How To Protect The Sanctity Of India’s Economic DataBloombergQuintOpinion
In the modern, interlinked world, data is power. Narratives of policy success or failure rely on the availability of data as well as clarity on the methods used to generate that data. A proactive decision to not collect data on key variables is as effective in stunting debate as is denying people access to key data or assumptions underlying computed numbers.
A recent example of this is the fiscal deficit that was announced in the budget presentation earlier this month. The budget estimated the deficit to be 3.4 percent of gross domestic product for both fiscal years 2018-19 and 2019-20. The fiscal deficit has three variables. In the numerator, there are estimates of revenues and expenditures of the government while the denominator has an estimate of GDP. All three variables are based on government projections and assumptions. Given the amount of attention that the fiscal deficit generates from markets, one would expect that there would be objective ways of assessing the salience of the projections. Unfortunately, given the processes that are currently followed, forming such a judgment is extremely difficult.
Revenue, Spends, GDP: All Opaque?
Consider first the revenue estimate. This is based on projections of tax and non-tax revenues that the government expects to collect. The key assumptions underlying this are the base on which taxes are going to be levied, the rate at which revenues are likely to change as tax rates change, and the extent of tax compliance by taxpayers. This requires some serious technical modeling of the growth process for the economy and the revenue elasticity of taxes.
An iconic result in public finance is that tax revenues have an inverted-U shape relationship with tax rates: as tax rates increase revenues rise up to a threshold after which total revenues start declining with further hikes in the tax rate. This is known as the Laffer curve, named after the economist Arthur Laffer who first documented this. Intuitively, as the tax rate rises, the tax base declines since higher taxes reduce economic activity or reduce compliance. Beyond the threshold tax rate, the base effect dominates and consequently aggregate revenues fall. The implication of this relationship is that governments should never choose tax rates that put the country on the downward sloping portion of the Laffer curve since one can raise revenues by reducing rates.
The budget assumes that GST revenues will grow by 20 percent in 2019-20 even though rates have been reduced for a number of items on the GST list.
This estimated growth can only occur if India was either on the downward sloping part of the Laffer curve in 2018-19 or the growth in nominal incomes and tax compliance next year will more than offset the negative effect of the fall in the tax rate.
How valid is this assumption? Were we on the downward sloping side of the Laffer curve last year?
Next, is the estimate regarding government expenditure. Here, amongst others, there are two fundamental issues. The first is due to the fact that the government budgets on a cash basis. It counts all cash expenditures made between April 1 and March 31. This implies that if payments for government services for 2018-19 are postponed to April 2019 then they do not get counted in expenditures for 2018-19. This can be a tempting option for a government.
The problem is that there is virtually no way for independent analysts to determine the extent of this type of expenditure postponement from the data that is made available.
A second issue with the estimated budget expenditure is the costing of the various programs that are proposed in the budget. The cost of any new policy that is targeted at individuals depends on the per-capita cost of the program as well its estimated take-up rate. Similarly, estimates of infrastructure expenditures also involve cost assumptions. Uncovering the assumptions underlying these estimates is very difficult since very few of the relevant parameters are revealed in the budget.
The last key piece of the deficit number is the denominator: the projected nominal GDP for the relevant fiscal year. The projected nominal GDP number requires an estimate of real GDP growth and the expected GDP deflator inflation rate. The government usually relies on the Central Statistics Office for these estimates. Typically, this tends to be the least controversial of all the estimates since the CSO is viewed as an independent agency that collects and processes data in an objective and scientific way.
Unfortunately, a succession of controversies over the past year related to the recent GDP revisions and the GDP back series data releases, as well as the involvement of the NITI Aayog in the data release process has dimmed the CSO’s lustre.
Creating A Constitutional Office
These problems with budget numbers are not unique to India. Budgeting exercises everywhere are subject to similar issues. Recognising its potential deleterious effect on the credibility of policy planning and policy announcements, some countries have set up institutions to deal with the issue. The Congressional Budget Office in the United States and the Parliamentary Budget Office in Australia are two such institutions that are constitutionally mandated to give a costing of proposed policies as well as to provide updates on the evolution of the budget during the year. Some of these institutions are also required to cost the policies that are proposed by different political parties in their election manifestos. Despite coming under periodic attacks from different parties, these constitutional offices are generally considered to be objective and neutral.
Given the increasing global integration of capital markets and India’s continued dependence on $50-70 billion of international capital inflows a year to just fund its savings-investment imbalance, the last thing the nation needs is uncertainty about key statistics of the economy.
The need of the hour is for the constitutional creation of a Parliamentary Budget Office that will report to Parliament.
Its tasks should be tightly defined to doing a costing of proposed policies, an assessment of the realism of the budget assumptions, and periodic updates on its evolution over the fiscal year. To keep the office from getting mired in accusations of bias, its mandate should not extend to making policy recommendations. In addition, Parliament must move forthwith to re-establish the primacy of the CSO and the National Statistics Commission to oversee data collection and dissemination. The optics of the data ecosystem needs to be above reproach. India needs to act now.
Amartya Lahiri is Director of the Centre For Advanced Financial Research And Learning (promoted by RBI), and Professor of Economics at University of British Columbia. Views are personal.
The views expressed here are those of the author and do not necessarily represent the views of Bloomberg Quint or its editorial team.