| Who lost out from this budget "" no one that I can observe. To be sure, the market did not like the increase in capital gains tax to 15 per cent; but the market also did not like the loan waiver for farmers and sent the bank index spiraling down by 4 per cent! What were they thinking? That the money for loan waiver for public sector banks (public in more ways than one "" they are owned by tax paying individuals) would be paid by innocent bystanders? Of course not; and the bank index actually went up on the day "" rationality prevails. |
| After a series of mis-step budgets, Mr P Chidambaram finally produced a budget from economic, and political, text-books. First, he did a mea culpa "" by removing the tax on cash withdrawals. This sets the stage for another rollback in the future "" the removal of the fringy fringe benefits tax. Second, he provided relief to small farmers in the form of waivers on loans. This was both a positive, and negative, move. Positive in that this was a form of cash transfer, something that the government should increasingly adopt for poverty alleviation. Negative, possibly, if it sets up perverse incentives. However, rich folks around the world (our own UTI in 1998, and England's Northern Rock in 2008) are bailed out by governments. To be fair, some of the fine-print suggests that there is a rebate for those who do pay back the loans. One will have to just wait and see. |
| There was some rationalization and reduction on customs and excise taxes. There was little expectation that the peak customs duty would be reduced in the presence of the muscle-flexing rupee. Having backtracked from the earlier enthusiasm for a strong rupee, it was unlikely that the FM would make Indian industry even more uncompetitive. The middle class was then given goodies in the form of a large improvement in the structuring of tax rates. For most taxpayers, this would result in a 5 to 10 per cent reduction in the average tax rate. It is true that income tax slabs have been unchanged since 1997, and it is likely equally true that the real effective tax rate is higher today than 10 years ago. But a large welcome improvement over last few years "" definitely. |
| All these benefits at no cost? Almost. Tax revenues have been buoyant because of the strong growth that India has experienced. And the FM has prevented expenditures from rising as fast as tax revenues. Hence, the confidence in exceeding this year's fiscal deficit and the promise of next year's target of only 2.5 per cent of GDP. In order to keep his leftist colleagues in tow, the FM had to do the sock it to the capitalists policy "" not reducing (eliminating) the dividend tax and raising the short term capital gains tax to 15 per cent. How much additional revenue the government gets from these populist ploys is highly unclear. How they think they can get extra votes is even more unclear. But as we have all learnt, mostly to our regret, the thinking of Indian politicians is different than that of mere humans. But elections may be around the corner. All in all, revenue neutral and neutral-neutral in its impact on the economy and politics. |
| However, the door was left open, if not opened more, on two financial sector items deserving the attention of policy makers. First, was there a broad hint to the RBI to reduce rates? Excise tax reductions should mean some tackling of inflation; fiscal deficit reduction should gladden the minds of all monetarists, pure, rigid or otherwise. This will also help in controlling the unnatural ascent of the rupee. While it is the case that over the long run the currencies of developing countries should appreciate, it clearly is nonsensical to presume that such appreciation should occur regardless of the initial level of currency overvaluation. In 2007/8, the current account deficit at around 2 per cent of GDP will be the largest since 1992. This is in large part due to our recent policy of keeping interest rates very high in real terms "" and widening with respect to the US. A declining fiscal deficit should be the cue for the RBI. Maybe this is what the FM was referring to when he said that on a short term basis the Finance Ministry and RBI would collaborate on the management of the rupee. |
| Yet another missed bus was that pertaining to a genuine legacy reform of the tax system. Removal of cesses, a broad band of direct tax rates, a cleaning up of the exemptions in corporate taxation, reduction of corporate tax rates to east Asian levels, and a unification of tax rates on capital gains. The FM's own tax department had pleaded for a unification of rates on all stock exchange transactions. At present the anomaly of treating stock purchases as short-term (15 per cent tax rate) and futures transactions as ordinary income (33 per cent tax) prevents India (or Mumbai) from becoming a financial center. The tax gains of a few thousand crores from the dividend tax and increasing the capital gains tax would pale in front of the tax gains from the true development of the financial sector in India. This would have been a genuine legacy "" instead, the FM will be remembered for being sometimes a bad tinkerer and sometimes a good one.
Surjit S Bhalla |
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