The Hindu Business Line : Budget: Innovative and worrisome

THE Finance Minister, Mr P. Chidambaram, has introduced innovations in Budget-making. He has raised the share transaction tax, which he introduced last year, and has brought in the cash transaction tax on bank withdrawals above Rs10,000.

The idea is to "push people into the cheque economy where their spending leaves an audit trail". As The Economist (March ) points out, taxing "white" money, making banking unattractive, encouraging Rs 9,999 withdrawals, and giving an unreliable taxman opportunity to harass, may not be the best way to go about this task.

Emulating Australia and New Zealand, the Finance Minister has introduced the fringe benefit tax. While corporate houses are, no doubt, unhappy, this levy will make our law look modern.

The cut in depreciation rates will pave the way for the abolition of minimum alternate tax (MAT).

This is because, at least in the initial years, the depreciation rates as per the income-tax law will be much less than the allowance under the company law. This is what several working groups that have studied the two laws have been recommending for years.

The Finance Minister's announcement of the new savings formula for tax benefit will allow taxpayers to invest in various types of savings. They will no longer be confined to specific instruments such as the National Savings Certificate and the Public Provident Fund.

India's savings rate is 28.1 per cent, an all time high. The rate of investment, however, is only 26 per cent, proof that the economy is not absorbing all the saving.

The new saving formula, however, will be more beneficial to the rich classes than to those in the lower income brackets. This year's Budget is deceptive. The Finance Minister has reduced the tax rates for companies and raised the exemption limits and slabs.

Only those who read the fineprint will know that the so-called tax reform means more tax outgo for companies which now stand on equal footing with foreign companies. Segments of society such as the salaried class, the pensioners and the senior citizens stand to lose in the bargain.

Fiscal slippage

From the standpoint of the economy, slippage in targets set by the Fiscal Responsibilities and Budget Management (FRBM) Act is worrisome. The fiscal deficit figures quoted in the Budget are disputable because they do not account for the Rs 29,000 crore that represents borrowals by State governments for financing their Plans as per recommendations of the Finance Commission.

The revenue deficit for 2005-06, Rs 95, 312 crore, represents 2.7 per cent of GDP. As per the FRBM Act, this figure is to be brought down to nil in three years.

This is practically impossible. It was for this reason that last year, the target for reducing the deficit was pushed by one year so as to coincide with the term of the present government at the Centre.

It is not expenditure per se but quality of the expenditure that should concern policy framers and economies. Expenditure on subsidy has been going up in gross figures (Table 1). The same is true of interest payment as well. A reform-oriented government, especially one with support from the Left, should have targeted subsidies that benefit the creamy layer. This has not happened.

The Centre proposes to borrow more from the market and there is every indication that the fiscal deficit may touch 5 per cent of GDP on a like-to-like basis.

Examine the pattern of the Centre's expenditure in the post-reform era(Table 2).

Wagner Law

The compression in expenditure, which can impact the social sector is a matter of concern. According to Dr B. B. Bhattacharya, Director of the Institute of Economic Growth, for a developing economy it is necessary to increase the expenditure-GDP ratio. In the US, the ratio is double that of India's.

He questions the reformist view, of the government not being an efficient spender of public money. As Table 2 indicates, the expenditure-GDP ratio has fallen below 15 per cent. Higher expenditure would have meant a multiplier effect for the economy, especially if under Plan expenditure. Table 3 gives the Plan and non-plan expenditure in the Budget.

German economist Adolph Wagner had hypothesised that the share of public expenditure in the Gross National Product would rise with the development of an industrialised economy. Wagner identified three main reasons for this growth in expenditure:

A relative increase in the cost of public administration, law and order, and the regulation of economic activity as society gets more developed.

Cultural and welfare activities offered by the state have an income elasticity of demand greater than one; as income rises, so does demand for these services more than in proportion.

Rise of industrial monopolies, bring about economic development, which then need state control.

From this standpoint, the compression in Plan expenditure as percentage of GDP is not welcome.

Positive turnaround

There are, however, positive turnarounds which will benefit the economy. Till recently commodity taxes accounted for a chunk of central revenue. The picture has changed in recent times, today it is direct taxes that account for the bulk of government revenue.

This means that India is emulating the Western model. The fact, however, remains that this has been achieved not by an increase in the percentage of direct tax collections to GDP but due to the decline in the tax effort on indirect taxes because of the steep reduction in the Customs duty because of globalisation.

Much remains to be done. A recent issue of the Time magazine spoke of two Indias, the 35 per cent wallowing in poverty and the one million enjoying filthy lucre, not bothering to report real incomes and wealth. People below the poverty line earn less than $1 a day in India. There is a need to accelerate growth to bridge the income gap in society. The Budget does not even attempt to solve the problem of endemic poverty.

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

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