler alert: For those who have not watched PK there is at least one spoiler ahead.
One of the advantages of not being employed is that one can still go and watch a movie when it releases on a Friday morning. And that is what I do from time to time, when all the reading and the writing starts getting to me.
So, this Friday I ended up watching an early morning show of Rajkumar Hirani’s PK, on the day of its release. A friend who works the film industry had already told me who or what PK was. So, I wasn’t really interested in finding that out, like a lot of people are. But I did enjoy watching the movie, given that it tackles a very difficult subject of religion, god and godmen and what they mean to each one of us, in a very upfront manner.
The most surreal moment in the movie is when after a bomb blast, the immortal words written by Sahir Ludhianvi, set to tune by Khayyam and sung by Mukesh, from the movie Phir Subah Hogi, start playing: “Aasman pe hai khuda aur zameen pe hum. Aaj kal wo is tarf dekhta hai kum”.
I don’t know if the finance minister Arun Jaitley was able to watch PK over the weekend, but if he did, he would be definitely complaining that the “economic god” seems to have abandoned him and his government.
On Friday i.e. December 19, 2014, the ministry of finance released the Mid-Year Economic Analysis for this financial year. On page 6 of this report is a very interesting table. As per this table the government has overestimated the tax revenues this year to the extent of Rs 105,084 crore. This has primarily happened due to two reasons, the report says.
Estimating the Revenue Over-Projection in the Union Budget 2014-15
Source: Ministry of Finance
Notes: a) Budgeted GDP for 2013-14 is Rs 1,28,76,653 crore assuming a growth rate of 13.4 per cent whereas the actual GDP is Rs 1,25,58,711 crore @ 10.6 per cent growth rate achieved so far in 2014-15.
b) In the year 2010-11, there was an accelerated upward trend in the gross tax revenue majorly due to an increase in the growth rate of corporation tax, customs duties and union excise duties and also on account of dismal performance of tax revenue collections in the preceding years.
c) The year 2013-14 witnessed a downward trend in indirect tax collections.
1. Computed as the ratio of average growth rate of tax revenues to average growth rate of nominal GDP during 2008-09 to 2013-14. Alternative sample periods could be considered for computing historical buoyancy. A longer sample risks including periods where significant changes occurred in the tax base and rates. The sample chosen, although short and restricted to the post-crisis period, has the virtue of not having witnessed significant policy changes.
2. Computed as ratio of growth rate of tax revenues in 2013-14 (Provisional Actuals) to budgeted growth rate of nominal GDP in 2014-15.
3. Computed as the product of difference between historical and budget 2014-15 buoyancy, the actual GDP growth rate for 2014-15 and the tax collections in 2013-14 (Provisional Actuals).
4. Computed as the product of difference between the budgeted GDP growth rate and the actual GDP growth rate for 2014-15, the historical buoyancy and tax collections in 2013-14 (Provisional Actuals).
5. For Customs duty, buoyancy has been computed as the ratio of growth rate of import duty collections to growth rate of imports.
The first reason is the overestimation due to growth optimism. In the budget it was assumed that the nominal GDP for the current financial year would grow by 13.4 per cent to Rs 1,28,76,653 crore. Nevertheless, the actual growth between April and September 2014(the first six months of the financial year) was at only 10.6%, which means a nominal GDP of Rs 1,25,58,711 crore.
The taxes collected ultimately are also a function of how fast an economy grows. Given that the economy has grown at 10.6%, the taxes collected are lower in comparison to a situation where the economy had grown at 13.4% assumed in the budget. The short fall due to this overestimation is expected to be Rs 27,079 crore.
The second reason is the overestimation of the tax buoyancy. The report defines tax buoyancy as the ratio of revenue growth to the growth in the corresponding base, typically nominal GDP. So what does that mean in simple English? It essentially refers to a situation where the amount of taxes collected is expected to increase at a much faster rate in response to the growth in nominal GDP. That hasn’t turned out to be the case.
