There is considerable hope and expectation that the forthcoming Union Budget will rekindle the business environment. With elections to five states completed, the entire investing community in India, including the foreign investors, will be hoping that the government will use the narrow window of 15-18 months from March 2012 to implement serious reforms. Indeed, that is not an option, but an imperative for the ruling coalition. There is no doubt that the failure to move forward on the reform front will see the UPA facing a ?we all fall down? situation. In fact, it is better go back to the electorate, if the government cannot muster the numbers to implement reforms to rekindle the animal spirits.
The most important initiative to change the sentiment is to undertake fiscal consolidation measures. The third quarter review of monetary policy of the Reserve Bank of India (RBI) and the accompanying document on macroeconomic and monetary developments has underscored serious concerns on the persisting large fiscal deficit and debt since 2008-09. Both fiscal and revenue deficits, instead of contracting in the current year, have increased, mostly due to structural rather than cyclical factors. The slippage in the fiscal deficit from the budgeted level is expected to be over 1% of GDP due to overshooting of subsidies, shortfall in direct tax collections and inability to realise non-debt capital
receipts. The additional government borrowing of almost R93,000 crore and tight liquidity situation has forced RBI to resort to substantial open market operations. According to RBI reports, the impact of this has been to crowd out private investment and to aggravate inflationary pressures. Surely, the expanding fisc has severely constrained flexibility in calibrating monetary policy. In addition to these, the impact of worsening fiscal situation in compressing the much-needed capital expenditures will be known only when the Budget is presented.
The medium-term fiscal policy statement presented along with the 2011-12 Budget sets the fiscal deficit target for the Centre at 4.1%. Assuming that the slippage this year is about 1% of GDP, in 2012-13, reduction in the fiscal deficit required will be over 1.4% of GDP. In addition, there will be additional claims for meeting various entitlements, including food security, universalisation of healthcare and education. Of course, the government can embark on an ambitious target of disinvestment to raise substantial revenues. After the Supreme Court judgment on the 2G case, the government can raise some more money from spectrum auction. However, these will not bring about structural improvement in government finances. Therefore, systematic reforms in tax system and expenditures, particularly in the subsidy regime, are unavoidable.
The subsidy bill has been a major contributor to the slippage. The projected subsidy on account of petroleum products for the whole year is R1,32,300 crore, which is close to 1.5% of GDP, as against the budgeted amount of R23,640 crore. Even after the supplementary demands of R30,000 crore, there is an uncovered deficit of about 0.8% of GDP. Decontrolling of diesel prices is the single-most important policy instrument that can help achieve fiscal consolidation. In fact, it is also important to revise kerosene and LPG prices. Some have suggested levying higher excise duties on diesel cars to reduce consumption of diesel. However, levying taxes based on the end use of a commodity or a service is not advisable because this does not prevent distortions arising from the excessive consumption in other uses. Similarly, despite discussion on rationalising fertiliser subsidy for several years, the problem has persisted. Moving over to a nutrient-based subsidy without changing the price of urea does not make any sense.
Despite the delays in implementing the goods and services tax (GST) and direct taxes code (DTC), there is no reason why some elements of these cannot be introduced in the forthcoming Budget. First, there is a strong case for increasing the central value-added tax (Cenvat) and service tax rates to the pre-crisis level of 12% from the
prevailing 10%. Back-of-the-envelope calculations show that this alone can raise an additional R50,000 crore. In addition, changing over to a negative list of service taxation as against the positive list prevailing at present can substantially expand the tax base and add to revenues. The rail transport of passengers and goods alone can generate an additional R15,000 crore. Further, the negative list approach to service taxation, in effect, will transform the existing Cenvat and service tax into a GST at the manufacturing stage, facilitate administration, minimise litigation and demonstrate the gains from the expanded base to the states to move over to GST. It would also be worthwhile to examine the possibility of increasing the taxes on tobacco products to enhance revenue and reduce health costs.
The important elements of DTC that may be implemented in this year?s Budget include the enactment of the concept of residence in the case of companies incorporated outside India and amendment of general anti-avoidance rule to bring in clarity when there is a conflict between double tax avoidance rule and domestic law. The government can also levy the taxation of wealth and do away with the distinction between long-term and short-term capital gains for tax purposes. Another major anomaly that exists at present relates to the securities transaction tax. The best thing is to abolish it. If that cannot be done, the tax should be extended to currency and commodities transactions as well, for both online and over-the-counter transactions to make it neutral between various types of transactions.
A major problem with the Indian tax system is that the government pursues too many objectives with tax policy. Besides revenue and equity, tax policy is used to enhance employment, protect small-scale industries, incentivise investments in infrastructure, promote backward area development, protect the elderly, promote small cars versus large and so on and so forth. Thus, the laws get complicated, administrative, compliance and distortion costs increase and, as tax incentives proliferate, tax expenditures explode. Clearly, tax expenditures in India are large and it is necessary to phase them out in the interest of revenue, efficiency and horizontal equity.
Expectations are high on this year?s Budget. Hope the finance minister will take the initiatives to revive the sagging animal spirits. The forthcoming Budget will be an acid test as to whether the UPA government can and will restore confidence of the investor community. Let us hope it will.
The author is director, NIPFP, and member, EAC to the Prime Minister. These are his personal views