He’s banking on 24% hike in tax revenue, question: will that happen?

Indian Express, 9 July 2004

The lack of bold reforms in the budget is disappointing. Will P Chidambaram’s budget improve the investment climate or is it just a better delivered version of Laloo’s railway budget?

The bright shining mistake, which leaps out of the speech, is clearly the turnover tax. This is a distortionary tax, which sets the clock back on financial sector reforms. It is as wrong as the stamp duty which hobbles the real estate market.

When Manmohan Singh was finance minister, he had fought to remove the stamp duty on financial market transactions, as part and parcel of the depository legislation. Chidambaram and his staff have clearly not understood what they are doing on the turnover tax. When they obtain wisdom on this issue, they should completely back away from this flimsy idea.

The budget seems to score on one crucial question. It proposes to reduce the resources pre-empted by the government, freeing them up for private investment and reducing the pressure on interest rates. This is to be achieved by cutting the revenue deficit to 2.5% of GDP. In fact, Chidambaram put forward the set of rules for reducing the deficit on the eve of the budget. The reduction means a 1.1% cut from last year’s revenue deficit of 3.6%.

The question is how will this be achieved?

He has budgeted for a 24.7% increase in tax revenues. Such a massive increase in tax revenue has never been witnessed before. If GDP grows at 12% in nominal terms, as has been assumed in the exercise, this implies that tax revenue will grow at double the rate.

The 2% cess is not enough to give us this huge growth in tax revenue.

Nor are there any tax reforms. Budget estimates of a 26.5% increase in income tax, and a 40.4% increase in corporate tax appear to be too optimistic.

Rebates have not been removed. Tax-avoidance schemes, like PPF have been left untouched. The numbers, therefore, don’t add up. It is not clear that the budget will achieve the massive increase in tax receipts seen in the budget.

The good news is that revenue expenditure is budgeted to grow only by 6%. Since nominal GDP is projected to grow by roughly 12%, this means that the Tax/GDP ratio will go up and the revenue expenditure to GDP ratio will go down. This is reassuring to those who watched the speech and got worried by the range of spending proposals. Money seems to have moved from one pocket to another.

This is consistent with Manmohan Singh’s address to the nation that indicated that there is a need to add up various schemes that have similar objectives, address the same target groups and are implemented by the same administration into single schemes. If expenditures and receipts are as estimated the revenue deficit should reduce from Rs 99,860 crore in 2003-04 to Rs 76,171 crore in 2004-05.

Under the FRBM the revenue deficit is to be brought to zero by 2007-08. Though, in the budget the FM introduced an ammendement to push the date forward by one year, on the eve of the budget he tied his own hands down with a notification that required him to cut the revenue deficit by 0.5 percent, and the fiscal deficit by 0.3 percent. This indicates his commitment to fiscal consolidation.

It is obviously possible to obtain much better tax revenues through extensive reforms to the tax system. But the speech was silent on this front. Exemptions have been kept intact. The integration of service tax and VAT is a historic milestone in modernising India’s tax system. But there is no mention about a proper IT system for implementing these.

Without a complete overhaul of the tax administration, and a move away from the existing corruption-ridden and paper-intensive systems, tax buoyancy will not come about.

The new pension system will gain legislative strength—though there was no mention about when the pension fund managers will be up and running. Drinking water schemes are being taken closer to local government. The commodities market will be integrated with the securities markets, thus allowing the agricultural sector to benefit from the modern institutional development of the securities markets.

For observers who were gloomy about modern economic policy coming out with the Left in government, there are a few rays of hope. The FM has clarified that selling shares in PSUs will, indeed, continue. FDI limits have been raised in telecom, civil aviation and insurance. But, it does not offer big new ideas for institutional change, such as NHAI, in the area of infrastructure.

In terms of expenditure, Manmohan Singh had got hopes up when he talked about reforms on how government functions.

He recognised that the existing mechanisms of expenditure on the part of government are hopelessly dysfunctional and fail to work effectively in reaching the poor, or in producing public goods. Yet, the budget speech went on to merrily send large amounts of resources through the dysfunctional government system.

Yet to be fair, we are already in July 2004, and the goverment has had very little time. Chidambaram has left most things untouched and promised that big changes will be made in the February 2005 budget. By that time, the PM and the FM, and their policy teams, will be in place. However, there is no reason to wait for the budget. Reforms and institutional changes should not have to wait for 2005. If policy initiatives are taken, there will be no reason to wait for the next budget to improve the investment climate.

Ila Patnaik