The Hindu Business Line : Budget blues and uncertainties

The Finance Minister can surely claim he has been doing something right, judging by the way the economy is growing and the market is booming. He should not, by a misstep in the Budget, squander that success. The goals of the NCMP can be met only if the economy is robust and taxes continue to pour in at a healthy pace. Mr Chidambaram must ensure that the Left is on board to enforce compliance with tax laws as much as it is keen to follow up on the NCMP agenda, says S. Venkitaramanan.

AMID the euphoria over Sensex hitting 10,000, there is a fear among market participants that February 28 may shatter the pleasant illusions of investors. The Finance Minister, Mr P. Chidambaram, has a difficult task on his hands, made trickier by the conflicting pieces of advice offered to him.

It takes a practised politician to act the patient listener to the mass of petitions and suggestions that crowd his corner office in North Block. There was a time, in the 1980s, when Mr V. P. Singh used to computerise all such suggestions, but with very little impact on his Budget-making. Mr Chidambaram obviously has his share of friendly fire from Cabinet colleagues, who think nothing of asking for the moon. It is Budget time, and who is to bother where the money is to come from. It is the Finance Minister's lookout.

Part of the national scene is the tamasha created by the coalition partners, who seem bent on upsetting the UPA applecart. They are against easier ways of raising money, such as privatisation of profit-making PSUs.

It is perhaps a godsend that they objected to the divestment of BHEL, even keeping a majority stake in government's hands. Today, the BHEL share has gone up to Rs 1,800. Had Mr Chidambaram succeeded in convincing the Left of the need to divest, the Government would have been looking at the lucky investors who took up the offer sitting on a nest-egg of profit.

But that is all in the game and it is no argument against divestment that the shares divested may go up in value after divestiture. The Government is not responsible for subsequent gyrations in the value of the share once it is sold.

Having dismissed the comparatively painless route of privatisation, the Left experts have suggested a variety of additional taxation measures, which amount to "soaking" the rich. It is their privilege to suggest such measures. But it is not their responsibility to implement them.

One of the suggestions made by Left economists is to tinker with the structure of capital gains taxation. The merit of the present structure is that it acts as an incentive to stock market investors who hold equity for the longer term.

Even if the capital gains tax were to be reintroduced in all its rigour, there will be avenues of avoidance through infrastructure bonds and the like. The net accretion of revenue from capital gains tax cannot be very large, given that those who make such gains on a taxable basis can invest the proceeds in bonds specifically designed to reduce tax liability. The Mauritius route may also be available to the FIIs who make capital gains.

Capital gains tax re-imposition in all its manifold dimensions, without any allowance for relief, would be counter to the general government policy, which favours investment in the stock market with all that the policy implies. Those who buy stocks do so to make profits, and a favourable tax treatment of such profits is a necessary incentive for large capital inflows into the market, on which our BoP depends.

The Finance Minister, in one of his earlier avatars, had introduced a fairly radical departure from the existing canons of taxation by abolishing tax on dividends, although he tried to compensate for the loss of income therefrom by a dividend substitution tax. That helped remove the patent anomaly of double taxation of corporate incomes, once in the hands of corporate and again in the hands of the shareholder.

Thus, he simplified the operations of the Tax Department, which had otherwise to collect taxes on dividends received by millions of shareholders. This is one reform on which we were ahead of the US, which has not yet fully implemented its reform on dividend taxation.

There are many well-meaning reform artists hovering around the North Block. Some of their ideas, such as the Fringe Benefit Tax (FBT) and the Cash Transaction Tax, have been instances of much ado with little gain. The FBT brings in a relatively small turnover of Rs 1,000 crore a year. But it causes much avoidable pain. It keeps the honest tax-payer awake at night lest the taxman knock at his door for failing to keep the fringes clear of unintended violation.

The Finance Minister owes the country an explanation whether the effort has been worth the pains and whether the outcome has served to rationalise the expenditure of corporates, which was its ostensible purpose.

There is one pending issue that has caused concern to many senior citizens and savers. I refer to the taxation of small savings, including public provident funds. The Finance Minister had referred earlier to the appointment of a Committee of experts to look into the different alternative options, variously called as the Exempt Exempt Tax or Exempt Tax Exempt, referring to the stages at which savings and incomes from them are to be exempted or taxed.

The Vijay Kelkar Task Force on FRBM had made fairly drastic recommendations on the subject, but had taken care to introduce what it called "grandfathering". That is, if the savings had been made under certain tax provisions, they would continue to carry forward their privileged position in spite of any changes.

I do hope Mr Chidambaram's reforming zeal does not go too far, in the sense that even those who had invested in PPF or National Savings at a time when the tax provisions favoured them do not have to forfeit their concession after the forthcoming Budget. This is a legitimate fear because, in spite of a general feeling against retrospective amendment, some experts have advised that the tax exemptions make savings like PPF too costly to the Government in terms of interest paid plus tax concessions.

It is appropriate in this context to refer to the relative contribution made by National Small Savings to financing the public exchequer. The receipts budget of 2005-06, presented by Mr Chidambaram in February 2005, discloses that the national savings was estimated to contribute during 2005-06 a sum of Rs 33,000 crore to the Central Government and Rs 90,000 crore to State government securities. This compares well with the total of market loans raised by the Government during the same period, amounting to Rs 100,000 crore. State Government loans are additional to this.

The contribution of small savings to sustaining the fiscal gap of the Centre and the States is thus not to be sneezed at. Tax-adjusted savings schemes are quite common in many countries. I do not think the search for ideological purity should lead to abolition of tax concessions on small savings. In any event, savers do deserve to be "grandfathered".

The trend of tax collections in the economy has been quite robust. The Finance Minister can surely claim that he has been doing something right, judging by the way the economy is growing and the market is booming. He should not, by a misstep in the Budget, squander that success.

True, he has to meet the goals of the NCMP, including the burden of the National Rural Employment Guarantee Programme and the Health Insurance Scheme. But all that can be done only if the economy is robust and taxes continue to pour in at a healthy pace. He has to ensure that the Left is on board to enforce compliance with tax laws as much as it is keen to bolster follow-up of the letter and spirit of the NCMP.

Stability of tax regime is an important factor in inducing private investments to grow in an economy. Too much tinkering with the basics of the income taxation and indirect taxation can cause great harm to the investment climate, which can impact the growth of the economy.

To Mr Chidambaram, these are familiar pieces of exhortation. The reformer in him twitches to rewrite the tax code every year. But there is a high cost to too frequent reform. The climate for private investment, both domestic and foreign, requires a stability of tax regimes. I do hope Mr Chidambaram heeds this lesson from past reformers' fiascos and does not experiment too rashly with the fiscal regime to please his radical critics, both on the Left and the Right.

Death and taxes are certainties. But the certainty of the tax system is a principle of great importance. May the Budget of 2006-07 herald an era of fiscal stability and economic growth!