Shankar Acharya: A curate's egg

A PIECE OF MY MIND

This Budget's raft of tax policy proposals is like the curate's egg, good in parts. Let's begin with the tastier morsels. First, and perhaps most important, the Budget speech commits the government to phase in a national goods and services tax (GST) in the four years to April 2010. If this happens, it will be a truly historic (an overworked word these days) accomplishment in India's tax reform journey. At least, the government's intention has been formally proclaimed and must be warmly welcomed. The announcement's credibility quotient would have much higher if the target date had been set for April 2009, within the allotted five-year span of the present government. But let's hope for the best.

Second, the Budget makes actual forward movement towards the announced medium-term objective by raising the general services tax rate from 10 to 12 per cent, in the direction of convergence with the CENVAT 16 per cent rate for goods. Third, the minister has correctly noted that "the bane of excise and customs tariff is the plethora of exemptions". He has gone on to remove some of them. Somewhat discordantly, he has also created a few more. More importantly, he has pioneered the publication of an annual "statement on revenue foregone" or a "tax expenditure statement" as part of the Budget papers. This is truly innovative and important. It's also quite an eye-opener as numerous editorials have already noted. These public estimates (and one can quibble about the methodology) can become a potent weapon in the arduous struggle to reduce tax preferences and exemptions enjoyed by various sectional interests. Finally, the Budget leaves the rates of company and personal income taxes unchanged. The minister has also restrained his usual proclivity for introducing controversial new taxes, at least as far as direct taxes are concerned.

That pretty much completes the delectable parts of the curate's egg (literary types may google to refer to George du Maurier's cartoon in Punch of November 9, 1895). The rest of the tax policy meal is forgettably bad. To begin with, I find it quite depressing that well into the first decade of the 21st century, when simple folk are glibly chatting about fast breeder reactors, comprehension of the Budget's tax proposals still requires a solid background in inorganic chemistry. Alright, PVC is almost a household word. But LDPE, PP, EDC, VCM, DMT, PTA, MEG? I ask you! All this is eloquent testimony to the utterly needless (and dysfunctional) complexity of our indirect tax structure. It takes the minister a full 37 paragraphs to merely outline his indirect tax proposals. Incredible India, indeed! In contrast, in most modern tax structures annual indirect tax proposals are confined to minor changes in the general VAT rate and a couple of customs duties.

Turning to customs, this was a golden opportunity to converge all non-agricultural rates to just two, 10 and 5 per cent (even a single rate of 10 might have been possible). This would have been especially easy when a fresh 4 per cent CVD was being levied. (By the way, how come all the pink papers pounced on poor Yashwant Sinha for his 4 per cent SAD in 1998, while there is hardly a peep of protest from them now when Chidambaram repeats a similar measure? Perhaps they are distracted by fast breeders ...) No such luck. Instead we are treated to a measly 2.5 per cent reduction in the peak rate down to 12.5 per cent and a promiscuous proliferation in other rates...2, 5, 7.5, 10, entailing an impressive variety of effective protection rates (of value added). Obviously, simplicity and economic logic are no match for the persuasive powers of established industrial interests.

The Budget's excise proposals are even less palatable. After a pro forma genuflection towards " our intention to converge all rates at the CENVAT rate" the speech goes on to outline a bewildering variety of new concessions and deviations from the 16 per cent CENVAT for goods such as packaged foods, footwear, DVD drives, LPG stoves, lamps and synthetic yarns and fibres. For footwear alone, we now have three rates of excise: zero, 8 per cent and 16 per cent! In effect, the concessional rates of 12 and 8 per cent, originally intended for exceptional items, are becoming increasingly populated. And the number of exempted products has increased.

Such multiplicity of rates makes for bad tax policy for several reasons. First, it strengthens the incentives for the general run of producers to seek concessional rates and thereby undermines the integrity of the 16 per cent CENVAT rate. Second, the prevalence of multiple rates means that commodities in a production chain suffer value added taxation at varied (and often unpredictable) rates. (In contrast, if all goods were taxed at 16 per cent, then value added at all stages would also bear that same rate of tax.) Even the supposedly expert practitioners of this complex tax policy are often innocent of the actual results. Witness the need (in this Budget) to retract the recently granted exemption for computers because domestic manufactures have woken up to the need to avail of CENVAT credit. Third, new exemptions on final products create pressure for exemptions at earlier stages in the production chain, thus playing havoc with a VAT system. Fourth, the avowed use of "temporary" excise concessions to promote specific industries (as in the case of synthetic yarns and fibres) is totally at odds with a stable CENVAT (or GST) structure and betrays a weak understanding of a true VAT system (my more worldly friends pity my naivete, since they attribute such concessions to powerful industrial lobbies and not to any misunderstanding of the VAT system).

Regarding direct taxes, the stability of the key rates has already been commended. No such welcome can be extended to the perseverance with the two bad taxes introduced in the previous Budget, namely the FBT and the cash withdrawal tax (see my article in this paper, January 24, 2006). This Budget has introduced another new bad "tax" in the form of a mandated, below-market interest rate for short-term agricultural loans. This "tax" on co-operative and commercial banks is to be compensated through subventions channelled through NABARD. Basically, it is a throwback to the bad old days of subsidised credit and interest rate controls, which also treats banks as government departments. The poor old RBI must be squirming in discomfort.

All in all, this Budget's tax policies are a very mixed bag. They could easily have been much, much better. And you can't even blame the Left.

The author is Honorary Professor at ICRIER and former Chief Economic Adviser to the Government of India. The views are personal