What is Budget? What is the distinction between revenue and fiscal deficit? What are Finance Minister P Chidambaram’s options, and what are his compulsions? A primer to help you make sense of the buzz beginning today:The basics
• What happens on Budget Day?
At 11 am today, the Finance Minister will present the Budget for the remainder of 2004-05. That is, he will sketch the plans for revenues and expenditure of the Government from now until March 31, 2005.
• Why is the Budget speech important?
It spells out the Government’s thinking on the massive money flows of taxation and expenditure for the few remaining months of 2004-05. These flows are so large, and their consequences for the economy are so big, that the Budget speech matters greatly.
Beyond this, there is a tradition that the Finance Minister generally talks about economic policy going beyond the narrow scope of revenue and expenditure, and beyond the financial year. The Budget speech articulates the work plan for the Government for the year, in terms of economic policy. Indeed, this year, the first year of the UPA Government, the Budget speech is expected to give the broad direction of the country’s economic policy for the next five years. This will shape the expectations of investors, entrepreneurs and households.
•What about the Finance Bill? Is it not the same thing as the Budget?
In legal terms, the Finance Minister puts the ‘Finance Bill’ to vote in Parliament. The Bill consists of all the taxation proposals of the Budget. It includes proposals for the levy of new taxes and for modification or continuance of the old ones. The main Budget, on the other hand, is an estimate of the income and expenditure of the Government that takes into account the impact of proposals in the Finance Bill. After a period of debate, Parliament votes on the Bill, and if the Government loses this vote, it falls.Revenue expenditure
•What is revenue expenditure?
The Budget is classified into revenue account and capital account. The revenue account is the current or recurring receipts and expenditures of the Government. Expenditure which does not result in the creation of assets is treated as revenue expenditure. Last year, the revenue spending of the Central Government was about Rs 3.6 lakh crore.
•‘3.6 lakh crore rupees!’ What kind of number is that?
It is a lot of money! The revenue expenditure was Rs 3,60,000,00,00,000. To make sense of this number, it helps to know that 1 km of the new NHAI four-lane highways cost Rs 5 crore. Every Rs 5,000 crore wasted by the Government comes at the cost of 1,000 km of highway that could have been built. A sum of Rs 3,60,000 crore is enough to build 72,000 km of highways.
‘Lakh crore’ is an awkward unit, and it equals a trillion. So we often say ‘Rs 3.6 trillion’ for Rs 3.6 lakh crore.
•Where on earth is all this money going?
The biggest chunk, one-fourth, goes into paying interest on the accumulated debt of the Government. The other big pieces are the spending on defence, pensions and explicit subsidies.Capital expenditure
•What about public investment?
Public investment is that part of the expenditure that leads to the creation of assets. In the Budget, when assets are created, the expenditure is called capital expenditure. So, for example, if a fighter plane is purchased, the expenditure is called capital expenditure. The operation and maintenance expenses for the aircraft are, however, current expenditure and get classified in the revenue account. The same is true for bridges, highways and dams.
•How big is capital expenditure?
It is currently about one-fifth of the revenue expenditure. Thus, last year, about Rs 0.7 trillion were spent on the capital account. Out of this, roughly half was in defence, which does not directly feed into economic growth.Policy issues in expenditure
•Is there an opportunity to sharply cut defence expenditure?
If we make peace with Pakistan, this could pave the way for lower defence expenses. This would be a ‘‘peace dividend’’. But regardless of this, India’s defence expenditure, at about 2 per cent of the GDP, is low by world standards.
•How does ‘plan’ and ‘non-plan’ expenditure fit into all this?
Plan and non-plan expenditures are an additional, parallel classification, over and above the revenue versus capital classification.
‘Plan’ versus ‘non-plan’ is not planned and unplanned as in normal English. All expenditure is budgeted and planned out at the start of the year. The terms ‘plan’ and ‘non-plan’ refer to the mode of spending. When the spending is routed through the Planning Commission, the expenditure is part of the ‘plan’ expenditure. This includes both revenue and capital expenditure.
