Good,bad revenue

The first budget of UPA-II will be presented on July 6,and Finance Minister Pranab Mukherjee will have to walk a tightrope when it comes to the decision between increasing expenditure and reducing it. Cutting taxes may be desirable from the point of view of pushing demand but not if he worries about the deficit. One thing he can do,and where there is broad consensus,is to remove bad taxes. The basic intuition of economists guides a concept of bad taxes. A bad tax is a tax which should just not exist.

An example is a tax on the revenues of a business. In a modern economy,production is broken up into a network of firms,each of which buys Rs 100 of raw materials,adds value of Rs 10,and sells finished goods for Rs 110. If each stage of production is taxed then this yields a very high burden of cascading taxation. This also generates an incentive for companies to do excessive vertical integration,which is detrimental to productivity and focus. The sensible thing in the modern economy is for each company to identify its areas of core competence,and outsource or contract out the production of everything else. This is enabled and supported by removing taxation of revenues,and shifting to taxing the value added. Anything that aids the growth and development of Indias companies is particularly useful in a downturn-hit period. That is why the fringe benefit tax must also go. The FBT has done little for revenue,but is,in a word,messy. It has caused the burden of paperwork on individual companies to greatly increase something that disproportionately hits small and medium enterprises,which might well serve as the engine of Indian growth and recovery. Any attempt to rationalise the tax system must start with the FBT.

The third major source of bad taxes can be customs. Integration with the world economy is central to Indias growth strategy. When India shut itself off from the world economy,it stagnated. When India opened up to the world,this brought competition and new ideas,and the country progressed. Every interference with Indias economic integration is inconsistent with Indias quest for high GDP growth. Customs duties reduce competition in India,and hold back the flow of new ideas into the economy. Customs duties,thus,must be levied judiciously.