The Budget Session of Parliament concluded earlier this week. While it was disrupted as on many earlier occasions, the Finance Bill was at least discussed in both Houses. Union Finance Minister P. Chidambaram, in fact, made several changes in the bill, responding to the discussions in the Lok Sabha, most of them with an anti-inflationary bias. Some sceptics even remarked that it was a mini-budget, but government must have the flexibility to change policies when needed. From the time the budget was introduced in late February to the present time, the domestic pre-occupation has changed from growth to inflation, from energy security to food security. This has echoed global concerns as well, although sub-prime mortgage, financial uncertainties and the contagion effect of a US slowdown occupies centrestage. Chidambaram conceded that Budget 2008 was expansionary, given the general thrust in providing breaks to small and middle-class earners, higher threshold of tax exemptions, and large increases in public outlays. If this is designed to be contra-cyclical, fearing impact of a global slowdown and based on pre-election compulsions, it may be understandable. Nonetheless, if inflation and demand management is the short-term goal, its appropriateness remains debatable. In the medium term, there is merit in nudging the economy away from an increasingly consumption-led growth to an investment-propelled growth. This is good for fiscal management, sustaining higher growth and making it more inclusive. The centerpiece of the Finance Bill are the revenue and the expenditure components. Let me comment on the revenue budget. Tax reforms, beginning in the early 1990s and accelerating during the latter part of the decade, have concentrated in moderating rates. Personal income tax has just three slabs of 10, 20 and 30 per cent, and combining it with an improved tracking system has resulted in better compliance. Similarly with corporate tax, rates were moderated even though they remain somewhat misaligned with global averages. With customs duty, peak rates are well on their way to replicating average Asian rates. Central excise has achieved high convergence through CENVAT and a road map has been articulated for a general tax on goods and services. In short, high revenue buoyancy is the outcome of moderate rates, keeping them stable, improving information network and bench-marking with best practice. On the revenue side, the finance minister must also take credit that the overall tax-GDP ratio has increased from less than double-digits to over 18 per cent for the Centre and the states as a whole. For the Centre alone, the tax-GDP ratio is 12.6 per cent, having crept up significantly. What is equally positive is that direct tax-to-GDP ratio has increased significantly thanks to improved administration and some kind of a ‘Laffer curve effect’ in which stable moderate tax rates create virtuous circles of growth and buoyancy. On direct taxes, the forward path needs to include the following: • The all-inclusive applied corporate tax rate is 33.43 per cent but the realised rate is just 20.68 per cent. In the receipts, the budget depicts a wide variation in the realised rate from different sectors, from, say, the very low of six per cent for the software sector, to multiple other rates. • Far too many exemptions still exist. The way forward is to align the realised rate with applied rate by phasing out the distortionary exemptions. This will also enable corporate rates to be reduced. • Talking of exemptions, we cannot overlook the SEZs, a subject that has been discussed repeatedly. China, which is mentioned as an example, has only six or seven SEZs. All of them are owned by the states, which develops the infrastructure and then parcels them to private investors. In contrast, we have over 500 SEZs creating a tax haven of unimaginable proportions. A huge hole in anticipated revenue stream! We need to rethink on how to optimise the externalities from such SEZs which can generate employment, create world-class infrastructure, remain competitive and at fiscal costs which are still affordable. • Taxation of financial intermediaries needs to be revisited. These costs are reflected in the real world by raising the cost of capital which hurt investment. • Further, the issue of an appropriate tax regime for savings also needs to be resolved. • On indirect taxes, the overall share has come down. Nonetheless, dependence on indirect taxes remains excessive in comparison with international norms. The excessive dependence on the petroleum sector needs significant rationalisation. We have also departed from the earlier practice by creating too many ad hoc rates on excise and customs to meet short-term exigencies. We need to seek their convergence and minimise divergences within a narrow band. The stability of these rates, analogous with what we have done for direct taxes, has long-term benefits. Of course, on indirect tax, our rectitude in implementing the roadmap on GST will be decisive. We still have a long way before completing the tax reforms. These comments are relevant for Budget 2009. Continuity is an abiding concern irrespective of who presents the next budget.
