We need tax reforms to support India’s expenditure path

livemint.com:

The dust from a heated election campaign has now settled down. A new government has been sworn in. The Union finance ministry led by Nirmala Sitharaman is busy preparing the full budget for the current financial year.

It is a good time to take a look at the way ahead for Indian fiscal policy over the next five years. A lot of attention is lavished on the bottom-line of annual government budgets, aka the fiscal deficit. That is understandable.

The fiscal deficit influences a range of current economic variables, from aggregate demand to interest rates, which in turn has important implications for companies, home buyers, job seekers, bond traders and many other economic agents. However, the overarching goal of fiscal policy over the medium term is to stabilize the ratio of public debt to gross domestic product (GDP), to help achieve rapid economic expansion with macroeconomic stability. The pandemic shock led to a massive increase in public debt in all major economies, as tax collections fell sharply even as governments spent money to prevent a total economic collapse.

India was no exception. The ratio of public debt to GDP shot up by more than 13 percentage points in one year, which itself came on the heels of a gradual increase over the second decade of this century. Since then, this key fiscal ratio has come down gradually from 88.4% in fiscal year 2020-21 to 82.2% in 2023-24.

The International Monetary Fund expects the public debt ratio to fall to 77.5% in 2029, very near its pre-pandemic level, but still higher than what fiscal economists believe is ideal for India. The fall in the public debt ratio was because of underlying debt dynamics. First, nominal GDP growth was well above the rate of interest that the