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| Revving up: Duty cuts in pipeline |
Palaniappan Chidambaram, 61, is going to be the
envy of most finance ministers when he rises to present the Union
Budget for 2007-08. After all, it is not every day that the treasury
manages to exceed even its most optimistic revenue targets, and,
that too, by a comfortable margin. The finance ministry is expected
to close 2006-07 with at least Rs 20,000 crore more than the Rs
4,42,200 crore that Chidambaram had estimated he would collect in
taxes. And mind you, this wasn't an easy target by any stretch of
imagination; it was as aggressive as it gets. Finance ministry officials
point out that the target of Rs 2,10,000 crore for direct taxes
was exactly double the actual direct tax collections in 2003-04-a
100 per cent growth in three years-and even that is likely to be
exceeded. This has given rise to optimism that the Finance Minister
may play Santa Claus on February 28. "If tax compliance improves,
there is scope for moderation," he reiterated recently in a
television interview. That's the positive part. On the flip side:
Chidambaram will be under tremendous pressure from his own party,
coalition partners and allies to allocate resources to populist
schemes in a year when several states go to the polls.
It's the Economy, Stupid
| YOU CAN EXPECT
CHIDAMBARAM TO... |
| Remove the 10 per cent surcharge on corporate
and personal income taxes
Reduce income tax rates on personal income
Reduce peak customs duty rate by 2.5 per cent to 10 per
cent
Increase the service tax rate to 14 per cent and bring
more services into the tax net
Announce a clearer roadmap for transition to the Goods
and Services Tax by April 2010
Reduce myriad exemptions across the tax system
Make visible and probably enhanced allocations for education
and healthcare
Make a visible effort to spur growth in the lagging farm
sector. He may set up a farmer infrastructure investment
fund as proposed by National Commission for Farmers
Announce a special package for unorganised sector workers
and for minorities
AND MAYBE...
Reduce the excise duty on large cars from 24 per cent
to 16 per cent. He could push this to the next year as well
Take small steps on financial sector reforms, including
capital account convertibility |
For economy watchers, this abundance doesn't
come as a surprise. It has been in the works for a long time, as
the government, over the years, rationalised and simplified the
country's complex tax structure. But the more immediate trigger
for this bounty is the stupendous economic growth that India has
been experiencing over the last few years. "Public finances
are improving partly because growth is feeding revenues and partly
because of improved tax systems," says Sanjeev Sanyal, Director,
Global Markets Research, Deutsche Bank.
The economy has been galloping quarter after quarter.
So have corporate profits (See In Step With Each Other). Gross
Domestic Product (GDP) growth in the first-half of the current
financial year topped the 9 per cent mark-close to the aspirational
double-digit growth figure. If the services sector was the lone
sprinter earlier, then industry has now joined the race, clocking
14.4 per cent year-on-year growth-nearly 3-4 percentage points
over consensus estimates-in November, 2006. The rest is a no-brainer:
rapid industrial growth naturally leads to higher excise collections
(though they are still lower than what the fm would want) while
higher imports swell the customs duty kitty. And corporate tax?
This rose over 50 per cent during the first three quarters of
the current financial year. It's a virtuous cycle-corporate expansion
is fuelling a secular rise in salary levels that has fuelled an
over 27 per cent growth in personal tax collections during the
same period (See The Coffers Brimmeth Over).
The boom in the services sector, which accounts
for 55 per cent of India's GDP, is also being reflected in the
tax collections. Though the service tax to GDP ratio is still
a low 1 per cent, it is growing rapidly on its still small base
and helping sustain the over 20 per cent growth in indirect tax
collections. New levies introduced over the last three years,
such as the securities transaction tax (STT) and the fringe benefit
tax (FBT), also help sustain the momentum. "These new taxes
are easing the pressure on traditional contributors such as customs
and excise," says Gaurav Taneja, Partner, Ernst & Young.
Improved Tax Systems
Across the economy, the emphasis has shifted from
tax avoidance to wealth creation, says Rahul Garg, ED, PricewaterhouseCoopers.
