Suman Bery: Savouring the Budget

Professional tasters assess a wine in various stages. They start with the appearance or colour, go on to the fragrance, or "nose", continue with the taste (or palate), and end with what they call the "finish": the lasting impression left in the mouth.

So it is with the tribe of Budget-watchers, a company I have joined comparatively recently. The insatiable demands of the media compel us to make initial judgements on the basis of the Budget speech and a quick examination of the documents.

My efforts in this regard were published in these columns last Tuesday. Yet, like wine, any Budget needs to be swilled in the brain for a while before its various shades reveal themselves.

Much of the exegesis in the intervening week has been on the fringe benefits tax (FBT) and the cash transactions tax. On public finance grounds, I find the latter to be the more objectionable, as it disadvantages one means of payment over others, and could be the thin end of the wedge to wider transactions taxes.

These would once again clutter up a system that is slowly moving towards the taxation of income, international trade and domestic value-added, all at moderate rates.

It also penalises the form of payment used most by those of ordinary means, who, despite bank nationalisation, are poorly served for payment services by our formal financial institutions.

By contrast, I see the FBT as part of the continuing game of cat and mouse played between tax authorities and clever accountants the world over on the taxation of personal compensation of wealthy individuals.

The latter are paid to find loopholes in legislation; the former to plug them. The yelps of pain suggest that the authorities may be on to something.

However, the FBT does raise several interesting and important issues. The short-term issue is a procedural one. If indeed the relevant sections of the legislation were poorly drafted, as the finance minister has publicly asserted, who is accountable for this lapse?

It beggars the imagination to believe that the copious references to the proposed tax in the Finance Bill and the Explanatory Memorandum could have been slipped in at the last moment by a junior functionary.

Yet, senior officials of the ministry all appear studiously to deny ownership, and certainly do not rush to defend it. One cannot resist the conclusion that some deeper game is being played.

The medium-term issue is what the implementation of this tax might do to the compensation culture in the country. On my reading of the Explanatory Memorandum, public sector companies (presumably including public sector banks) would also be subject to this levy, even if the civil service (and Parliament, including the minister himself) is not, at least for now.

The sheer act of valuation of the multiple fringe benefits accorded to employees in such companies, if done honestly (a big assumption), would make a tremendous difference to transparency in the cost-to-company (CTC) of such benefits.

From there, it should be a short step to argue that it would be better to pay this compensation in cash rather than in kind.

A rather different issue arises with respect to global talent. Ireland is famous for having attracted a great number of talented artists through a low income-tax rate. India is not Ireland, in either wealth or size. However, we are just beginning to see the first glimmerings of India once again becoming an attractive potential residence for executives who have alternative jurisdictions available to them.

This partly reflects income tax rates that are similar to elsewhere, a contribution of this finance minister in his earlier incarnation. A confident, globalising India will need to compete with China for such talent, particularly if we are serious in our goal of turning India into an international financial centre.

Our taxation of personal compensation should support this goal.

The deeper shades of the Budget reveal themselves in the accompanying statements to Parliament under the Fiscal Responsibility and Budget Management (FRBM) Act, 2003.

In addition to providing a valuable gloss on the Budget, these documents also provide the basis for an initial judgement on the impact and value of the FRBM Act itself, and the interplay between the FRBM Act, the introduction of the state-level VAT, and the award of the Twelfth Finance Commission.

Knowledgeable readers would be aware that international opinion remains divided on the value of fiscal rules of the kind represented by the FRBM Act. The most notorious case is of course the Stability and Growth Pact supporting the introduction of the euro, which, in a stroke of poetic justice, has seen France and Germany, the two most superior members of the EU, hoist with their own petard.

The main criticism of such rules is that they are too rigid to accommodate events as they unfold, and divert attention and energy to the short term and to creative accounting, rather than addressing the larger normative issues of the desired role of the state in society, and the effectiveness of government expenditure.

Supporters of such legislation believe not just that such rules prevent fiscal indiscipline, but that they encourage intelligent debate on the future course of public finance, and indeed of macroeconomic policy as a whole.

On the basis of one year's experience, over two Budgets, I would judge that, on balance, the Act is serving a useful purpose.

Taking the new documents produced under the Act, together with the increasingly transparent and sophisticated policy (and analytic) documents coming out of the Reserve Bank of India, as well as the well-established Economic Survey, the official sector is doing a fair job in equipping Indian democracy with a framework within which to assess the conduct of macroeconomic policy.

While a single year's "pause" in the adjustment of the revenue deficit is perhaps not so serious, the underlying medium-term fiscal picture remains extremely grim.

The documents make it clear that the finance ministry is pinning its hopes on a combination of rapid growth, low interest rates, and tax reform, to escape from a debt trap that otherwise threatens to close in. The documents confirm the unwillingness of the government to take any serious action on revenue expenditure on the lines signalled in the second Kelkar report.

The various proposals in the Budget also mark a worsening in the quality of the balance sheet of the consolidated public sector. As the documents point out, following restructuring the average yield on state government debt at 7.5 per cent will be below the average cost of government liabilities at 9.3 per cent.

Many analysts, particularly from overseas, have remarked that economic conditions have seldom been as favourable as now. Yet the fiscal space available to the government remains extremely limited.

To conclude, the minister has gambled that the economy will remain buoyant for the remainder of this government's term, with nominal growth at 12 per cent. This might be seen as representing the triumph of hope over experience, but it can also be seen as a bet on the continuation of economic reform, and the growth of the tax-paying classes.

With no apologies to the Left, I would conclude that the Budget is best described as a cru Bourgeois, firmly rooted in the terroir of India.

(The author is Director-General, National Council of Applied Economic Research. The views here are personal.)