Household savings and tax collection decline, new instruments needed to fund the recovery

India’s Tax: GDP ratio is low, household savings are declining and Pension and PF funds cover a small percentage of the privileged. Out-of-the-box solutions to boost taxes and savings are needed

Representative Image
Representative Image

Abhimanyu Girotra

Economist Milton Friedman had once quipped, “If you put the federal government in charge of the Sahara Desert, in five years there’d be a shortage of sand”. As we unlock and hope for an ‘Atma Nirbhar’ India - which requires heavy capital investment - Government’s financial predicament is not much different.

Governments have two sources of funding: one through its revenue streams like taxes and second, through borrowings - predominantly household and small savings made available via financial institutions like pension, housing, provident & insurance funds. For India, both sources of these funds have unfortunately been in the doldrums long before the pandemic hit us.

On the revenue side, India’s tax-GDP ratio of around 17% is half the average of OECD countries (35%) and is low even when compared to other emerging economies like Brazil (34%), South Africa (27%) and China (22 %).

Government’s primary borrowing source -household savings - is also on a declining trend, clocking 7% in recent years vs 12% of the GDP in 2007-08. This is deeply worrying as Indian economic growth has largely been financed by domestic savings. To add to the Government’s woes, Indians have never preferred a lot of financial savings (only 5% of household assets in financial savings vs 77% in real estate) but the decline is worrying even as India shies away from foreign funding due to inherent risks.

Given this, it is important to understand why Indians’ trust in financial savings is deteriorating. For households, this is largely due to performance of banks and NBFCs which has dented the traditional confidence. This can be seen to be in play now also: At the hour of crisis the currency-in-circulation has touched an all-time high of 12% of GDP.

To start with, the banks definitely need to come across as more credible but a policy thrust is also needed to promote savings schemes like provident and pension funds and insurance products to the common man.

It can be argued that India has all of these but the fact of the matter is, India is largely an informal economy and there is really no social security - like a provident fund - for 90% of the workforce and pensions are available to only the privileged few. Pension funds’ assets as a percent to GDP are 1% for India while 95% for the UK.

Jan Dhan Yojana has enabled financial inclusion however more needs to be done. There is a pressing need for the provision of a savings vehicle that can provide a positive real rate of return with some degree of assurance and should be so simple and easy to understand that even a migrant worker should be able to apply for it. Can you think of such a savings vehicle? Needless to say, this is predicated on the maintenance of low inflation in the country on a sustained basis, so that the invested money does not lose its value.

To enable this, the Government’s role becomes critical as weak public finances contribute to inflation, rendering household savings useless and pushing interest rates upwards which impedes investment activity. In the past the government’s borrowing has consumed all of household financial savings and the private corporate sector has to finance itself from its own retained earnings, thereby pushing up their cost of financing and deteriorating their international competitiveness.

To correct this, the Government’s borrowing should start to exclusively focus on creating infrastructure which enables supply like housing, rural infrastructure, efficient supply chain, refrigeration facilities etc.

Borrowings done for subsidising water bills, providing free metro rides etc. get votes but they also lead to price escalation of scarce commodities - making both citizens and the Government poorer! One subsidy reform area could be that any addition of a new subsidy must be accompanied by the elimination of two existing ones. If followed, the total public capital outlay on desirable projects can increase manifold.

The Government should also enable alternative (to banks) sources of credit for India’s ‘Atma Nirbhar’ investment needs. A liquid bond market can efficiently channel intermediate savings into investments. However, India’s bond market is characterised by low Government participation which demotivates scaling up of the corporate bond market as former is needed by the latter for benchmarking. Enabling foreign participation in corporate bonds can also provide much needed liquidity.

‘Atma Nirbhar’ or self-reliant India is a great shibboleth. But putting this into practice will require much greater discipline and Government needs to ensure its spending habits are not self-defeating and erode public confidence which funds it.

(The author is a management graduate from IIM Calcutta and a freelance writer. Views expressed are personal)

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