| Not only does it provide an overarching and internally consistent path for fiscal consolidation, it also dovetails long overdue reforms""essential for fostering an open and dynamic economy""in our inefficient and iniquitous framework of direct and indirect taxes. |
| It may be argued, not without merit, that implementing the Fiscal Responsibility and Budget Management Act, 2003, (hereafter FRBMA) will unduly constrain the government's counter-cyclical stabilisation capacity. |
| On the other hand, while discussions regarding the quality of governance are in vogue, it is worth keeping in mind that the health of a nation's finances is the bedrock of its system of governance, not to mention its international standing. |
| Within a fortnight, two documents from the ministry of finance, viz. the Medium-Term Fiscal Policy Statement and the RTF have made (official) prospective fiscal indicators for the next few years public, which is both unprecedented and welcome from a macroeconomic perspective. |
| Our fiscal management is graduating from an annual exercise to a commitment to rule-based multi-year fiscal targets; among other things, it will help economic agents form informed expectations pertaining to important macroeconomic variables, including, but not limited to, interest rates. |
| The RTF makes a sound case for the Centre's revenue effort (although states too will benefit due to their 30 per cent share) as the proximate mechanism for eliminating the revenue deficit and reducing the fiscal deficit to less than 3 per cent of GDP, by 2008-09. |
| It argues that there really is not much choice but to increase tax revenues by about 3 percentage points of GDP over five years, if capital and Plan expenditure is to increase and fiscal prudence is to be credibly institutionalised. |
| Moreover, this has to be contemporaneous with reductions in customs duties and the implementation of a consumption tax structure to make India a common market. It is noteworthy, as the RTF observes, that for China the share of import duties in its tax revenues is less than 3 per cent compared to 18 per cent in our case. |
| How this fiscal transformation takes place is where the RTF can leave its mark. The RTF does not claim that a successful transition can be achieved solely by methods that it has proposed. |
| What it does, by carefully laying out both the implications of its proposals and the economics behind them, is convey that "expansionary fiscal consolidation" is well within India's reach. Not only that, this may actually be an opportune time to front load the decisions, especially since there are signs that the positive economic outlook locally and globally will be sustained. |
| Also, given the inevitable lags in terms of behavioural impact on economic agents, if full benefits are to be derived by 2008-09, then implementation has to start early. This is feasible given the homework already done. |
| The tax proposals in the RTF draw on the recommendations made in 2002 by committees that separately examined the frameworks for indirect and direct taxes. Under most circumstances, a re-balancing of revenues towards direct taxes and away from indirect taxes makes the tax system more fair. |
| Since over two-thirds of the increase in tax revenue is envisaged to be contributed by direct taxes and that too with a commitment to enhance equity, it is inevitable that the removal of exemptions is at the heart of the proposals on direct taxes. |
| Some recommendations like the elimination of income tax on incomes of up to Rs 100,000 are in the 2004-05 Finance Bill. A fundamental change in rewarding savings and penalising dis-savings is recommended; tax concessions hitherto available for gross savings are proposed to be restricted to net savings. |
| On the corporate tax side, for domestic companies the rate would come down to 30 per cent from the present 35.875 per cent. Most exemptions under, inter alia, Sections 10 and 80 of the Income Tax Act would not be available in future but will be grandfathered for existing units. There are two important (and, for India, somewhat novel) proposals that will be helpful to corporations. |
| First, business losses can be allowed to carry forward indefinitely (much like unabsorbed depreciation). Secondly, while depreciation allowance will be capped at 15 per cent, capital expenditure would enjoy full (and immediate) set-off for VAT purposes. |
| On excise duties, the proposals comprise the following: reduction of CENVAT to 12 per cent; reduction in the number of rates to a three-tier ad-valorem structure; trimming exemptions; and bringing services into the VAT structure at both the central and state levels underpinned by full set-off for inputs under the invoice-credit method. |
| Regarding the basic customs duty for non-agriculture imports, a three-tier structure has been proposed: 5 per cent for basic raw materials, 8 per cent for intermediate goods, and 10 per cent for final products. |
| Concomitantly, for coherence with the overall VAT structure, the countervailing duty on imports would be replaced by CENVAT at the Centre and by state VAT at the sub-federal level. |
| On the subject of government expenditure, alas, the RTF loses some of its lustre. For starters, only a handful of pages are devoted to reforms in this area; work already available, e.g. reports of the Expenditure Reforms Commission, could have been used to impart substance. |
| While it is recognised that we need to move from a "top line" spending orientation to an outcome-based metric, the RTF fails to develop this theme; it essentially limits itself to pleading a re-examination of the institutional structure through which capital expenditures are undertaken. |
| As a specific example, the national highway programme, underpinned by the Central Road Fund, has been lauded. In this context, it would seem that this year's Budget was a missed opportunity for establishing, as recommended by the Naresh Chandra Committee on Civil Aviation, an Essential Air Services Fund for enhancing air connectivity to under-served regions by transparently deploying a minimum subsidy bidding mechanism. |
| The RTF should also have gone beyond capital expenditure; the institutional design of centrally sponsored spending on social sectors (and, therefore, disproportionately as revenue expenditure) deserves equal attention. |
| A much-needed precedent for transparency could have been initiated by ring-fencing the proposed 2 per cent education cess, thereby helping to keep the spending under the lens of both potential beneficiaries and tax payers. |
| As a final point, the constituency for implementing the RTF is, prima facie, wide. On the administrative side, the entire top brass of the finance ministry was involved in its preparation. Also, the RTF, while it may not be immediately obvious, is the culmination of a bipartisan effort. |
| The FRBMA had been passed with the support of the Congress; and committees constituted by the NDA government first proposed the tax reforms contained in the present report. |
| Furthermore, state governments, if the RTF is implemented, will stand to benefit substantially from higher tax revenues. Surely, such a fortuitous confluence presents an opportunity to put our fiscal house in order. (The author is with IDFC Ltd. The views expressed here are personal) |
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