The Hindu Business Line : Budget: An incremental approach

A great opportunity had presented itself to the Government. GDP was growing at 9 per cent, savings at 32 per cent and investment at 34 per cent of GDP and buoyant tax revenues scaling all-time high. What was needed was a bold structural transformation to change the course of the economy.

"The dreams of 2007 are different from the dreams of 1997."

— The Finance Minister, Mr P. Chidambaram

Mounting inflation, suicides by farmers in Maharastra, Andhra Pradesh and even Kerala, low indices of human development — all set the stage for the Finance Minister to present a Budget to galvanise the country into a higher trajectory of fuller employment, better productivity and greater investment in industry to resolve the constraints in supply and capacity.

The Government was put on notice about the problems facing the nation.

The response of the Finance Minister has, however, proved disappointing. He has satisfied himself by making higher allocations for agriculture, unmindful of the fact that outlays do not necessarily mean outcomes.

The agricultural economist, Prof M. S. Swaminathan, faults the Finance Minister for not touching the core issue plaguing agriculture.

Mr Chidambaram has been pointedly questioned in several TV shows about his plans for increasing the production of pulses. In Para 49 of the Budget speech, he mentioned various agricultural research institutions that would be invited to submit plans to scale up production of seeds. Prof Swaminathan points out that the reason for low productivity of seeds is not their absence but the want of remunerative marketing system in dry farming areas.

The Budget should have provided for direct subsidies to indigent farmers through smart cards. Farming provides livelihood for 115 million families. The Budget is full of rhetoric and means nothing much for landless farmers.

Monetary Policy

The Finance Minister explains that he is attacking inflation from the monetary, fiscal and supply-side policy angles. There is a slight contradiction in the approaches of the Finance Ministry and the Reserve Bank of India. The RBI would like to raise the interest rate to counter inflation.

The Government's fiscal-deficit-control measures depend a great deal on the low interest rate regime of the past five years. Inflation-targeting becomes difficult when the stability of the rupee has to be maintained to cater to the export sector. In 2001, a Government committee had recommended the setting up of a Debt Management Office. It has taken five years for the Government to take action.

Mr Chidambaram has promised an autonomous DMO. A Middle Office will be set up to facilitate the transition to a full-fledged DMO. In the context of the Government buying the shareholding of the State Bank of India in the RBI, we can expect a more independent management of debt.

We can also expect more expertise in matters concerning capital account convertibility and the exchange rate stabilisation mechanism. Interest rates can be controlled only if there is a fall in the inflation rate. That requires far bolder measures than the mere token cuts in duties.

Indirect taxes will amount to nearly 30 per cent of the final cost of finished goods. A 4 per cent reduction in the excise duty of all goods would have substantially increased industrial output and reduced costs. Industry would have become more competitive and there would have been better employment. It is estimated that such a cut would have probably cost the Government about Rs 20,000 crorebut would have been worth it. Inflation is a hidden tax that affects people relying on fixed incomes and earning low incomes.

Tax Policy

The Government has patted itself on the back justifiably on the increase in tax revenues. It is satisfied that the tax-GDP ratio is rising to 11.4 per cent, though this is still far below the rates achieved in the East Asian and European countries. It is 37 per cent in the US and 25-30 per cent in the European Union. Broadening the direct tax base requires introduction of several taxes such as the Inheritance Tax and the cross-border Financial Transactions Tax. That, however, calls for a different mindset.

When revenues were buoyant, a direct tax rate cut and a higher tax exemption limit could have been thought of. Despite the claim of the Mr Chidambaram about the average corporate tax rate being only 19.1 per cent, the truth is that the current rate hurts companies, which do not take advantage of tax exemptions. Corresponding tax rates in other countries are given in the table.

India's corporate tax rate is apparently 33.7 per cent. After taking into account the enhancement in the Dividend Distribution Tax and in the education cess, the effective tax rate for the Indian company is the same as the rate for the foreign company and stands at 43.58 per cent. In certain situations, the foreign company will suffer a tax rate of just 42.23 per cent .

There is reverse discrimination against the domestic companies and an erroneous impression among Finance Ministry officials that direct taxes cannot be shifted and that the impact and the incidence will be on the same person, unlike in the case of indirect taxes.

This assumption is no longer true. It is now known that companies can shift the burden of direct taxes to the shareholders by way of cut in dividends and to the employees by way of lower wages.

The minimum tax liability in India sets in where the incomes cross Rs 1,10,000 per individual. For a family of four, with one earning member, this is less than the per capita income.

Mr Chidambaram is not correct in reiterating that tax rates have not gone up. Not all companies will be in a position to pay the average effective rate of 19.1 per cent. No serious attempt has been made in this Budget to remove major exemptions. The Minimum Alternate Tax could have been made applicable to companies in the Special Economic Zone too. The revenue loss because of SEZs has been estimated at Rs 1,75,000 crore in the next five years.

Transformation Needed

A great opportunity presented itself to the Government. GDP was growing at 9 per cent, savings at 32 per cent and investment at 34 per cent of GDP and buoyant tax revenues scaling all-time high. Infosys' mentor, Mr N. R. Narayana Murthy, is justified in bemoaning that never in the history of Independent India has such a great opportunity presented itself to any government.

What was needed was a bold structural transformation for changing the to change the course of the economy. But the Government has chosen to be incremental in its approach to the problems of the economy. Sad but true, this is a story of missed opportunities.

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