M Govinda Rao: Budget tips for Chidambaram

The challenge is in resuming on the adjustment path set in the Fiscal Responsibility and Budget Management Act

Come February, it is Budget time again. Elsewhere I have characterised the event as the "Great Indian Circus". Speculations on the policy changes, the entertainment and hype provided by both multiple audio-visual channels and print media and the galaxy of experts dishing out "instant analysis" and ready remedies for all economic problems make the event very lively. In fact, the Budget in India is not merely a fiscal policy statement and presentation of income and expenditure accounts of the government. It is a "nirvana pill" meant to provide everything for everyone. Forget that even fiscal policy initiatives are undertaken throughout the year without much notice. Forget also that the pronouncements made in the Budget may not be implemented during the year. In spite of the awareness that much of what happens in the Budget has become irrelevant, the show goes on.

The hype and hoopla is probably a legacy of history. The public sector dominance in the planned development strategy and the centrality of fiscal, financial, pricing and regulatory policies to economic agents placed enormous emphasis on annual Budgets as instruments to steer the policy mix in conformity with plan objectives rather than merely calibrating fiscal policy instruments. However, even as the planning process has receded, the Union Budget continues to be seen as setting the overall policy direction.

In this piece, important fiscal policy measures in the Budget are speculated on. The latest estimates indicate that the government is likely to adhere to the Budget estimates of revenue and fiscal deficits, contrary to predictions of many that the estimates were too optimistic. The revenues have been buoyant and expenditures seem to have been contained. Of course, revenue from excise duties has not shown the assumed buoyancy and there could be some shortfall also in non-tax revenues due to lower interest receipt from the states and lower dividends from oil companies. But the GDP estimates would be higher and that should take care of the ratios.

The challenge is in resuming on the adjustment path set in the Fiscal Responsibility and Budget Management Act (FRBMA). This requires significant reduction in fiscal and revenue deficits in 2006-07, particularly after the "pause" in 2005-06. In normal circumstances, this would have been eminently feasible, but compulsions of coalition politics will require resources for additional spending on various schemes. Thus, financing the Rural Employment Guarantee Act, Bharat Nirman Programme, Sarva Shiksha Abhiyan, midday meal scheme and National Rural Health Mission""all these will require additional funding.

While in the medium term, a high buoyancy of direct taxes, seen in the last three years, may continue, this by itself will not meet the requirements. Additional resource mobilisation measures will be necessary. At the same time, increase in revenues by raising the rates of tax will be counterproductive. Any revenue mobilisation measure should be done within the framework of evolving a rational tax system in the country.

From the perspective of evolving a rational system of consumption tax in the country, it is important to transform the existing CENVAT into a manufacturing stage value-added tax on goods and services. This calls for extending the service tax to all services and ensuring a tax credit mechanism for taxes on both goods and services in the first stage and merging CENVAT with the service tax by having a common exemption limit and uniform rate in the second. This is an opportunity to extend the service tax base and raise revenues and move towards a more rational tax system. Another rationalisation measure to move towards a simplified and a rational excise tax is to convert the prevailing specific duties into ad valorem.

Another set of measures that the Budget should consider is to broaden the tax base further. One source that could bring in significant revenues is to levy import duties on all imports that are exempted at present, at 4-5 per cent. The list of exempted items runs into several pages and from the viewpoint of achieving convergence in rates, this is an important measure. Equally important is the measure to levy an additional countervailing duty on all imported items in lieu of sales taxes. At present, while excise duty is neutral between domestic production and imports, sales tax is not leviable on imports and therefore discriminates against domestic production. It is, however, important to ensure that this tax is eligible for CENVAT credit when the imported commodity is used in production or is resold.

Expanding the tax base and minimising distortions in tax system also call for doing away with various exemptions and concessions given both in corporation tax as well as excise duty. The exemption to small-scale industry with a turnover up to Rs 4 crore or tax payable up to Rs 1 crore is a major distortion as it only helps to split businesses. The revenue cost of this exemption is estimated at Rs 12,500 crore in 2005-06 in a recent NIPFP study. The area-based exemptions in excise duties and corporation tax are a significant drain on the exchequer (Rs 2,000 crore) and they also distort the investment pattern in a major way. It may not be easy to do away with these exemptions or advance sunset clauses, but this is an area that should be explored.

Another set of measures that should be undertaken in this Budget is to facilitate the evolution of destination-based value-added tax at the state level. An important measure in this direction is to reduce the central sales tax to 2 per cent. Surely, this involves a revenue loss of about Rs 9,000 crore to the states, and surely, some mechanism for compensating them will have to be put in place. Returning the additional excise duty items""sugar, textiles, and tobacco""to the states for the levy of VAT will have to be considered. At present, in lieu of this, the states receive 1 per cent of central tax revenues as per the recommendation of the 12th Finance Commission. They could continue to receive this and the three groups of commodities could also be given to them.

What ultimately happens in the Budget will depend on the political manoeuvrability. Let us hope the government will be able to steer the fiscal policy back to conform to the FRBMA targets.

The author is Director, National Institute of Public Finance and Policy. Comments at mgr@nipfp.org.in