End-game in sight

Finance Minister P Chidambaram has delivered the Budget that the economic situation demanded. Nothing was broken, and nothing therefore needed to get fixed. The finance minister has focused therefore on keeping his side of the bargain with regard to the revenue and deficit numbers for the current year. And he has stayed on course for next year with more fiscal correction, a higher tax-GDP ratio and tariff rates coming down another notch. Personal and corporate taxation has been untouched after the changes last year. So the main taxation effort has been to narrow the gap between the basic excise rate and the service tax rate, and to extend the special countervailing duty to almost all products, so that domestic manufacturers get a level playing field against imports when it comes to the neutralisation of state taxes. Both measures are logical and sensible.

For the medium-term future, the finance minister has promised an integrated goods and service tax (GST), and said that the central sales tax will be abolished as soon as the state finance ministers come on board, thus removing a barrier to inter-state trade. The triple objective of zero revenue deficit, "Asean-level" tariff rates and an integrated GST may thus come together in 2010. In short, the end objective of tax reform is in sight. From 1991 to 2010 it would have taken nearly two decades, but the Indian elephant moves at a steady pace.

Fortunately, there were no tax innovations of the kind seen in Mr Chidambaram's last two budgets. It would have been best if he had scrapped the fringe benefit tax, since it has delivered little revenue, but he has at least modified it in response to criticism. On the second controversial tax introduced last year (on cash withdrawals from banks), the finance minister has justified its impost by pointing out that it has indeed helped unearth tax evasion. There may be some carping about the hike in the rate of the minimum alternate tax, but since roughly half the companies seem to pay less than 10 per cent of their profits as tax, the finance minister has logic on his side. The hike in the rate of tax on securities transactions risked upsetting the stock markets, but they have remained bullish and ignored the irritant. Expect Mr Chidambaram to further raise this tax rate in coming Budgets!

Are next year's revenue numbers realistic? Certainly, they seem ambitious with a third successive year of about 20 per cent tax growth being planned. The secret may lie in the service tax, which has grown by 62 per cent this year and is slated to grow a further 50 per cent next year, to Rs 34,500 crore. Customs revenue too is expected to be buoyant, perhaps on the twin assumptions that a growing economy will need imports and oil prices will stay high. The worry should be on corporation tax revenue, which is expected to grow by over 28 per cent when profit growth for the corporate sector has flattened. The even bigger problem is excise, which has shown little buoyancy although industry has had a good year. Excise revenue has grown barely 11 per cent, and is slated for an even more modest 6 per cent next year. Even if this is explained by the many tax cuts announced by Mr Chidambaram, is there an assumption that industry is slowing down?

The Budget documents give, for the first time, the details of what it costs the government to hand out tax breaks to different groups, and part of the problem with excise revenue may be explained here. The exemption for small-scale industries costs Rs 11,316 crore, and concessions to special areas like Himachal Pradesh and Uttaranchal cost another Rs 1,502 crore. The bigger tickets are accelerated depreciation (Rs 27,077 crore), export profits from units in software parks (Rs 7,080 crore), and rebates for investment in specified savings instruments (Rs 6,568 crore). Clearly, the exemption issue remains to be addressed. If it does, as the minister has promised, there should be elbow room to drop the core excise rate from 16 per cent to 12 per cent and thus equate it with the service tax, as a superior alternative to raising the service tax rate any further. After all, the Kelkar report which argued for an integrated goods and service tax had recommended that this tax rate settle at 12 per cent.

The finance minister spent more than half his long speech listing a series of big hikes in spending. In past years, this was a smoke and mirrors exercise because the total numbers were modest (this year's growth in total expenditure is barely 2 per cent!). Next year's growth will be noticeably better at 11 per cent, with the additional positive aspect that much of the increase will be in Plan spending. However, although energy gets the biggest increase in the Plan, capital spending under the Plan actually declines! The explanation lies in the big increases announced in the social sectors""which would be fine if the money were spent well, because India does need more schools and hospitals, more doctors and teachers, rural roads and drinking water. What is interesting is that the subsidy bill shows no growth at all for the second year in a row, and the increase in defence spending just 9 per cent. Despite the grandstanding on spending, the minister has shown restraint.

We are left with the growth question. Mr Chidambaram has done well to allow foreign institutional investors to invest more in government securities and corporate bonds; this will ease the liquidity crunch and thereby fend off any sharp increase in interest rates""which could choke growth. But looking at the message in some of the Budget numbers, does the finance minister know more than he is letting on, about the economy slowing down next year after three years of 8 per cent growth?