Who will pick up the tab?

On indirect taxes, it is unfortunate that the finance minister chose to move away from the annual cuts in customs duties. He cited appreciation of the rupee as the reason for deviating from the path of cutting customs duties. The move to cut the general CENVAT or excise duty rate from 16 per cent to 14 per cent is welcome. It will help give industry a boost at a time when it could be facing a slowdown. It is also a step in the right direction towards convergence of the CENVAT and the service tax rate, which stands at 12 per cent.

Direct taxes have seen an increase in the threshold exemption limit. No doubt, this will give relief to households facing rising prices and, therefore, falling real income. This is also good economics from the point of view of tax policy, which suggests that tax slabs should be linked to real income, and thus move up when there is inflation. Allowing ‘set off’ of the dividend distribution tax by parent companies for taxes paid by their subsidiaries is a good move. Despite the likelihood of a slowdown and the emphasis on infrastructure, there is no cut in corporate taxes, or even removal of the surcharge. This is unfortunate.

The finance minister has proposed to increase the short-term capital gains tax from 10 per cent to 15 per cent. There was no need to do this. Good tax policy advocates low taxes on capital income. At the very least, if he is proposing to raise the capital gains tax, he should remove the securities transaction tax (STT). Instead he has introduced a commodity transactions tax. Transaction taxes too have a life of their own, and once they start drawing revenue, their rates tend to be raised no matter how distortionary they may be.

Chidambaram noted that the larger expenditure on account of allocations for health, education and the social sector means that the budget would not achieve the target for lower revenue deficit set out by the FRBM (Fiscal Responsibility and Budget Management) Act. The budget estimate for 2008-09 for the fiscal deficit, at 2.5 per cent of GDP, is, however, below the 3 per cent target. But this figure does not include the subsidies given by the Central government to oil companies, the Food Corporation of India and fertiliser companies, for which it borrows separately through bonds. Last year these were estimated to be 1 per cent of GDP. This year they are expected to be higher. So, taking these into account, the fiscal deficit may be around 3.5 per cent of GDP, if not higher. Further, this number does not include the largesse of Rs 60,000 crore to farmers. If this is to be covered by government borrowing, it will put further upward pressure on interest rates. This is not good news for households and industries already facing high interest rates. With prospects of a slowdown in domestic and global demand, it would not be surprising if investment, that engine of growth the government appears to be taking for granted, is affected.

To compensate for the impact the budget is likely to have on interest rates, there should be an urgent and immediate change in monetary policy. Instead of waiting for data on slowdown to come in, or for the next policy announcement, the Reserve Bank of India should step in and cut interest rates before brakes are put on the Indian economy’s current growth momentum.