Chidambaram’s challenge

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Given limited choices, FM needs to pull off a desperate trick or two in this Budget

Chidambaram’s challenge
As Budget Day approaches, every word that spews from the mouth of finance minister P Chidambaram is weighed, dissected and interpreted to divine some kind of pointer to his mind.

He does not have the luxury of many options, with the economy caught between slowing growth and high inflation – a seemingly intractable problem duo: try to fix one, the other gets undone.

Still, there are a few things he can do that can potentially start a process out of the economic quicksand. One is get the tax reforms process going, by implementing at least the direct tax code from April 1. Given the divisions among states (rather, intransigence of a couple of states), GST may have to wait, but the least he can do is unroll a road map for the unified tax.

As important as the actual budget proposals is, the signal of that process starting, which, in turn, will hopefully trigger a resumption of investment by Indian companies, many sitting on small or big mountains of cash waiting to be deployed.

Some signals have been available already, like the decontrol of diesel prices, which are being upped a few paisa at a time (though frequently), or the end of the GAAR problems.

The finance minister may now top these initiatives by vigorously offloading government stake in ONGC, Coal India, Indian Oil and getting rid of its residual shares in Balco and Hindustan Zinc. The disinvestment target being talked about for 2013-14 is Rs 50,000 crore.

He would want to slash government expenditure (or at least not let it grow in a runaway manner), but in this, his hands are tied: 2014 being election year, he can hardly do anything about the money going into the government’s flagship programmes.

However, he can and will be a bit tightfisted about giving budgetary support to plan expenditure, which will get a raise, but not big enough to cover even inflation. For the first time, the incremental support will be under 10 per cent, according to people in the know.

The star of the coming budget could still be the direct tax code.

Parthasarathi Shome, adviser to the finance minister, is on record that a modified DTC bill would be offered, taking into account the parliamentary standing committee’s suggestions, specially about the tax structures. The ministry is said to have been working on this.

The committee headed by Yashwant Sinha suggested that income-tax exemption limit be Rs 3 lakh, against Rs 2 lakh proposed in the original DTC bill and Rs 1.8 lakh in practice now. Another of its suggestions is that subsequent tax slabs be adjusted accordingly.

In a year before the election year, there will be temptations to have a populist overload in the budget, especially for a government beset with zillion problems. So D Swarup, former expenditure secretary and now member-convener of the financial sector reforms commission, will think “it will be a good budget if the government does not succumb to the usual and compelling temptations of election year.”

By good he means the budget should announce no new schemes, programmes or projects. Also, it should offer no fresh tax concessions, but contain spending on subsidies, announce concrete and time-bound steps for GST and DTC and, most importantly, lower fiscal deficit by at least 0.5 per cent to 4.8 per cent.

Nevertheless, Swarup, keeping his fingers crossed, says the minister’s task is made all the more difficult by the sluggish economy and persistent inflation and the coming elections.

One can also look forward to stability in tax rates, something that Chidambaram has already promised. Yet, he will strive for more revenue by widening the tax base. DTC will help. DTC will do away with most of the tax exemptions companies enjoy, eliminating rent seeking and increase the effective corporate tax rate from 22 per cent now to 25-26 per cent. All this is expected to widen the tax base and reverse the falling tax-to-GDP ratio and restore it to the pre-2008 level of 12 per cent or more.

Most importantly, for all, DTC will bring in more direct tax revenue, without increasing tax rates.

Of course, all this presupposes that the DTC law will be passed quickly. The finance ministry hopes to accomplish this in the budget session, and if, for some reason, the passage gets delayed a bit, say till May, DTC can still be implemented retrospectively from April 1.

It will be interesting to see how competing demands of the government’s plethora of departments for money and of various interests outside it for tax concessions are accommodated in the budget. Yet the priorities are obvious, says Swarup, who lists them as: 1) increasing tax and non-tax revenue, 2) reducing wasteful expenditure, but increasing capital expenditures and 3) providing incentives for investment.

He says there is scope for cutting wasteful expenditure. Merely issuing directives does not help. “The answer zero-based budgeting, where every proposed item of expenditure is scrutinised and only then provided for in the budget,” he says.

If followed, this will mean a paradigm shift in how expenditure is sanctioned and made, hopefully enhancing its effectiveness and reducing corruption and leakages. The cash transfer scheme is one such way to better targeting of expenditure and in the coming financial year may be applied to the entire country.

