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Swimming out of a numerical soup (Hindu)

In a reasoned and realistic Budget, the Finance Minister missed a couple of tricks while reducing the income tax rate for the first slab and the corporate tax rate for small companies

Several commentators have remarked that Finance Minister Arun Jaitley’s budget for 2017-18 lacks much fizz. But everything has to be viewed in perspective. This year’s Budget was presented at a time when there are several storm clouds hanging over the economy. We are still reeling from the effects of demonetisation, which must have earned a prominent place in the record books as one of the biggest policy induced disasters of all time. The International Monetary Fund (IMF) estimates the effect of demonetisation to be a 1% reduction in the GDP growth rate. Even the Economic Survey admits some adverse effect on the economy, but naturally claims that it will be much lower. To make matters worse, the introduction of the uniform Goods and Services Tax (GST), as well as advancing the date of the presentation of the Budget by a month meant that the government did not really have firm estimates of either the rate of growth of the economy or the amount of indirect tax revenues that it could hope to collect during the year. Finally, this was also the first time that the Railway Budget was being integrated with the general Budget.

The electoral temptation
The political atmosphere, with elections in several States, including the crucial one of Uttar Pradesh, being just round the corner, was also not propitious for good Budget-making. It must have been tempting for Mr. Jaitley to indulge in some cheap populism in order to counter any negative reaction of voters to the demonetisation. The Election Commission would not have interfered — by agreeing to allow the government to present the Budget just before the elections, it had signalled that it would treat the budget as a routine and necessary piece of government policy.

Highlights of Union Budget 2017-18

But the overall impression is that Mr. Jaitley has refrained from any overt acts of populism. It is a workmanlike exercise, devoid of any frills or fireworks. There are no sops — the clearest indication being the absence of any announcement about new train lines! His philosophy this time round seems to be to let the economy grow more or less on its own, with minimal additional interference or help from the government.

The government has achieved the fiscal deficit target of 3.5% of GDP that was set for 2016-17. The earlier target of bringing this down to 3% during 2017-18 has been relaxed, but only slightly. Mr. Jaitley has increased it to 3.2%. This must actually have come as a disappointment to many who felt that it was imperative for the government to choose a larger deficit so as to provide a big dose of fiscal stimulus in order to offset the contraction of demand following the demonetisation exercise. However, the Finance Minister has chosen the path of fiscal prudence. Perhaps, he is hoping that the State budgets will be sufficiently expansionary. Also, the Reserve Bank claims that the economy will soon be fully remonetised (but then why was it ever demonetised?) and this will provide another source of demand stimulus.

The Budget proposals reveal that both revenue as well as expenditure will record only modest increases during the next financial year. Expenditure is forecast to grow at 6.6% over the year, compared with a rise of over 12% during the current year. Gross tax revenue is forecast to increase by 12.2 % during the next year, significantly below the 17% expansion witnessed during the current year.

A major reason for the rather conservative forecasted increase in tax revenue collection is that excise duties will contribute very little to the increase. This is in contrast to the current year when higher duties on petrol and diesel provided something of a windfall gain to the government. Since crude oil process have started climbing up, the government can no longer afford to increase taxes of petroleum products.

Tax slabs
Perhaps, a small act of populism is the decision to reduce the income tax rate for the first slab from 10% to 5%. This has resulted in a discontinuous rate structure, with the marginal tax rate for the next slab jumping to 20%. While the discontinuity by itself is not bad and not uncommon — the rate for instance in the United Kingdom jumps from 20% to 40% for two contiguous slabs — it is a bad move for a quite different reason. Total tax revenue in India is ridiculously low at 11% of GDP. It is essential that the tax to GDP ratio be increased significantly in order to finance increased public expenditure in the social sectors and infrastructure, to mention just a couple of priority areas. This will be possible only if a twin-pronged strategy is carried out. First, there should be no decrease in tax rates. Second, a significantly larger share of national income must be brought under the scope of income tax. Increased computerisation, KYC requirements, penalties on large cash transactions will all help in making tax evasion more difficult. Perhaps, the government should have kept the 10% tax slab unchanged, and actually introduced a new 5% tax slab for those with taxable income of ₹2 lakh to ₹2.5 lakh. That would have been an exhibition of real political courage!

The only other notable change in direct taxes is the decision to reduce the corporate tax rate to 25% for companies with an annual turnover below ₹50 crore. Those above the threshold will continue to pay the existing rate of 30%. This move may have been taken to compensate small companies that have been adversely affected by demonetisation. Nevertheless, it is a regressive step. This tax reduction provides quite perverse incentives because companies should be induced to expand, to grow big in order to reap economies of scale. This may also encourage bigger units to split up so as to enjoy the lower tax rate.

The farm challenge
Readers may recall that the Prime Minister had promised to double farmers’ incomes within a spell of five years. Roughly a year has passed since the promise was made, and it is increasingly clear that the promise is nothing but a pipe dream. However, agriculture and the rural sector does constitute a major thrust area in the Budget, with the budgetary allocation being increased by as much as 24%. Agriculture has also been promised increased credit. Market reforms in agriculture will also be encouraged. A somewhat surprising allocation is the one to the Mahatma Gandhi National Rural Employment Guarantee Act, which was the flagship scheme of the previous United Progressive Alliance government. The Prime Minister as well as many economists have on several occasions attacked the scheme because of the leakages and corruption associated with it. Perhaps fears of an adverse political fallout prevented any drastic reduction in budgetary support for the scheme.

A most welcome proposal in the Budget speech was the promise to reform the system of political funding. The budget has proposed a ceiling of ₹2,000 on cash donations to political parties, as well as the introduction of electoral bonds for political funding. Of course, these will not clean up the system completely. But, these measures are certainly steps in the right direction. They need to be supplemented by other steps such as subjecting the accounts of all major parties to auditing perhaps by the Comptroller and Auditor General of India’s office.

The Budget keeps the structure of indirect taxes virtually unchanged. Perhaps, this is because the government hopes to introduce the GST during the next financial year, probably by September 1, and the GST will in any case radically alter the structure of indirect changes. The GST is of course the most important development in tax policy in decades, and successive Central governments have tried to get this approved by State governments. Many commentators have pointed out that there are many flaws with the structure of the GST, with numerous slabs being the most glaring defect. The Budget has nothing much to say about the GST. But this is out of necessity since decisions on the GST remain with the GST Council, in which the Central government representative is just one of many members.

Perhaps the biggest plus point of Mr. Jaitley’s budget is that this is not a big-bang budget. The demonetisation exercise has provided enough shocks to the economy — time and relative calm are required for the economy to be nursed back to health. The Budget does provide this.

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