The Hindu Business Line : A Common Minimum Budget

THE Union Budget for 2004-05 was finally presented this afternoon. It was keenly awaited for many reasons. One was the unexpected change in government at the Centre and the second was the scare that the allies of the ruling Congress imparted to capital markets in the early days of the government. The third main reason was that the Budget was to be presented by the reformist Finance Minister who had dared to reduce tax rates in India in 1997.

The Budget does not fulfil expectations of either kind. That is the good news about it. There is no repeat of the horror story of July 1996. There are some even redeeming features about this Budget. There is a determination to hold the line on revenue expenditure even though the Finance Minister has pushed back by a year total elimination of the revenue deficit from 2007-08 to 2008-09. However, it is not necessarily welcome that the government would have more to spend on capital expenditure with the elimination of revenue deficit. Without a reform of governance at all levels, the more government spending of any type would be a misallocation of resources.

In this regard, it is worrying to note that the Government is pinning its hopes on eliminating the revenue deficit by widening the tax base. This is revealed in the Fiscal Policy Strategy Statement that was part of the budget documents. That is, the government is keen to expand the tax to GDP ratio. But it shows no commitment to expenditure reforms. There is a tone of resignation with respect to the latter. It acknowledges that measures recommended by the Fifth Pay Commission and the Expenditure Reforms Commissions are yet to be considered/implemented and that those implemented have a long gestation period to bear fruit. There are some signs in this Budget that the government would attempt some reforms on targeted subsidies: One is the attempt to restrict the universal health insurance scheme to the people below the poverty line and the second is the pilot scheme with food stamps. Set against these mild reform measures in targeted subsidies is the usual increased allocation to various schemes.

A glaring example is the Government's proposed capital subsidy to NABARD for funding water-harvesting programmes targeted at farmers belonging to scheduled castes and scheduled tribes. The programme oozes with scope for misuse and wastage of funds. Water harvesting is done at village level, backed up by a clear formula for sharing the water harvested and stored. This is best left to panchayat leaders and village elders. Hence, if the money for the Accelerated Rural Water Supply Programme could be devolved directly on Panchayat Raj Institutions, it defies logic that the money for water harvesting schemes cannot also be devolved on them.

On the securities market, the elimination of long-term capital gains tax and the promise to create an alternate trading platform for small and medium enterprises to raise debt and equity from the capital market must be surely welcome. But the proposed turnover tax on securities on the buyer of all securities (including options and futures) is straight out of the book of Mr A. B. Bardhan. Under the proposed tax that covers all securities including derivative securities, an investor in a call option would end up paying tax on the value of the option, which equals the option premium plus the strike price of the underlying security. Should the option become worthless on the maturity date, the investor would have paid tax on losses! The inclusion of derivative securities such as Options and Futures under the transaction tax would encourage speculation rather than arrest it. Further, since the buyer of options would pay taxes, this tax encourages investors to write (sell) options rather than buy them. Any textbook would reveal that short option positions potentially suffer from unlimited losses.

India had only recently introduced options and futures trading. Taxing transactions on these is a bad idea and would discourage the use of such securities for hedging purposes. It appears that the stock market did not like this particular measure and has shown its disapproval with a 2 per cent-plus drop.

With the increase in the minimum tax slab to Rs 1, 00,000, the country faces a peculiar situation of having the top rate of 30 per cent being levied on the income that is just 50 per cent above the no-tax limit. However, with the Minister promising a more comprehensive tax reform in the February budget, it is fair to hold fire until then.

While most of the measures on the service tax were anticipated, the decision to avoid extending the tax to cover truck owners and operators is a triumph of political compulsion over economic logic.

One hopes that the proposals to raise the cap on FDI in telecommunications, aviation and insurance would not be killed by the Left.

Overall, the Bdget fails to inspire or excite with imaginative and bold thrusts either on reforms or on fiscal consolidation. The Budget does a good job of tiptoeing around the minefield of the Common Minimum Programme. But India deserves better and this Finance Minister is capable of a better budget. The tragedy is uniquely Indian: Performance below potential.

(The author is Director, Global Economics and Asset Allocation in Credit Suisse, Singapore. The views are personal. Address feedback to nageswar@singnet.com.sg)