Of special interest is how the super rich is taxed. This evokes extreme reactions. If DTC is implemented, tax slabs may be widened: about 450,000 taxpayers with annual incomes over Rs 20 lakh may have to bear a higher tax burden in the shape of temporary surcharge, to be withdrawn when the economy significantly improves.

Swarup thinks piling extra taxes on the super rich – by creating a higher, fourth tax slab -- will result in uncertainty over what is stable or not in the tax regime. Nor will it result in any appreciable increase in tax collections.

Taxing the super rich more is an idea floated by C Rangarajan, chairman of the prime minister’s economic advisory council. Pranob Sen, former principal adviser to the planning commission, seconds the idea, saying a lot of people now earn over Rs 1 crore a year and should pay 35 per cent tax, or face a surcharge if the current tax rates are retained.

Parts of civil society couldn’t agree more. Their argument is that the tax-to-GDP ratio is low in India, and the rich should be taxed more if only to fund inclusive development. “India needs to increase the ratio to at least 20 per cent,” according to Oxfam CEO Nisha Agrawal. Oxfam says other countries have a more “progressive” tax structure as they bank more on direct taxes to raise greater revenues from those who can afford to pay.

Oxfam’s estimate is that inheritance tax and wealth tax alone can bring in Rs 63,539 crore per annum – equivalent to 0.8 per cent of GDP in 2011-12 and the current healthcare expenditure, which is 0.9 per cent of GDP. That’s Oxfam’s view, to be resisted, no doubt, by anyone who is rich.

DTC, however, will benefit salary earners. Their income-tax exemption limit will go up. But DTC also takes away – several exemptions will have to go. Besides, it also seeks major changes in wealth tax rates and the way it is calculated.

According to extant DTC proposals, India Inc stands to lose all profit-linked incentives for area-based investments (one example: factories in backward areas or in the north-east).

One indeterminate of the coming budget is GST, even after years of discussions and negotiations with states. Whether or not the Rs 34,000 crore compensation package for states (to make good their revenue losses resulting from the phasing out of central sales tax) works as an inducement for them to agree to a GST rollout date, is yet to be seen.

Chidambaram has given them until February 22 to agree to the rollout plan, which is ready but cannot be implemented unless the states come on board. If the states oblige, Chidambaram can at best announce in his budget a ‘roadmap’ for GST, not a rollout. The earliest a rollout can happen is the middle of the coming financial year, as other issues need to be resolved first and GST itself ratified by half the states.

If the monsoon session sees these completed, then there is a chance of GST becoming a reality in September. If not, brace for the long haul.

Whenever it comes, GST will not just bring down indirect tax rates, but expand the tax base as well. It will simplify rules and help enhance compliance and reduce harassment. Despite the lower rates, both the centre and states will get more revenue because the tax base will expand.

DTC and GST are the two big-ticket reforms trade and industry has been asking for. No, doubt their introduction will send a very strong signal to investors; that’s when the next cycle of investment can expected to begin in right earnest.

Sen, who had earlier been India’s chief statistician, believes the falling savings rate to be another area of concern the finance minister will have to address. The rate, he says, could drop to 25 per cent this financial year. The portents are not encouraging: in the first half-year the rate was 27 per cent. When India achieved growth of 9 per cent, the savings rate was a high 34 per cent and investment rate 37 per cent – which gives a measure of where we had slid since then.

“The savings-investment gap (in rates) has widened. The government should take note of this and announce measures to reverse the trend. This is critical for growth,” Swarup says. Chidambaram will get “full marks” if he can, in his budget, effectively deal with “seemingly irreconcilable goals.”

Sen doubts the finance minister can. “How can you have higher investments if you have a low savings rate?” he asks. Investments by public sector undertakings and private companies are inter-linked. PSU investments create demand for companies to invest. “What we need to do is to kick-start corporate investments by investing in infrastructure and telling PSUs to aggressively start spending,” Sen suggests. He believes the savings rate can turn around quickly and get back to 34 per cent in two years if investments by both public and private sectors start now.

Kick-starting the investment cycle in infrastructure is easier said than done. The investments have not come in the past two years not because there are no projects to invest in but because they are hamstrung by administrative and procedural hurdles that the government has failed to clear.

The lesson is this: first, remove these hurdles, which the cabinet committee on investments is supposed to do. Second, give reforms another leg up in the budget. The rest will take care of itself.


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