The nominal GDP as mentioned earlier was expected to grow at 13.4%. The total taxes collected by the government were expected to grow 16.9%. During the first six months of the financial year the total taxes collected actually grew by 5.1%. The short fall due to this overestimation is expected to be at Rs 78,005 crore.
Hence, the total shortfall in tax collections is expected to be at Rs 1,05,084 crore. Within this “the optimism was greater in relation to indirect taxes than for direct taxes”. Hence, direct taxes may have been overestimated to the extent of Rs 36,108 crore, whereas indirect taxes may have been overestimated to the extent of Rs 68,796 crore.
Interestingly, in a piece I wrote last week I had said that the indirect tax collections will be lower by Rs 68,496 crore, against the amount that has been estimated in the budget. The number is very close to the number that the half yearly economic analysis report has come up with.
Other than the lower tax collections, the government’s other big problem was the fact that subsidy payments from the last financial year had been postponed to this financial year. As the report points out: “In addition, the budget was strained by a legacy effect, reflecting the excess carryover of subsides from the past. This amount is difficult to quantify precisely but could range from 0.3 to as much as 1 percent of GDP.”
Hence, the report goes on to point out that: “Therefore, evaluating the fiscal performance this year should take account of the legacy costs and the ambitious targets that were inherited. They were ambitious because of optimistic revenue projections, of unanticipated moderation in inflation (the consumer’s gain being the Government’s loss), and also because of below-potential growth.”
In an era of clean chits, this is an attempt by the finance minister Arun Jaitley to give himself and his government a clean chit. Nevertheless, the situation is not as simple as it is made out to be. When Jaitley presented the first budget of the current government on July 16, 2014, he had an opportunity to correct the “so called” optimistic assumptions that the previous finance minister P Chidambaram had built into the interim budget presented earlier.
However, Jaitley had accepted these optimistic assumptions as a challenge. As he had said during the course of his speech: “ Considering that we had two years of low GDP growth, an almost static industrial growth, a moderate increase in indirect taxes, a large subsidy burden and not so encouraging tax buoyancy, the target of 4.1 per cent fiscal deficit is indeed daunting. Difficult, as it may appear, I have decided to accept this target as a challenge. One fails only when one stops trying.”
Back then Jaitley had an opportunity to work with a more realistic set of numbers and present a more realistic total tax number, than what was presented. Now that he and his government have failed on that front it is hardly fair to blame ambitious targets that were inherited.
What was a challenge in July has now become an effort to pass the buck. As far as subsidies that were passed on are concerned, it is not as if Jaitley and his team did not know about them. They could have budgeted properly for these subsidies.
This government had an opportunity to start on a clean slate. And they chose not do that.
The trouble is that how will the government fill this gap of Rs 1,05,000 crore in its budget. In fact, the gap might be even higher given that the disinvestment target of Rs 58,425 crore looks unachievable. Only Rs 1,700 crore has been collected through this route until now.
As I have mentioned in the past, the only way for the government to fill such a massive gap in the budget is by cutting “asset creating” plan expenditure. This is a strategy that was followed by the previous government as well. In 2013-2014, the plan expenditure target was Rs 5,55,322 crore. The final expenditure came in at Rs 4,75,532 crore or around Rs 80,000 crore lower.
A similar exercise will have to repeated this year as well. The trouble is that in an environment where private investment is not growing much, if the government expenditure is also slashed, it will have a negative impact on economic growth.
Suggestions have started coming in that the government should forget about the fiscal deficit target for this year and continue spending money. But would this be a good strategy to follow? The previous government cranked up public spending in the aftermath of the financial crisis. For a couple of years India grew at near double digit rates, when the rest of the world was slowing down.
But this splurge came back to haunt us in the form of high interest rates, high inflation and a substantial fall in financial savings. I will write on detail on this issue in tomorrow’s column. Watch this space.
The column originally appeared on www.equitymaster.com as a part of The Daily Reckoning, on Dec 22, 2014