Tangled web of tax policies

The Union Budget presented last week has received generally positive reviews. The financial markets have been rather exuberant. All three markets, namely the stock market, bonds and currency have gone up steeply. This is like a twenty-one gun salute to the budget proposals, and the Finance Minister is surely mighty pleased. Such a triple bounce has rarely happened after any Union Budget.

The only major point of discord seems to be the controversy about the taxation of Employee Provident Fund (EPF) withdrawals. It will probably fade away, with an amicable compromise, if not an outright rollback. The reason all three markets were happy, was mainly because of the strong message of fiscal prudence.

Last year the FM had targeted a fiscal deficit of 3.9% of GDP for this year, with a subsequent reduction to 3.5% in the second year and 3% thereafter. He kept both the promises, i.e. achieved 3.9% (itself rather remarkable) and maintained the target of 3.5% for the next year.

No point quibbling about the fact that much of the credit for achieving 3.9% goes to fall in international oil prices, and not any special belt tightening in the North Block. The FM is still owed some kudos, for deftly managing oil subsidy savings, and splitting it between consumers, oil companies and the national treasury. A less disciplined FM might have succumbed to the temptation of populist measures or some other spendthrift tendency.

Thanks to his message of fiscal restraint, this now opens up the possibility of an aggressive rate cut by the Reserve Bank of India, leading to enthusiastic inflow of dollars, causing the currency to stabilize or even strengthen, leading to lower inflation and thus making even more rate cuts a possibility. This virtuous cycle was let loose by the FM’s signal of fiscal prudence.

A less disciplined FM might have succumbed to the temptation of populist measures or some other spendthrift tendency. Thanks to his message of fiscal restraint, this now opens up the possibility of an aggressive rate cut by the Reserve Bank of India, leading to enthusiastic inflow of dollars, causing the currency to stabilize or even strengthen, leading to lower inflation and thus making even more rate cuts a possibility.

The Union Budget along with the Medium Term Fiscal Statement (tabled earlier in Parliament) tells us about the tax policy of the government. Ever since the reports of tax reform committees chaired by Vijay Kelkar were put out, the attempt has been to have a tax system that is simple, with lower tax rates and few exemptions. Despite these noble objectives, India’s current tax code is still filled with inconsistencies, loopholes and inefficiency. No wonder that tax attorneys are kept busy all the time. The holy grail articulated by Kelkar committees is still far away, and even the implementation of the Goods and Services Tax is not likely to iron out the infelicities.

Here are three examples. First example is about indirect tax burden. Since the early 1990’s India has moved steadily to increase the share of direct taxes in total tax collection. Direct taxes are taxes on income, wealth, capital gains and inheritance. Indirect tax examples are excise, customs, service tax, octroi etc. The ratio of direct to indirect is about 35 to 65 today. Direct taxes are more efficient and fair. Indirect taxes are unfair, since their relative burden is higher on the poor as compared to non-poor. Of course it is possible that indirect taxes are “easier to administer” and maybe less prone to corruption. But this is an empirical question, and should be tested if really true. India has the lowest tax to GDP ratio as documented in the most recent Economic Survey. It also has the lowest direct tax to GDP ratio, as also lowest share of expenditure on health and education of GDP. In the current Union Budget, the tax proposals are such that direct tax collections will go up by zero percent, and indirect tax collections will go up by nearly Rs 24,000 crore. As a result next year’s tilt will go toward a higher share of indirect taxes, something we have been trying to reverse.

A second example comes from treatment of Special Economic Zones. A manufacturer wishing to setup a plant in an Indian SEZ will find it more attractive to set it up in Thailand instead. That’s because goods manufactured in SEZ in India face a duty barrier of nearly 10 to 15% when trying to sell to rest of India. But goods manufactured in Thailand can come to India at zero duty, thanks to the Free Trade Agreement. Why would then anyone set up a plant here? This is seriously detrimental to the Make in India program, and the tax policy anomaly should be corrected.

The third example is the proliferation of cesses. At least three new cesses have been introduced this year: the Swachh Bharat cess, Krishi Kalyan cess, and the coal cess (renamed as the Clean Environment Cess). Cess revenue accrues only to the centre and not subject to sharing with states, as with all other tax revenues. The cess is indirect taxation and hence adds a disproportionate burden on the poor. It also adds to cost of doing business, and thus adding the “uncompetitiveness” burden. For instance, the cost of mining coal in an open cast mine is about Rs 300 per tonne. But the cess is now Rs 400 per tonne. It was doubled three times in the past four years, and has thus gone up by 800% in just four years. One can imagine the impact it can have on the cost of electricity, since most plants are coal powered. At a time when electricity discoms are struggling with staggering losses, surely the coal cess could have been postponed, or less steep. India has the third largest coal deposits in the world, and will have to depend on cheap (and clean) coal for power in the foreseeable future.

Not environmental, but fiscal compulsions seem to have caused the coal cess to go up so steeply.

These are but three examples to illustrate that even the best laid plans and budget proposals can have anomalies that creep in. The dynamics of democracy, and the push and pull of competing interests, and argumentative Indians can hopefully correct these mistakes, and steer the policy in the right direction.

The author is an economist based in Mumbai.

(Syndicate: The Billion Press)

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