By now it is clear that India faces a difficult fiscal environment at present and the medium-term challenges are formidable. The indications are that the central government?s fiscal deficit target is likely to slip by one percentage point and at the state level, although the consolidated deficit is within the Finance Commission?s target, the power sector losses add to the problem. The consolidated deficit excluding the power sector losses for 2011-12 would be close to 8% of GDP (9% of GDP) and this has to be brought down to 5.4% in 2014-15. In addition to this 2.6 percentage point adjustment, there will be additional demands for spending on healthcare, education and food security, which could result in an additional 3% of GDP. Thus, the required fiscal correction in the next three years would be 5.5-6% of GDP and at the central level alone it could be 4-4.5%.
Acceleration in growth and making the growth inclusive surely requires larger as well as more efficient public spending on social and physical infrastructure. An inclusive growth strategy calls for economic empowerment of the excluded, for which imparting skills and enhancing their employability and productivity is necessary. A part of the adjustment and increased outlay on empowerment will have to come from cutting down subsidies and transfers. These have been initiated in the mistaken notion that mere redistribution will achieve inclusion. Instead, they have hindered even the limited skill development that used to occur through migration, and have distorted the labour market. There is a fear that these programmes will result in condemning the poor to perpetual poverty and could lead to the adoption of capital-intensive technology in a labour-surplus economy. Additional spending on social and physical infrastructure is necessary for inclusion even as we need to make them more efficient.
All this implies that significant volumes of additional resources will be needed to achieve the required fiscal adjustment and to finance additional spending on social and physical infrastructure. Often, it is pointed out that cutting down tax concessions could be one source of funding. A common refrain of economists is that pruning tax concessions will not only enhance revenues but also minimise unintended distortions. In the Union budget, revenue forgone due to tax concessions in 2010-11 is estimated at R5,11,530 crore, which is 72% of the actual tax collected or 6.5% of GDP. Indeed, if this is completely eliminated there is no fiscal problem whatsoever. However, unfortunately, neither are the estimates of revenue forgone realistic nor can they be eliminated easily. Therefore, while every effort must be made to reduce them, this has only a limited applicability.
Since 2006-07, the Union budget has been reporting the estimate of revenue forgone from tax concessions with the fond hope that this will help educate the parliamentarians and the public and it will provide motivations to contain the concessions. The revenue budget estimates the tax forgone due to various concessions in 2010-11 at R5,11,530 crore, of which R1,98,291 crore (38.7%) was due to excise duty, R1,74,418 crore (34.1%) was due to customs duty, R88,263 crore (17.3%) was due to tax incentives in corporation tax and R50,658 crore (9.9%) was due to personal income tax.
A closer examination of these estimates, however, makes it clear that the estimate of revenue loss is clearly an exaggeration. First, there are serious shortcomings in the methodology used for estimating the revenue loss and, second, it may not be possible to withdraw many of the concessions. On the methodological issue, the estimates are made on the assumption that the removal of concessions will not reduce the tax base and the tax bases are independent. In the case of area-based concessions, for example, the assumption is that the additional investments would have occurred even in the absence of concessions and, therefore, both the income and production/sales from additional investment and production could have been taxed. In the case of excises and customs, the estimated revenue loss is arrived at by estimating the difference between the nominal tariff rates and effective rates.
Those familiar with the excise/customs tariff schedule know that the nominal tariffs are merely enabling rates and, in the case of agricultural commodities, the nominal import duty rates are fixed as a part of the negotiating strategy and these are not the intended rates. Further, the high nominal rates on agricultural commodities like edible oil and pulses are reduced to zero when there are severe supply shortages. The predominant portion of the concession in corporation tax is for accelerated depreciation (40%) and exemption to power generation, transmission and distribution (10%) and other infrastructure companies (9%). Furthermore, a number of items imported are processed and re-exported and it is never the intention to levy customs duty on re-exports. The estimates show that duty forgone on the import of mineral oil amounted to R40,893 crore (17.9%), on precious stone and jewellery R48,798 crore (21,4%) and on vegetables, fruits and vegetable oils R29,069 crore (13.7%). Taking the difference between the nominal and effective rates and multiplying it with quantities imported/ produced gives an exaggerated picture of the revenue lost.
All this does not mean that there is no scope for pruning tax concessions. Unfortunately, even as most economists decry tax exemptions and concessions in pursuit of a variety of objectives through tax policy, it is a fact that special interest groups in every country secure them under the guise of one social objective or another. In India, the tax policy has been made to pursue a variety of objectives such as promoting savings, encouraging exports, enabling balanced regional development, creating infrastructure, promoting scientific research, encouraging employment, enabling gender equity and many others, besides raising revenue and promoting equity. Surely, these objectives are worthy, but they should be pursued through other policy instruments rather than loading the tax policy with them. Pursuit of multiple objectives through the tax policy complicates the tax system and provides enough scope for evasion and avoidance. Unfortunately, this is a cancer that pervades every country, and we would prefer less of it and hope the current fiscal adjustment challenge provides an opportunity to cure the cancer.
The author is director, National Institute of Public Finance and Policy. These are his personal views