M Govinda Rao: Worrisome fiscal concerns in Budget

The revenue department must be complimented on working out the amount of revenues lost due to tax exemptions and preferences.

The Budget presentation this year and the discussions that have followed have been a low-key affair. The visit of President Bush stole much of the thunder. There were not many surprises, either. The high buoyancy of tax revenues had assured that Budget estimates of revenue for 2005-06 would be largely met. In fact, since 2001-02, tax revenue has grown at an average rate of 18.6 per cent and direct taxes during the period grew at an impressive 26.5 per cent. Not surprisingly, the gross central tax-GDP ratio increased from 8.2 per cent in 2001-02 to 10.5 per cent in 2005-06 and is budgeted to increase at 19.5 per cent.

Unfortunately, given the compulsions of coalition politics, much of the increase in tax revenue is used to finance populist schemes and not to reduce deficits. Of course, the finance minister has been niggardly in allocating funds to populist schemes though despite being liberal in extolling the virtues of various flagship programmes. Nevertheless, considerable additional resources had to be allocated to Bharat Nirman and flagship programmes. This has put pressure on capital expenditure, on the one hand, and revenue and fiscal deficits, on the other. Not surprisingly, the capital expenditure share in GDP stays stagnant at 1.9 per cent.

The estimates presented in the Budget show the revenue deficit for 2006-07 lower by 0.5 percentage point and fiscal deficit lower by 0.3 percentage point. Thus, even after a year's pause, not much has been achieved in containing the deficits. Thus, even as tax revenues of the Centre are expected to increase from 7.2 per cent of GDP in 2004-05 to 8.4 per cent in 2006-07, the compression of revenue and fiscal deficits is expected to be much lower. Besides, with bonds to cover oil companies' losses being contemplated, there would be additional off Budget liability of 0.3 per cent. Thus, fiscal deficit reduction contemplated in 2006-07 is more illusory than real.

As mentioned earlier, expenditure compression has been mainly in capital outlay, particularly on the plan side. The plan capital expenditure declined from 1.4 per cent in 2004-05 to 0.8 per cent in 2005-06. It is budgeted to be marginally lower (0.7 per cent) in 2006-07. The plan revenue expenditure as a ratio of GDP, in contrast, increased from 2.8 per cent in 2004-05 to 3.2 per cent in 2005-06 and is budgeted to increase to 3.7 per cent in the next year mainly due to the higher allocations made for Bharat Nirman and flagship programmes.

Continued buoyancy in tax revenues without undertaking any significant discretionary measures shows the importance of instituting a credible information system for tax administration. The disappointing aspect, however, is that we still do not think of co-ordinated calibration of the consumption tax system in the country. It is not enough to set a date for the levy of goods and services tax (GST) as April 1, 2010. It is more important to lay down the roadmap for achieving this end. This would not only require the Centre to convert its CENVAT into a central GST but also work towards completing the state VAT reform and infuse confidence among the states that a unified VAT is in their interest as much as it is in the interest of the Centre. The continued levy of selective taxation of services does not serve the purpose. Similarly, much remains to be done to phase out the central sales tax. On the latter, the finance minister has promised to come back to Parliament with a detailed plan. In fact, under VAT, the concept of declared goods has no place. The extension of the concept to LPG is retrograde and does not help to infuse confidence among the states.

The simplification of the fringe benefit tax (FBT) and increase in the minimum alternate tax (MAT) were on expected lines. Given the criticisms on the FBT, some simplification of the tax had to be done. The fact is that effective tax rates in some companies, even after levying MAT, were extremely low and levying an additional rate of corporate tax would only bring in inequity between those companies that pay the tax and those that avoid. Of course, in some sense MAT itself is an aberration. The need for its levy is the existence of tax preferences. The ideal way is to eliminate them but, MAT has been taken as an implementable compromise.

The novel feature of this year's Budget is the statement on tax expenditures. The revenue department must be complimented on working out the amount of revenues lost due to various tax exemptions and preferences. At the request of the department, the NIPFP had worked the revenue cost of some important exemptions. The estimates presented in the Revenue Budget are much more comprehensive. The problem with tax preferences is that they impose four different costs on the economy. The revenue cost is only one such cost and these implicit subsidies are not subject to any scrutiny. The second type of cost which is even more damaging to the economy is the resource cost caused by altering the relative prices. The complications introduced into the tax structure due to these preferences increase both collection cost and compliance cost. Tax preferences also violate horizontal equity. Indeed, the publication of the estimate of revenue forgone will at least educate the public about the revenue loss and hopefully, make the policy makers realise the cost of their bounty.

The estimated revenue cost of Rs 158,661 crore, however, looks exaggerated. Indeed some exemptions are given in pursuit of legitimate objectives other than revenue. It could be equity or to promote reinvestment. It would be more realistic to factor in the exemptions prevailing in most tax systems (such as depreciation allowance). Similarly, applying the peak rate on all imports exempted or those subject to lower rates may not project a realistic picture. It is extremely important that the estimate of revenue cost is credible if it is to be an effective deterrent. That does not take away the credit for the hard work done in estimating the revenue cost and it is hoped, in coming years, the revenue department will refine the numbers.

The author is Director, National Institute of Public Finance and Policy, New Delhi. Comments at mgr@nipfp.org.in