We should therefore not confuse the classification of ‘plan’ versus ‘non-plan’ with the classification of revenue versus capital. The former is about how the money is disbursed. The latter is about what it is spent on.
•Is revenue expenditure, or non-plan expenditure bad?
No. These include money spent on the legitimate role of the Government, such as police, defence and judiciary. That is what we pay taxes for. Maintenance of roads, dams and canals is classified as revenue expenditure. In India, if anything, we need to spend more on maintenance of these assets.
There is plenty of ‘bad’ revenue, or non-plan expenditure—overt or covert subsidies. But the legitimate role of the Government requires the expenditure.Overview of expenditure
•What was the total expenditure of the Central Government last year?
Rs 4,40,000,00,00,000. It would buy 2.2 million flats, costing Rs 20 lakh each.
•How do they find all this money!!?
There are three ways through which they find this money. The first is tax revenue. This is primarily income tax, customs and excise. The second is ‘non-tax revenue’. This is primarily dividends from PSUs such as RBI, the oil companies, banks. It also includes telecom licence fees. The third is the deficit. The Government sells bonds to raise money to fill the gap between expenditure and revenues.Deficits
•What is revenue deficit?
Revenue deficit is the gap between revenue expenditure and revenue receipts. It is therefore the borrowing undertaken to meet the current needs of the Government.
•What is fiscal deficit?
Fiscal deficit is the total borrowing of the Government. It is equal to the total expenditure by the Government minus the total receipts.
•What is wrong with running deficits?
Running deficits today means promising to pay interest on them tomorrow. Today, the Central Government borrows about Rs 1.53 lakh crore. Out of this, Rs 1.23 lakh crore is paid out as interest on previous borrowing. At this rate, all additional borrowing will be going only to service the debt!Taxation
•What are the main sources of tax revenue?
There are three main taxes. There is the income tax, which is charged on incomes of individuals and profits of companies. There is taxation of production, in the form of excise and service tax. There are customs duties, which constitute taxation of imports.
•What is non-tax revenue?
Non-tax revenue is primarily dividends from PSUs, including RBI, and telecom licence fees.
•Where do privatisation proceeds go?
Privatisation proceeds are not classified as revenue income. They show up in the Budget as capital receipt.
•What is the goal of a sound tax system?
First, a sound tax system must earn enough tax revenue to pay for the expenses of the Government. Second, there is a core economic principle. A sound tax system must not distort the economy. Anytime a decision is made by an individual or a company that is influenced by the tax system, it is a mistake in the way the economy is functioning. The ideal tax system would have no impact on behaviour, it would just quietly take taxes from the economy without spoiling the decisions of those in the economy. An ideal tax system is one in which there are no tax consultants and no tax planning.
•What is wrong with the ‘exemption raj’?
The creeping growth of exemptions has choked off the tax base, and helped give us our fiscal crisis. Exemptions distort behaviour. This violates the core principle of a non-distortionary tax system. India’s growth suffers when companies and households suffer inefficiencies in order to dodge taxes.
The rich have access to the best tax consultants. The rich have the strongest incentives to put in effort into tax planning. Big companies will innately do better tax planning than small companies. So the biggest beneficiaries of the exemption raj are the rich and powerful. When the exemptions are removed, everybody will pay the same tax rates, which will be more fair and equitable as compared with the present situation.
•Who opposes tax reform?
The rich oppose tax reform, since exemptions are best harnessed by them. Accountants, tax consultants and lawyers oppose tax reform, since their revenues depend on a complicated exemption-ridden tax system.Income tax
•How much money is collected through income tax?
In 2003-04, the Government collected Rs 40,269 crore in income tax.
•What lies next in income tax reforms?
