Financial Daily from THE HINDU group of publications
Thursday, Feb 03, 2005
No dream Budget, just a credible one please
At the base of the preparatory work on the Budget for 2005-06 is the issue of not meeting the budgeted fiscal deficit for 2004-05. And there are a number of areas where pressures on expenditure are going to be strong. The Budget has to take into consideration the recommendations of the Rangarajan-led Finance Commission and the promise the Centre has made to State governments that it would take the financial burden that might devolve on them while implementing the value-added tax (VAT) from April 1. In addition, Ministries, especially those under the coalition partners whose performance is perceived to be weak and unimpressive, would make exaggerated demands for grants to gain political advantage by citing serious budget constraints for their lacklustre performance. Besides, there would be (a) a trended growth in expenditures on some of the subsidies (food and fertilisers, for example), and (b) heightened demands for expenditures for fulfilling the obligations relating to the common minimum programme.
The Finance Minister has to find enough revenues to meet the likely huge growth in expenditure in the next fiscal. Here the story so far has not been good. The percentage of gross tax receipts to GDP has not touched the double-digit figure ever since 1992-93. The budgeted ratio for 2004-05 placed at over 10 per cent may not materialise, notwithstanding the fact that nominal GDP for the year is likely to exceed the GDP assumed at the time of the presentation of the Budget. There could, however, be a lagged effect but it may not by itself affect the numbers under tax receipts in the Budget for 2005-06.
In the event, the Finance Minister would have to raise resources through non-tax revenue sources or/and capital receipts. The familiar route for the Finance Ministers of the recent past has been to divest shares of identified public sector enterprises without losing management control. The decision now is to create a National Investment Fund out of such divestment to invest in social sector projects and to revive some of the public enterprises. The creation of the Fund raises more questions than answers: The Fund managers need to be overseen and the volatility of receipts reduced. In case the Fund is delinked from the Budget, the credibility of the Government as the main driver of social sector development would be at stake. However good the guidelines for the Fund managers are, the Fund managers cannot avoid problems of adverse selection and moral hazard.
Disinvestment of any variety can hardly be a part of good public finance policy in the present context. It is essential to improve tax collections by reorienting the tax structure and widening the tax base. The public debate on the tax structure has largely been on issues of rates, exemptions, and incentives. On the direct tax rate structure, there has been some unanimity of opinion in favour of fewer tax slabs and the peak rate at the international benchmark. Regarding exemptions and incentives, many favour their elimination on the theoretical proposition that they distort and misallocate resources.
At a practical level, however, it could be argued that there is no reason why one should be so rigid about eschewing all exemptions and incentives. After all, we have (a) wide income inequalities, (b) high unemployment such that the number of dependents per taxable person is high, and (c) a known tendency to exploit the incentives offered by the lax judicial and tax administration systems to be non-compliant, ostensibly to meet the high costs of living of many households, especially on account of consumption of such services as quality education and medicare.
On corporate taxation, it is best to resist pressures to reduce the rate below the present 35 per cent, particularly in view of the increase in the instances of corporate mis-governance. For the same reason, exemptions currently in place for some types of incomes and corporate sectors should be eliminated.
Regarding the personal income-tax, the present exemption limit of Rs 50,000 does not make sense and it is best to raise it to Rs 1 lakh. Equity and compliance requirements apart, one needs to consider the current inflation environment and the high cost of commonly consumed services.
Against this context, one could consider taxing incomes in the range of Rs 1-3 lakh at 10 per cent; Rs 3-5 lakh at 20 per cent; Rs 5-10 lakh at 30 per cent; and Rs 10 lakh and above at 35 per cent. No surcharges or special cesses should be levied over these rates.
In addition, subject to a specified amount, individual and business contributions for public goods and causes apart from floods and natural calamities building of public toilets, and toilets in primary and secondary schools and hospitals, public parks, and public libraries could be exempted from taxation. Also, some carefully orchestrated partial exemptions on the interest income on bonds floated for specified infrastructure development and of business contributions for watershed development for augmenting agricultural output potential could be considered.
On VAT, it is too early to say whether it would be revenue enhancing. However, for the sake of effectiveness and simplicity, it is important to reduce the number of central rates to a uniform one of, say, 16 per cent as also the number of commodities exempted from VAT imposition.
It is time to reduce the peak custom tariff rate in order to constrain any latent inflationary pressures and to relax supply bottlenecks. It could be done, if necessary, in two stages from 20 per cent to 17.5 per cent in 2005-06 and to 15 per cent in the subsequent year.
Given the large increase in fees in private schools and colleges, and the rush for admissions into such institutions, there is no reason why there would be resistance to some (moderate) increase in fees in public schools, colleges and universities. Other user charges could also be raised in small, measured dosages without inviting much resistance.
The mood of coalition politics is in favour of simple living. Why not then increase the tax rates on perceived conspicuous consumption such as entertainment that takes the garb of large events, ostentatious marriages, boutiques, fashion shows, and trading in gold and silver including ornaments?
The large houses and the large surrounding spaces allotted to bureaucrats, and the people's representatives in New Delhi are not in good taste.
Some land space could be released out of these public properties and auctioned out to raise resources. This measure would perhaps be highly credible.
(The author, a former Executive Director of the Reserve Bank of India in charge of research, can be contacted on email@example.com)
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