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GDP decline: Fiscal stimulus is already on, why doesn’t the govt try lowering taxes?

Media reports suggest that the central government is planning a fiscal stimulus. In simple English, what it basically means is that it is planning to spend more than what it had budgeted for during this financial year.

Fiscal stimulus is an idea that politicians have latched on to for nearly eight decades since the British economist John Maynard Keynes published his tour de force, The General Theory of Employment, Interest and Money in 1936. What Keynes suggested in this book was that in a tight economic situation, cutting taxes, so that people would have more to spend, was one way out to revive economic growth.

But the best way was for the government to spend more money, and become the “spender of the last resort”. Also, it did not matter if the government ended up running a fiscal deficit in doing so. Fiscal deficit is the difference between what a government earns and what it spends. When Keynes wrote this book, government budgets used to be balanced (i.e. expenditure was more or less equal to revenue).

It wasn’t fashionable for governments to run a fiscal deficit back then, as it is now. Given this, Keynes suggested that in a tight economic situation (the world was going through what we now call the Great Depression) it made sense for the government to spend its way out of trouble. And if that meant running a fiscal deficit, so be it.

 GDP decline: Fiscal stimulus is already on, why doesn’t the govt try lowering taxes?

Representational image. Reuters

Since then, it has been a time-honoured tradition for politicians and a section of economists to talk about the government spending more, in times of economic trouble. The idea being that with the private consumption slowing down, if the government spends more, incomes will go up, and this will help in reviving private consumption expenditure, which in turn will push up economic growth.

QED
In fact, the government has already started providing a fiscal stimulus to the economy, during the first few months of this financial year. Take a look at Figure 1.

Fiscal deficit

What does Figure 1 tell us? It tells that between April and July 2017 of the current financial year, the government has already touched 92.4 percent of the fiscal deficit target that it had set at the beginning of the year. As is obvious from Figure 1, this is way beyond what usually happens. Now take a look at Figure 2. It plots the proportion of government expenditure carried out during the period April to July (the first four months of the financial year) against the total expenditure achieved/planned for the financial year. Figure 2: Govt expenditure

What does Figure 2 tell us? It tells us that during a normal year, the government spends around one-third of the total expenditure during the first four months of the year. And this is a logical thing to do, given that four months constitute one-third of a year. This time around, the government expenditure during the first four months of the year is at 37.7 percent of the total expenditure that the government plans to incur during the year.

What Figure 1 and Figure 2 tells us is that the fiscal stimulus is already on. If the government continues to spend at the same rate as it is currently, it will end up spending 13 percent more than it had planned at the beginning of the financial year. This will push up the budgeted fiscal deficit by around 51 percent (assuming government revenues remain the same).

This will push up the fiscal deficit to 4.9 percent of the gross domestic product (GDP) against the set target of 3.2 percent of the GDP. Now what the government needs to decide is whether it should continue spending money at the rate that it currently is.

Also, what this means is that people who are now asking for the government to unleash a fiscal stimulus, probably do not know, that a stimulus is already on. In fact, the government spending more than the usual, helped the GDP grow by 5.7 percent during the period April to June 2017. In fact, if we leave out the government expenditure from the GDP, the non-government part, which constitutes close to 90 percent of the GDP, grew by just 4.3 percent. Hence, the impact of the fiscal stimulus is clearly there to see.

The trouble is that most fiscal stimuli flatter to deceive. It does help in pushing up economic growth initially, but ends up creating more problems, which the economy has to tackle in the years to come.

India’s last experience with a fiscal stimulus was disastrous. It was unleashed in 2008-2009. It propped up economic growth for a couple of years. But it also led to high inflation and high interest rates. It also led to banks going easy on lending and in the process ended up creating a massive amount of bad loans, which the system is still trying to come out from.

Also, it is worth remembering that the state governments run fiscal deficits as well. During 2016-2017, the combined fiscal deficit of the central government as well as the state governments had stood at 6.5 percent of the GDP, down from 7.5 percent, in 2015-2016.

During this financial year many state governments are expected to run higher fiscal deficits because they have waived off farmer loans. With the central government also spending more, the combined fiscal deficit will cross the 7 percent level and that is not a good thing. People in decision-making should remember these points raised above.

The trouble is politicians like to look up to the next election. And the fiscal stimulus that has been unleashed now is likely to keep perking up economic growth over the next year or two and this will help the incumbent government in the next elections. Having said that, as I mentioned earlier, it creates other problems in the time to come.

Also, it needs to be clarified here, that Keynes wasn’t an advocate of a government running high budget deficits all the time. Keynes believed that, on an average, the government budget should be balanced. This meant that during years of prosperity, governments should run budget surpluses. But when the environment is recessionary, governments should spend more than what they earn, even running budget deficits.

But over the decades, politicians have only taken one part of Keynes’ argument and run with it. The idea of running deficits during bad times became permanently etched in their minds. However, they forgot that Keynes had also wanted them to run surpluses during good times.

To conclude, other than the government spending more, Keynes also talked about lowering taxes. Why doesn’t the government try and lower the GST rates to start with?

(Vivek Kaul is the author of India’s Big Government—The Intrusive State and How It is Hurting Us.)

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Updated Date: Sep 23, 2017 11:26:28 IST