Need to boost labor income and consumption expenditure

the story So Far: The Union Budget for 2022-23 has projected a fiscal deficit of 6.4% of the nominal GDP, lower than the 6.9% projected in the Revised Estimates for the current fiscal ending March 31.

Finance Minister Nirmala Sitharaman said the move was “in line with the broad path of fiscal consolidation” announced by her last year to reach a fiscal deficit level of below 4.5% by 2025-26. “While setting the fiscal deficit level for 2022-23, I am conscious of the need to spur growth, through public investment, to become strong and sustainable,” he said.

What was the economic context of this year’s budget formulation?

Although every economic crisis involves a sharp decrease in the rate of production growth, the uniqueness of the current crisis in India lies in a sharp decrease in labor income compared to profits. The resulting reduction in the income share of labor was associated with a sharp decline in the consumption-GDP ratio as well as the absolute value of consumption expenditure during the pandemic. While GDP is projected to attain pre-pandemic levels in 2021-22, the actual consumption expenditure is lower than in 2019-20.

Labor income and consumption expenditure declined during the pandemic, which turned out to be the longest episode of growth slowdown in the Indian economy since the period of liberalisation.

In the midst of these special challenges, the budget of 2022 was kept. The first challenge is specific to the pandemic and relates to the need to introduce policies that boost labor income and consumption expenditure. The second challenge was related to removing the structural constraints of the Indian economy that restricted growth even during the pre-pandemic period.

Against this backdrop, how did the budget perform and what are the major drawbacks?

While continuing with the objective of fiscal consolidation, the budget fails to address both these challenges.

There are three distinctive features of this fiscal consolidation process. First, while the share of revenue and non-debt receipts in GDP has remained more or less unchanged, the objective of fiscal consolidation has been sought to be achieved primarily by reducing the expenditure-GDP ratio (see Figure 1).

The brunt of this expenditure compression fell on the revenue expenditure. Continuing with the fiscal strategy adopted in the last two years since the pandemic, the allocation of capital expenditure as part of GDP has been marginally increased in 2022-23 as compared to 2021-22. Although additional capital expenditure can be financed either by deferring the fiscal consolidation process or by increasing revenue, the budget has sought to achieve fiscal consolidation by reducing the allocation to revenue expenditure-GDP ratio.

Second, since the bulk of revenue expenditure consists of current spending in food subsidies and social and economic services, the reduction in allocation to revenue expenditure is associated with a decline in several key expenditures that affect labor income and livelihoods ( see picture 2) )

For example, allocations for both agriculture and allied activities and rural development showed a sharp decline in nominal absolute terms in 2022-23 as compared to 2021-22. Similarly, amid the ongoing pandemic, overall nominal expenditure on medical and public health registered a sharp decline in 2022-23 as compared to 2021-22. Such expenditure compression has been associated with an overall decline in allocation for total social sector expenditure.

Third, despite a sharp rise in profits during the pandemic, the corporate tax-GDP ratio has remained below the 2018-19 level due to tax concessions. The last decade saw a sharp increase in the share of corporate tax concessions in GDP, reaching its peak at 3.9% by 2020-21 (see figure 3). Reflecting the trend of tax concessions, the corporate tax-GDP ratio recorded a decline especially since 2018-19, when the corporate tax-ratio fell sharply from 3.5% to 2.7%. Despite the fiscal consolidation objective, the corporate tax ratio remains low and limits revenue receipts.

What are the implications for development spending?

The objective of fiscal consolidation along with the inability to increase revenue receipts has put a constraint on development expenditure. With non-development expenditure consisting of interest payments, administrative expenses and various other components that are usually rigid on the downside, the brunt of expenditure compression has been on development expenditure.

Figure 4 shows the trend of the Centre’s share of development expenditure in GDP since 2008-09. While the decade of 2010 was characterized by various governments meeting fiscal targets by adjusting their expenditure, it marked a sharp decline in the development expenditure ratio in 2019-20 until the advent of the pandemic. To a limited extent, the fiscal stimulus implemented in the first year of the pandemic brought about a brief recovery in 2020-21. The fiscal consolidation strategy undertaken over the years has once again pushed down the development expenditure ratio.

The reduction in allocation of development expenditure ratio for 2022-23 reflects a reduction in allocation of expenditure to food subsidies, the National Rural Employment Guarantee Programme, agriculture, rural development and the social sector.

Why is the budget’s fiscal consolidation approach a concern from a macro-economic perspective?

The budget estimates for various expenditures are sensitive to the development estimates for 2022-23. If GDP growth rates and revenue growth rates are lower than expected, actual expenditure may be lower than expected. Given the fact that the growth rate of real GDP has been consistently lower for at least the last four years than was initially estimated by the Economics Survey, the possibility of real expenditure falling short of budget numbers does not preclude can be done.

But even if actual expenditure is close to budget estimates, recovery of labor income and consumption expenditure will be largely restricted by the manner in which fiscal consolidation has been done. This is because reduction in allocation for development expenditure will have an adverse effect on labor income and consumption expenditure. The positive impact of higher capital expenditure on the recovery process will be substantially outweighed by the adverse effect of a more than proportionate decline in revenue expenditure.

Given the government’s fiscal consolidation strategy, the scope and extent of economic revival currently depends heavily on external demand. Despite a brief recovery in exports over the past few quarters, the prospects for a sustained economic recovery, particularly dependent on the export channel, appear bleak at present as various countries have already started pursuing fiscal consolidation at the direction of the IMF. The Indian economy currently lacks an effective policy instrument that can boost labor income and aggregate demand.

Ziko Dasgupta is Assistant Professor at the School of Arts and Sciences, Azim Premji University, Bengaluru and Kavya Menon is Research Assistant at Azim Premji University, Bengaluru.