The first issue lies in removing exemptions. We should move towards a simple income tax system, probably with three slabs, where income below Rs 1 lakh is exempt; from Rs 1 lakh to Rs 3 lakh is taxed at 20 per cent; from Rs 3 lakh to Rs 10 lakh is taxed at 25 per cent; and incomes above Rs 10 lakh are taxed at 30 per cent.
The second issue is the need to abolish income tax on companies. The principle here is that only individuals should pay income tax, and all forms of organisations—clubs or associations or companies—should not be penalised by suffering a second layer of taxation. Whether individuals set up companies or clubs, ultimately incomes land in the hands of individuals, and taxation should be applied only to individuals.
The third issue is automation and customer service. The tax authorities should collect all tax deducted at source for you and put it into a single database. At the end of the year, a rough statement of your income and the tax already paid should come to you from this computer system. Your recordkeeping costs should collapse. You should not need an accountant or a tax consultant.Excise
•What goes under excise collections?
There are three parts to excise. On petroleum and petroleum products, there is a simple tax on production. On most manufacturing, there is a VAT, which taxes the value added by a company rather than the revenues. On some services, there is a simple tax on production.
•Why do we talk about the states shifting to VAT but not the Centre?
If VAT is a good idea for states, it is equally a good idea for the Centre. At present, what is called ‘excise’ on a good chunk of manufacturing is actually a VAT named CENVAT. But taxation of services is still on the total value of the output, it is not a VAT.
•How much money is collected through excise?
In 2003-04, the Government collected Rs 1,00,679 crore in excise on goods and services.
•What lies next in excise reforms?
The first issue is shifting fully into VAT. Just as the states are moving towards a state VAT, the Centre also needs to move to a VAT covering all kinds of goods and services. The VAT implementation efforts of the Centre and states need to be closely dovetailed, so that companies should not have to run around dealing with multiple tax authorities.
The second issue is automation. Companies should face a friction-less VAT system, operating through web browsers, and not have to deal with physical pieces of paper, arrogant and corrupt tax inspectors etc.Customs
•How much money is collected through Customs?
In 2003-04, the Government collected Rs 49,350 crore in custom duties.
•Why have Customs rates been steadily cut? Shouldn’t we be ‘protecting’ Indian companies?
Customs ‘protection’ constitutes tolerance of domestic incompetence. A Customs duty of 20 per cent means that a domestic manufacturer can get away with being 20 per cent more incompetent than the best in the world. Why should India accept that? You, the consumer, pay the difference. This incompetence also hurts India’s exports. If we want our companies to export, they have to be able to buy raw materials from the best firms in the world, without being forced to deal with local firms even if they are incompetent.
•What lies next in Customs reforms?
Broadly speaking, advanced countries do not have Customs duties of any significant nature. Even China’s average Customs duties work out to 4 per cent.
There is, however, a need to clearly impose VAT on imported goods and services (on parity with the domestic VAT), and to give VAT refunds to goods and services being exported. These activities need to be managed by a sound IT system, so as to avoid harassment and corruption.FRBM
•What is FRBM?
The FRBM is the Fiscal Responsibility and Budget Management Act. It was passed by Parliament last year. Under this Act, the Government is required to bring down revenue deficit to zero by 2007-08.
•How is fiscal deficit different from revenue deficit?
In case there is a balance on revenue account, the Government’s capital expenditure still has to be met. This is done through loans. These show up as capital receipts of the Government. Capital receipts is just another word for loans that the Government takes from various sources—the public, banks, RBI or from abroad. If the Government is repaid some earlier loans during the year, then clearly the total borrowing it needs to do is lesser by that amount.
When the government is also running a revenue deficit, then it has to borrow not just to meet the spending on the capital account but also to finance the revenue deficit. Currently, two-thirds of the fiscal deficit is on account of the revenue deficit! That is why the FRBM puts emphasis on cutting the revenue deficit. Once this is zero, total borrowing will come down substantially.