The Hindu Business Line : Budget leaves tax reform train derailed

Tax concessions and cash subsidies have much in common. They show how the Government favours certain groups or activities. The figures relating to project funding and direct subsidies are widely known and can be scrutinised by the Executive and by Parliament. This cannot be said of tax concessions, which remain comparatively hidden and secure from scrutiny.

The days of big-bang Budgets are over, said the Finance Minister, the other day. But how are Budgets judged? A Budget is, after all, a policy statement of how the government proposes to spend and how it plans to raise revenues. What is the role of the Government in ensuring the well-being of the masses? This is judged by the quality and quantity of public expenditure.

Despite what the Finance Minister has said about the increase in Plan Expenditure, the fact remains that, as the Economic Survey pointed out, as a proportion of GDP it is low by international comparison.

Total expenditure as a percentage of GDP was 15.4 per cent in 2000-01, 15.9 per cent in 2001-02, 16.92 per cent in 2002-03, and 17.1 per cent in 2003-04. Going by the Budget estimates, it has come down to 14.6 per cent in 2005-06. This is nothing to gloat about. The role of the government is shrinking. Without a statement on the outcomes of public expenditure, it is difficult to judge the quality of spending.

The net tax revenue, however, has been going up over the same period, from 8.9 per cent in 2000-01 to 8.2 per cent in 2001-02, 8.8 per cent in 2002-03, 9.2 per cent in 2003-04 and 10.5 per cent in 2005-06. It is projected to cross 11 per cent in 2006-07. Direct taxes, at 5 per cent of GDP, are catching up with indirect taxes, at 5.4 per cent in 2005-06. Very soon, there should be a reversal in the proportion of the two taxes.

Year of bad taxes

There was some expectation that the Banking Cash Transactions Tax (BCTT) and the Fringe Benefit Tax (FBT) would be withdrawn. Dr N. Shankar Acharya, former Chief Economic Advisor to the Government, has accused the Finance Ministry of upsetting the fisc with three bad taxes and derailing the train of modern tax reform, flagged off by Mr V. P. Singh in 1985.

The FBT has been liberalised, the Securities Transactions Tax has been raised across the board by 25 per cent, and the BCTT stays on. These new taxes should have no place in the Income-Tax Act. They cover expenditure and sales. The Income-Tax Act has been disfigured, making the case for its total withdrawal and substitution by a brand new Act, promised recently but somehow put in the deep freeze. The Budget is silent on the proposed new Income-Tax Act.

Tax expenditure

The Finance Minister, however, deserves kudos for the innovative statement of tax expenditure he laid before Parliament. Fiscal advantage is conferred on a group of individuals or a particular activity by reducing tax liability rather than by direct cash subsidy. Tax concessions and cash subsidies have much in common. They show how the Government favours certain groups or activities.

When Government projects receive aid, the figure is widely known and can be scrutinised by the Executive and by Parliament. Direct subsidies too are open to review and debate. This cannot be said of tax concessions. Deductions against tax liability mean cost to the Government in the same way as cash payments or provisions in kind. Still, they remain comparatively hidden and away from scrutiny. It is for this reason that several Western economists have shown how there is an interplay of vested interests in seeking and achieving tax subsidies.

"The design and implementation of tax policy are among the most fascinating activities. In their formulation is revealed not only the naked play of vested interest but also deep-seated cultural attitude and the impress of economic exigencies. Taxation in this scenario is less the villain than the victim. It does not so much determine the nature of social, the economic and political changes as it reflects the resolution of such changes in the fiscal arena," says Dr Richard Bird, in Tax Policy in the 21st Century.

Innovative statement

In the past 50 years, no government has thought it fit to come up with a statement giving the details of revenues foregone because of tax concessions. In the latest Budget, such details are given for the first time, in Annexure 12 of the Receipts Budget. It explains the impact of tax incentives and estimates the revenue loss from major items of tax preferences to indicate the potential revenue gain that would be realised by removing exemptions, incentives, weighted deductions, and so on. The cost of each tax concession is separately determined. Companies with profits above Rs 500 crore accounted for 73.5 per cent of the total profits of the sample companies but their share in the total taxes was only 60.70 per cent, at an effective rate of 15.99 per cent.

Taking all the companies in India as a whole, the effective tax rate was 19.37 per cent, at a time when the statutory tax rate was 35.875 per cent. The tax liability across companies is found to be unevenly distributed, and this is mainly because of the tax preferences. The statement gives details of tax expenditure, both for corporate and non-corporate taxpayers, summarised in the Table. The total revenue raised by way of taxes is Rs 3,48,474 crore.

More than 50 per cent of taxes due to the Government are foregone because of tax concessions. Those who cavil at the low tax-GDP ratio should ponder over the reasons for the same. It is not merely the failure to tax agricultural income, or merely tax evasion, but something beyond.

The Government is foregoing revenues by a built-in system of tax incentives and exemptions. And the details are not always known to Parliament and to the public.

A government that does not mind foregoing Rs 1,50,000 crore from corporate houses thinks it wise and prudent to withdraw the 10 per cent bonus given to the lower middle-class savers in the Post Office Monthly Income Schemes.

The Government would also like to move from the present system of Exempt-Exempt-Exempt savings to Exempt-Exempt-Tax from next year, knowing full well that it will hit the aged and the infirm hard. By all means, remove the distorting tax exemptions, but equity demands that the individual taxpayers will have to be protected against inflation and against the erosion in real income.

It would be useful if the Tax Expenditure Statement is followed with a statement of benefits to the community at large by way of the revenue foregone. The benefits should also be quantified in monetary terms.

(The author is a former Chief Commissioner of Income-Tax.)