Disappointingly, no substantive tax reform

One knew disinvestments would be low on the priority list and even Rs 4,000 crore is a pleasant surprise, assuming it materialises. One knew about the proposed 2 per cent cess on education, although one was unclear about what taxes it would cover. But whether Mr Chidambaram of 2004-05 would be closer to 1996-97 or 1997-98 was fundamentally a function of tax reform, the Part B.

Tax reform is contingent on removing exemptions, among other things. There was a sense that we weren’t ready for substantive tax reform in 2004-05, what with the partial VAT also having been pushed back to April 2005. However, The Economic Survey had pushed hard on tax reform.

The Budget speech has 29 pages and Part A takes account of 20. And the time distribution, in delivering the Budget speech, is even more biased towards Part A. That just about sums up the Budget. If you are looking for the 1997-98 vintage, you will find traces of it in Part A. As for Part B, it is all 1996-97 vintage. We will have to wait for 1997-98 Part B vintage till 2005-06.

Here is my listing of what I consider 1997-98 vintage. First, sectoral FDI equity caps have increased for telecom, civil aviation and insurance and the FIPB will be junked, with whatever is allowed, on automatic approval. The Investment Commission is a good idea, if it ensures higher conversion ratios for both domestic and foreign investments and doesn’t become another licensing authority. However, like the CMP, the Budget has too many Commissions and assorted bodies.

Second, 85 SSI items have been dereserved.

Third, there is some attempt to target subsidies better, although this is only a statement of intent on pilot basis and is restricted to PDS. But if it works, it can be extended to other subsidised delivery and is also linked to the Planning Commission’s review of centrally sponsored schemes and consequent decentralisation. In several parts of the Budget speech, there is also an attempt to target backward districts.

Fourth, there is adherence to the Fiscal Responsibility and Budget Management (FRBM) Act, notified on July 5 and sanctified through a medium-term fiscal policy statement, a fiscal policy strategy statement and a macroeconomic framework statement. FRBM requires elimination of the revenue deficit by 2007-08, now 2008-09. According to RE, the revenue deficit/GDP ratio is 3.6 per cent in 2003-04. To reach the 2008-09 target, one needs an average reduction of 0.72 per cent a year. However, The Economic Survey argued that with the economy in good shape, why not frontload the reduction? And indeed, the BE for 2004-05 has a revenue deficit/GDP ratio of 2.5 per cent and a fiscal deficit/GDP ratio of 4.4 per cent. But these reductions are not very believable, because they ride on a nominal GDP growth rate of 13.5 per cent and a tax revenue (net to Centre) growth of 24.7 per cent. There is thus a gamble on growth and revenue, perhaps more than is warranted. 2004-05 doesn’t benefit from the low base that 2003-4 benefited from.

Fifth, fiscal rehabilitation also concerns the States and the interest rate on loans to States has dropped to 9 per cent. It should probably be lower.

But on the flip side, there is plenty in the Budget that is 1996-97 vintage. First, going much beyond the go-slow on disinvestments, the entire restructuring package for the public sector.

Second, existing interest rates on small savings, with 9 per cent for senior citizens, although that was perhaps inevitable. Third, the exemption removal, such as for non-residents, is cosmetic. But we have a fresh round of exemptions. At this rate, the main plank of the two Kelkar Task Force recommendations will fast disappear.

Fourth, increased discretion in excise and customs duties, more so for excise than customs. We ought to be moving towards harmonisation and unification, not discretion.

Fifth, the hike in the service sector taxation rate to 10 per cent is also discretionary. Assuming input credit, the service sector rate has to be identical to the goods rate. The revenue neutral VAT rate is described as 12.5 per cent, although it is probably higher. Perhaps closer to the Cenvat rate of 16 per cent. With input credit, that should be the service sector rate also. Without it, the rate should be lower. The point is not that the service sector shouldn’t pay taxes, but that there should be some logical method of deciding the rate, over and above the issue of extending taxation to more sectors. Otherwise, the hike is arbitrary.

Sixth, I don’t like the turnover tax in the capital market, because it is not a tax on income and because it discriminates across asset markets.

Hence, half-empty and half-full, depending on your point of view. Not a dream, but not a nightmare.

The writer is Director, Rajiv Gandhi Institute for Contemporary Studies