M Govinda Rao: Budget 2007: A reality check

The opportunity to introduce general taxation of services has been missed in this Budget.

The Union Budget unleashes energies more than any other event in India. The build-up of expectations until its presentation and its instant analysis after it is laid in Parliament are unique to the country. The expectation, entertainment and hype provided by the multitude of television channels and the print media have subsided and before the frenzy of the cricket World Cup takes over, there is time to undertake a considered analysis. Indeed, the stock market, after the negative response, has bounced back to saner levels as the rhetoric of the Budget has waned and reality dawned.

The Union Budget 2007-08 has been presented in the background of a buoyant economy and sound economic fundamentals. The economy is expected to grow at about 9 per cent in 2006-07, after 9.2 per cent in the previous year, with both the manufacturing and service sectors logging double-digit growth rates, but low growth and high fluctuations in the agricultural sector need to be addressed. Buoyant merchandise exports and invisibles have helped to finance growing import demand and contain the current account deficit. However, rising inflationary expectations have been a matter of concern and the Budget was expected to undertake measures to contain it. Infrastructure bottlenecks have continued to constrain the growth potential. The Budget was required to do the balancing act of meeting competing claims on resources to finance the plan and various programmes of the UPA government while fulfilling the fiscal restructuring targets.

In many ways, the Budget is on predicted lines. The high growth of GDP expected during the year, along with strong revenue growth, has helped to meet the revenue and fiscal deficit targets. The revised estimate of tax revenue in 2006-07 has increased by 28 per cent over the previous year mainly due to the strong growth performance of corporate tax (45 per cent), personal income tax (29.7 per cent), Customs (25.7 per cent) and service tax (65.6 per cent).

Fiscal trends in India have an interesting lesson to offer. Clearly, right from 2004-05, when the FRBMA was implemented, tax revenue has registered an annual average growth rate of over 22 per cent mainly due to the strong growth performance of corporate tax (32.4 per cent), personal income tax (26 per cent) and service tax (69.3 per cent). A careful analysis shows that while the buoyancy in service tax was due to expansion in coverage, the strong revenue performance in direct taxes is attributable to the institution of the Tax Information Network (TIN). This task was entrusted to the National Security Depository Ltd. And similar initiatives in regard to central excise could increase the revenue productivity of the tax.

For the same reason, while it is heartening to see that the revenue deficit is expected to be brought down to 1.5 per cent of GDP, the prospect of phasing it out in 2008-09, the terminal year of the FRBMA, looks remote. In other words, the rate of reduction in the revenue deficit so far does not infuse confidence in reducing the revenue deficit by 1.5 percentage points in one year.

The Economic Survey comments that the progress in fiscal consolidation so far has been predominantly due to increases in revenue. Since the enactment of the FRBMA, tax revenue relative to GDP increased by 2.2 percentage points from 9.2 per cent in 2003-04 to 11.4 per cent in 2006-07. As non-tax revenue declined by 0.9 point during the period, there was a net revenue increase of 1.3 percentage points. Interestingly, the revenue deficit too declined by the same magnitude and it is tempting to attribute the entire adjustment to revenue increase. However, it is notable that transfers to states during the period also increased by one percentage point, requiring the compression of the Centre's own expenditures by that magnitude. Besides, schemes involving expenditure of over 1 per cent of GDP were initiated during the period. Although these items of expenditures are classified as central expenditures, funds are transferred to state/district level autonomous bodies for implementation. Thus, fiscal adjustment achieved since 2003-04 has involved an increase in revenue by 1.3 percentage points and compression of direct expenditure by the Centre by 2.3 percentage points, of which almost one percentage point was due to lower interest payments. Not surprisingly, higher transfers and the Centre directly taking up several schemes (such as rural roads, Sarva Shiksha Abhiyan, NREGS, SGRY, and Indira Awas Yojana) have helped the states in significantly improving their finances.

The finance minister has laid considerable emphasis on accelerating the growth process, particularly in the agricultural sector, and strengthening the social sector spending, in his Budget speech. The plan outlay on agriculture for 2007-08 has been enhanced by 15.7 per cent and the increase in the outlay on the social sector is almost 36 per cent. To be sure, these are legitimately in the states' domain and the Centre's intervention is largely guided by political sensitivity. Given that these have to be implemented at state and local levels, strengthening the delivery systems is important and in its absence, transforming outlay into output and outcome will remain elusive. On the other hand, there is need to ease infrastructure constraints, but the outlay on plan capital expenditure has been increased just by 9 per cent.

As regards tax measures, reduction in Customs duty was as expected. From the viewpoint of economic rationality, enhancing dividend tax too cannot be objected to, just as withdrawal of exemptions in MAT under Sections 10A and 10B. Reduction in the central sales tax by one percentage point is also on expected lines. However, the desirable tax proposals end there. A continued exercise of selectivity in tax policy is inimical to a stable tax system. The dual tax rate on the cement industry defies logic. The tax rate based on MRP to hold the price line shows a certain mindset. The MRP could well depend on the quality of the product and by having a dual tax rate could only end up encouraging the consumption of inferior cement. Increasing the exemption limit for small-scale industry is clearly retrograde from the viewpoint of introducing the GST. Instead of selectively expanding the coverage, the opportunity to introduce general taxation of services has been missed in this Budget. General taxation could have helped to enhance revenue, reduce relative price distortions, and minimise special interest group influence besides introducing an important preparatory step towards the GST.

The author is director, NIPFP. Comments at mgr@nipfp.org.in