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S. Balakrishnan

A NARROW tax base and poor tax compliance have long been the bane of successive Indian Finance Ministers.

The 90s saw a qualitative shift from the earlier ideology of progressive and rising rates of taxation, based on the creed of President Reagan in the US, Prime Minister Thatcher of the UK, popularly labelled "supply side" economics.

Reducing taxes was all about increasing incentives - the incentive to work and produce more - it was argued. Also, at lower tax rates, there would be less income concealment and tax avoidance. Growth would get a boost and the Government would earn more, even with taxes reduced. A win-win situation for everyone.

Has it happened? Is the famous Laffer Curve of the Reagan years, positing a negative correlation between taxation and the growth rate, working? The evidence in support is, on the whole, very fragile. When Mr Reagan was President, the US fiscal deficit scaled new heights. It was only during the Clinton presidency that the Budget moved into the black. But tax rates then were, in fact, higher than they are now, after the Bush tax cuts. The credit for turning deficit into surplus should mostly go to the strong economy of the late nineties, not to supply side economics. (Now that taxes have been cut, the US Budget is back in the red).

The new Finance Minister crashed tax rates in his first stint and Budget in the belief that supply side economics was the medicine necessary to shake the economy out of its stupor. Unfortunately, the timing was wrong. Indian industry was going through a wrenching downturn after the economy was opened up, made worse by the decline in public investment. Naturally, tax receipts fell and the deficit increased.

It was given to the previous Government to reap the fiscal fruits of the economic revival of the last couple of years. Tax collections improved dramatically on the back of the strong economy. Disinvestment receipts further improved the cash flows of Government.

The lesson? Better for the Finance Minister to hope and pray for a high rate of growth, which will, on its own, generate more tax revenues. Stop thinking of reduced tax rates as an engine of growth for the reason that exogenous factors such as the monsoon, demand, global economy, interest rates and the stock market are far more important. In India, it also is (and will be) Government spending on infrastructure and new projects, which will catalyse and move growth to a higher plateau.

Happily, this Budget places more emphasis on the role of Government in the neglected sectors of the economy and social services.

It has not shied away from taxing for targeted social spending, as, for example, the education cess.

A healthy recognition of the fact that tax reduction is no automatic growth driver.

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