Finance minister P. Chidambaram: Fiscal is The New Fad

Finance minister P. Chidambaram: Fiscal is The New Fad Mon, 03 Mar 2014

Finance minister P. Chidambaram: Fiscal is The New Fad

Finance minister P. Chidambaram on Wednesday assured the investors that he has drawn red lines and the fiscal deficit will be below the 4.8% mark in 2013-14. "A number of measures have been taken...We are determined to go back to the path of fiscal consolidation...We have laid out a new path and I have said these are red lines. This will be never, never breached," he said. It is nice to see the Finance Minister committed to keep the fiscal deficit under control.

Currently, the rest of the developed world is reeling under a debt problem, and therefore there is an increased focus on fiscal deficit. It has become fashionable in some way to focus on all the countries which have high deficits, and make all kinds of doomsday predictions. These days, popular discussions of deficits usually take it for granted that deficits are bad for the economy, and perhaps even immoral. Although this view can be defended, its justification is less obvious than one might think. Fiscal deficit wasn'€™t such a big villain a decade back. The fad is like, when '€œLage Raho Munna Bhai'€ became a hit, '€œGandhigiri'€ suddenly became the '€˜done'€™ thing. Offenders were gifted with roses and if somebody spit somewhere, many started at least objecting politely, if not cleaning it with a smiling face.

Of course, this fad on focus on fiscal deficit is more serious and longer lasting. Most economic debates a decade back would have argued that fiscal deficit has more benefits than defects. An analogy may be helpful in thinking about the desirability or otherwise of deficits.

Hypothetically, assume that you increase sales tax on cars and decrease it on motorcycles. This law does not benefit or harm the economy as a whole; it merely redistributes income among people. The direct effect is to benefit college-goers, young employees and the rural population and hurt the more well-to-do who buy cars. There are also likely to be other effects. For instance, the shift in tax burden from two-wheelers to four-wheeler personal vehicles may raise the demand for motorcycles and reduce the demand for cars, leading to higher sales for the Bajajs and the TVS'€™ and lower revenues for the Toyotas and the Hyundais. These pecuniary externalities sum to zero at the economy level, like the effects of the sales tax in the example.

A policy of running fiscal deficits is similar to a pro-motorcycle tax--it shifts taxes between groups. Here the shift is not between buyers of different vehicles but between taxpayers at different times. When the government runs a deficit, it accumulates debt that it must pay back in future. Such a policy just shifts the burden of taxes: current generation gains, and future generations lose. That'€™s what is happening in the developed economies right now. They ran high deficits for ages and the reality is now catching up, as it is pay-back time. However, it is not as bad as it sounds in the Indian context. People often assume a moral imperative that the current generation should sacrifice to ensure that future generations enjoy a substantially higher standard of living. In that sense, whether and why deficits are undesirable requires judgments that are more philosophical than economic.

Economists, traditionally have not been good at judging redistributions of income. Indeed, they often claim that this issue is outside of the sphere of economics altogether. It is, therefore, somewhat surprising that economists now are decrying budget deficits with such consensus and assurance. One widely accepted standard for judging redistributions is the ability-to-pay principle: redistributions of income are desirable if they go from better-off to worse-off people, like in that motorcycle-car example. Car owners typically will have higher ability to pay than motorcycle buyers. By this criterion, the redistributions arising from running fiscal deficit is desirable.

Most economists would agree that we are in course of being, at least, the top five economies of the world in the next decade and may be, the top three economies of the world, in a couple of decades. Our path to economic progress, like that of China, is undeniable. Because budget deficits shift taxes forward in time, they benefit relatively current taxpayers at the expense of relatively rich future taxpayers. If reducing inequality is a goal of policy, shouldn'€™t budget deficits be applauded?

The doomsday predictions for India is necessarily speculative as we haven'€™t had any hard landing so far and looks a bit far-fetched in the future as well. The bottom line is, we don'€™t have to be as much worried about fiscal deficits as the developed world, that are neck-deep in debt. That said, it is good to see that the Finance Minister being not complacent and addressing the issue unequivocally.

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