Reigniting the economy

Govt should cut taxes and abolish exemptions

As Finance Minister Arun Jaitley rises to present the Union Budget on February 1, he will have his task cut out. That is because the Indian economy is facing challenges on several fronts and the finance minister must go back to basics to counter the threats. Since it assumed power in May 2014, the Narendra Modi-led government has brought about a significant turnaround in the economy. Inflation is no longer the chief worry, but economic growth has remained largely range-bound and the target of growing above eight per cent has been missed in all quarters, except one.

This has been the case because, for the most part, the Indian economy has been essentially running on just two (government expenditure and private consumption) of four wheels (exports and private investment being the other two). Exports growth has been disappointing; between December 2014 and May 2016, Indian exports growth stayed in the negative territory, thanks to continued subdued global demand. And private investments have contracted, at a progressively faster pace, over the previous three quarters. This is not surprising given the fact that capacity utilisation in Indian industry has been under 75 per cent, while the bulk of the banks are saddled with non-performing assets and a large chunk of businesses are over-leveraged.

Even so, the economy was consistently clocking over seven per cent growth, albeit with rising worries about job creation. But the November 8 decision by the government to demonetise about 86 per cent of all currency by value has disrupted the fledgling consumption story as well. It was feared that, on the one hand, growth would tumble due to demand disruption, at least for a couple of quarters, and, on the other, the government’s revenue collection would take a significant knock, thus constraining its ability to spend itself out of this slump. Thankfully, the latter worries seem to be misplaced. On Wednesday, Mr Jaitley said the government would end this year with higher revenues for both direct and indirect taxes compared to the Budget estimates. Accordingly, as against a Budget target of a 10.8 per cent increase, indirect tax collections were up 26.2 per cent in the April-November period (the first eight months of this financial year). In particular, excise collections have risen by 43.5 per cent, as against a target of 12.15 per cent, and service tax collections are higher by 25.7 per cent, as against the 10 per cent projection. Customs collections were below budgeted numbers. Even on the direct taxes front, until December 19, the net increase was more than Budget targets. Corporate tax collection was behind the target but personal income tax has yielded 23.9 per cent growth as against a target of 18.1 per cent. 

Given the fact that the government is more than likely to meet its revenue targets, the path for Mr Jaitley would be to return to the promise he made during his Budget speech in 2015. That February, he had underscored the need for a transformative change in direct taxation to go with the radical overhaul of indirect taxes in the form of the goods and services tax. He had lamented the fact that India had high corporate tax rates and yet the effective collection was low due to myriad exemptions. The time has come for a cut in direct taxes as well as abolishing exemptions of all kinds. With reduced interest rates, this move will be India’s best chance to restart the growth engine.