Given the absence of pressure on producers to pass on tax cuts to consumers, this will only worsen fiscal deficit, but palliatives are required to meet immediate consumption needs.
Shubhashis Gangopadhyay
Research Director,
India Development Foundation
My simple answer is “no”. Let me explain why. Reducing tax rates to beat inflation is a solution left over from pre-1990 days when prices of basic intermediate goods and primary articles were administered by the government. In those days, producers were allowed a pre-specified return on the cost of production, including capital cost. The market price was this figure plus the added taxes. In that scenario, a tax reduction had an immediate impact on inflation since it reduced the cost to downstream producers. This was based on the assumption that upstream producers passed on the tax cuts to the users and consumers. Since most of the basic intermediates were highly government controlled, this last assumption was somewhat plausible. Today, there is no such pressure on producers to pass on tax cuts to the consumers, regardless of what the finance minister may say.
The real problem with the current inflation is that food prices are increasing rapidly. If one were to look closely at this, one would immediately observe that the food items for which prices have risen the most are precisely those for which demands increase with a rise in income. So the inflation on food items is largely due to increased demand. Those who are claiming that growth is leading to the poor becoming poorer will find it hard to consistently argue their case since the rich do not increase their consumption of basic food items when their incomes grow, but the poor do, fuelling higher prices. And, most of these items do not attract any taxes.
The real problem with food is the plethora of controls that producers face. This is not a central government issue but is largely driven by state-level policies. All that the finance minister or the central government can do is coax the state governments to open up agricultural trade. Of course, no single state will do this but if all the states implement agricultural trade reforms in a coordinated manner, much of the within-country trade restrictions can be relaxed. The central government can play this coordinating role, which will require a strong leadership on this front.
If the finance minister were to reduce taxes, and assuming the producers reduce prices as a result of that, it would reduce the overall inflation but not inflation on food items. And, if taxes are reduced, it would certainly not help the government coffers or fiscal deficit. Investment is seldom made because taxes have been temporarily reduced. And, since investment is largely responsible for our growth, it would not help growth either. Remember that investment has a much longer perspective than a temporary tax reduction.
Indirect taxes should be rationalised and reduced in accordance with our overall tax policy. Here, the Goods and Services Tax should be implemented and this schedule has already been revised several times, while international trade-related taxes should follow our trade tax policies. As for direct taxes, the Direct Taxes Code is expected to be implemented next year and there is no reason to jump the gun this year. Also, most of the people suffering at the hands of rising food prices are outside the income tax bracket.
It is not entirely clear whether food inflation is hurting the rural poor as much as the urban poor. During the 2008 inflation episode, food price increases were overtaken by nominal rural wage increases, implying a slight growth in real income in rural India. One does not have current data but the pattern this year is very similar to what was happening then. For the urban poor, fixed prices and more commodities through the public distribution system are much better than a reduction in taxes. Both will negatively affect the fiscal deficit. But public distribution subsidies will directly solve the problem, while reduced taxes will have a much more dispersed effect, if at all.
In short, tax cuts may or may not reduce food price inflation, may or may not stimulate growth, and will have an adverse effect on fiscal deficit. Often the best way to contain inflation is to convince people that prices will soon come down, which encourages people to delay purchases. This reduces current demand, thus arresting runaway prices. Unfortunately, reducing taxes that worsen an already bad fiscal situation does not give that much confidence to people.
Vikas Vasal
Executive Director,
KPMG
The macro revenue system is based on two premises. First, to collect taxes from a person depending upon his earning capacity or potential to pay. Second, to garner resources to meet the larger macro-economic and socio-development objectives like infrastructure development, creating employment opportunities for the masses, education and so on. In this process, the government takes upon itself the role of a welfare state, in which it endeavours to achieve a more equitable distribution of resources, by collecting taxes from those who can contribute, and then distributing the resources to those who need them. Further, it is generally observed that as the economy matures and human society develops, more choice is left in the hands of the individual constituents of society, which has a consequential effect in the form of a simple tax structure and lower rates of taxes.
In the case of income taxes, this is evident from the way the tax slab rates are structured for individual taxpayers, in which a basic exemption limit of Rs 1.6 lakh is provided (higher limits for women and senior citizens). Further, different tax slab rates – these are 10 per cent, 20 per cent and 30 per cent – have been prescribed for different income levels.
In the current economic situation in which prices of basic goods and services are literally going out of bounds and the common man is finding it difficult to manage his average household budget, it is necessary that some relief is provided to him by lowering the overall tax burden, leaving some additional money in his hands. This would help him combat the overarching impact of inflation, which is a cause for concern for a majority of the population.
Of course, it could be argued that one step alone would yield little and a multi-pronged approach is required for taming this beast of inflation. These measures, inter alia, include monetary policy intervention, relief on the indirect taxes front in goods and services of daily consumption, larger policy level interventions to remove supply-side constraints and strengthening logistics to avoid the wastage of essential commodities from farm to kitchen, opening up foreign direct investment in the retail sector and so on. But many of these are long-term initiatives. The issue at hand requires some immediate intervention including on the tax front.
Therefore, three points merit attention. One, increase the basic exemption limit. Two, widen the range of the existing tax slab rates. And three, reduce the tax rates per se. In other words, the minimum threshold limit to levy taxes may be increased to, say, Rs 2.5 lakh and the first tax slab rate of 10 per cent may be introduced for income between Rs 2.5 lakh and Rs 5 lakh. A combination of these measures would help leave some extra money in the hands of the taxpayer. In fact, this is also the underling intent of the Direct Taxes Code proposed to be effective from April 1, 2012, under which some rationalisation is proposed in the tax rates.
It is generally observed that leaving more disposable income in the hands of individuals could result in two possible actions. It is either saved or invested or it is spent to meet consumption needs. So if the basic exemption limit is increased and benefits of lower tax rates are passed on to the low- and middle-level income earners, it is likely that the additional disposable income would primarily be used to meet consumption requirements, which, at present, is being curtailed due to high inflationary prices. This would have a beneficial impact on the overall economy given the India growth story is primarily based on domestic consumption.
Thus, the common man rightfully expects the finance minister to help him manage his kitchen budget, since it is ultimately the man on the ground who shoulders the burden with the finance minister, helping him manage his budget by paying taxes every year.
