In October 2019, the government made a large supply-side correction by reducing corporate tax rates. By setting the rate at 15 per cent for new manufacturing companies, expectations for more reforms have gone up. The general thrust of these expectations include personal income tax (PIT) rate reduction, removal of dividend distribution tax (DDT), improving the investment climate and measures to boost declining aggregate consumption.
The budget is a balancing act — between expenditure and revenues of the government, with an eagle eye on the fiscal deficit. Any rate reduction in PIT or tax expenditure would increase the fiscal deficit burden. So, what are the options?
Presently, PIT rates are 5 per cent, 20 per cent and 30 per cent for different income brackets. In effect, there is no tax for individuals having income up to Rs 5 lakh per annum, considering the rebate they enjoy. The gap between 5 per cent and 20 per cent is too large, and affects tax progressivity. In order to address this disparity, it could insert tax rates in between for better progressivity. Increasing the tax threshold limit will definitely be required, just to pare it with inflation.
If the government decides to scrap DDT from the corporate side and bring it on to the personal income tax side, ( to be taxed in the hands of the recipient), there is a good chance that it will be revenue-neutral. Boosting savings and channelising them for asset creation is good economics, and certainly good politics. India has seen significant reduction over time in the savings ratio (with respect to GDP). The government may use the occasion to increase the Section 80C exemption limit by some amount.
Private investment in housing requires urgent attention. The government may think of increasing the tax rebate limit on housing loan interest for self-occupied properties. At present this is Rs 2 lakh. A back-of-the-envelope calculation shows that this gives a loan of Rs 25 lakh only. That is low for metro and tier-2 cities. People consequently have to mobilise their own savings to buy property. Increasing the rebate to a reasonable level will also boost the credit market. Undoubtedly, this will entail some revenue foregone but the real estate market recovery will have a positive impact on the economy. In the US, revenue foregone on this rebate is more than 1.5 per cent of GDP. Ours is much less.
The government may also bring measures to improve infrastructure financing. Globally, there are many infra funds with an investable surplus. A change in tax laws could also be on the agenda of the FM. That would bring us at par with some Asia-Pacific countries. Current capital gains tax laws are complicated and have multiple rates and multiple nuanced provisions — their rationalisation is one clear ask.
Low productivity growth holds back real wage growth. It also brings concerns about equity, and it is important that improving productivity is given due attention. In this budget, the government should bring in measures to improve productivity. No doubt, this will require some fiscal incentives. India’s revenue foregone is at 6 per cent of the GDP. The US, the UK and Canada have far more. If productivity has to be given attention, the deductions have to be far more targeted and some of the other items that are otherwise occupying the books, need to be weaned out. In India, a large part of the revenue foregone for corporate tax is for accelerated depreciation, deduction for export units located in SEZs, and undertakings engaged in generation, transmission and distribution of power, and a small part for expenditure on scientific research. Rationalising and removing some of this would be on the cards.
It is also expected that with reduction in the PIT rate, the government will make efforts to widen and deepen the tax base using data analytics.
An effective dispute resolution mechanism seems to be the need of the hour. An alternate dispute resolution mechanism can help in de-clogging the choked appellate channels and promote better compliance. This will help companies improve their balance sheets and their bankability.
All these reforms or changes would, finally, need fine fiscal balancing.
This article first appeared in the print edition on January 30, 2020 under the title “The Budget tightrope.” The writer is senior director with Deloitte India.
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