Some Cheer In These Taxing Times

Budget 2005 has received the thumbs up from most sections, and rightly so. While satisfying the demands of the NCMP with serious sums of money, Finance Minister P Chidambaram has managed to present a reformist budget. The budget shows the long-term thinking about taxes that was needed.

Chidambaram has delivered on the tax reforms budget that he had promised.

Personal tax rate slabs have been made compatible to the 1997 dream budget tax rates in terms of real income. Now the maximum tax rate kicks in at an income of Rs 2.5 lakh per annum.

This is far more sensible than having the highest tax rate kick in at Rs 1.5 lakh, as was the case till now.

This gives relief to people who were brought into the tax net even though their real incomes did not merit it.

By lowering the tax rate, compliance is expected to increase.

It may happen that there is a loss of revenue in the first year. However, tax collections can be expected to rise in the years to come. Higher tax rates encourage tax evasion.

Better tax administration will help in reducing the loss to revenue.

The finance minister has brought savings into the framework of the Exempt-Exempt-Tax system (exempt at the point of saving, exempt during accumulation and taxed at the time of withdrawal).

Chidambaram has decided to set up an expert committee which will consider changes in the treatment of savings. This is long overdue and welcome.

As far as corporate tax goes, the finance minister has accepted the recommendations of the Kelkar Task Force. The corporate tax rate has been equated to the individual tax rate of 30 per cent.

The reduction in the corporate tax rate as well as in the depreciation rate will improve the incentive structure for Indian industry.

Not only has the corporate tax rate been brought down, but it has also been proportionally reduced more for companies that have relatively labour-intensive technology. A high depreciation rate gives incentives for purchase of more capital-intensive equipment.

This distortion needed to be corrected.

The reduction of the peak custom rate to 15 per cent, along with the reduction in tariffs on many items is also very welcome. There was fear that this may not be done because of the importance of custom duties in the overall scheme of government tax collections. But the weightage of customs as a proportion of tax revenue has been declining.

The budget is not without gimmicks, though. The tax on cash withdrawals from banks of Rs 10,000 and above makes little sense.

Especially since the objective is not to raise revenues but to have a trail of cash withdrawals.

For one, the amount is too small. If it had been on an amount of Rs 50,000 or above, it might have been valid in tracking the cash economy effectively.

As is the case with taxes that distort behaviour, we could well see more people withdrawing Rs 9,999 and legally avoiding the tax. If the direct tax reforms show a clear thread of good economic thinking, this is plainly bad economic thinking.

The government can and should ask for information when large transactions take place. This information should go into tax information network (TIN) and should be used to improve tax compliance.

The revenue projections from the banking withdrawal tax will not be met, to the extent that people have an incentive to not use banks. Contrary to the purpose, this tax serves to increase the size of the black economy. This is a mistake that should be reversed.

Finally, what does this budget foretell for the Indian economy in 2005-06?

Quite simply, a very positive climate for investment, which will be further assisted by the major reforms in direct tax, which help companies directly (through reforms to corporation tax) and indirectly (by freeing up households from distorted savings plans). This could lead to high economic growth.

Ila Patnaik

Ila Patnaik