"Given the economic buoyancy, there is an increased ability
and willingness to pay taxes," he says, adding that the tax
department's systematic approach to investigations and scrutiny
is also helping create a credible deterrent against non-compliance.
"The department has become more aggressive; the intensity
of the action is very high," says E&Y's Taneja. The numbers
bear this out: tax demands made after scrutiny of a mere 2 per
cent of returns typically yield around 10-12 per cent of the gross
direct tax collections.
If this aggressive approach is working for the
corporate sector, then it is also working in the personal income
tax domain. The government is now tapping third party sources
such as banks (see Big Brother is Watching) to collect data on
"high value" transactions. "Unaccounted for income
has to be either spent or invested. We are tracking both routes,"
says a senior finance ministry official.
| BIG BROTHER
IS WATCHING |
| Economic buoyancy has worked in tandem with
a more vigorous and vigilant revenue department aggressively
chasing those leaking rupees. The approach has been quite
basic-map expenditure and investment and tally it with the
declared income statements. |
| Annual Information Returns (AIRs) have made
the first part possible while mandatory quoting of the Permanent
Account Number (PAN) has made the latter easier. AIRs are
collected from third party sources such as banks, credit card
companies, mutual funds and registrars of properties and then
fed into the online tax information network. |
| The mapped transactions include: |
| Cash deposits aggregating Rs 10 lakh or more
in a savings bank account in a financial year
Payments of Rs 2 lakh or more on a credit card
Payments of Rs 2 lakh or more for acquiring mutual funds
units
Payments of Rs 5 lakh or more for acquiring corporate
bonds or debentures
Payments of Rs 1 lakh or more for acquiring shares of
a company through the IPO route
Purchase or sale of immovable property valued at Rs 30
lakh or more; and
Payments of Rs 5 lakh or more for acquiring RBI Relief
Bonds.
The Banking Cash Transaction Tax, much maligned when it
was initially introduced, has also yielded a rich harvest
of information about the cash economy. Finance ministry
officials say nearly a third of such transactions are conducted
without quoting PAN. "We now have the information and
the capacity to process that information," says a finance
ministry official. |
Another associated factor, though not directly
linked to Central government finances, is the switchover in most
states to value added tax (VAT) from central sales tax. This has
created, what economists call, a "self-generating, complex
paper trail" for unaccounted wealth. And the effect on state
government finances has been dramatic. During 2005-06, tax revenues
of the 25 states that have implemented VAT grew 13.8 per cent
year-on-year-higher than the compounded annual growth in sales
tax collections in the previous five years up to 2004-05. As the
tax regime gets streamlined, more such advantages will accrue.
Room for Manoeuvre
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| Taxing services: Collections
are small but growing |
The government's coffers are overflowing. The big
question is: what will Chidambaram do with his bounty? Will he use
the available headroom to undertake some much-needed but politically
unpopular reformist measures or will he go down the populist path?
"The underlying momentum in the economy,
coupled with the new-found efficiencies in the tax collection
system, will definitely give the Finance Minister more leeway
to invest in areas like infrastructure and education," says
V. Balakrishnan, CFO, Infosys Technologies. Also, in the wake
of widespread prosperity, there is greater acceptance of the government's
"common man" agenda. "Demands for spending large
amounts on social sector schemes should not be seen to be at cross-purposes
with policies that spur economic growth. These will actually play
a complementary role," says E&Y's Taneja. But Rajan Varma,
CFO, Dabur India, adds a word of caution. "Higher allocations
for the social sector will certainly be welcome if they are targeted,"
he says, highlighting widespread concerns about the leaky delivery
channels for such spends.
However, the Finance Minister will be under tremendous
pressure to deliver a populist budget. Elections are due this
year in four states, including in the politically crucial Uttar
Pradesh; and for the political class the Budget is still a great
instrument to make its point. A sneak preview of this pressure
was in evidence when excise duty concessions for hilly states,
which were due to expire in March this year, were extended by
three years. Uttaranchal, a beneficiary of this move, is one of
the states going to polls. The same pressures seem to be driving
the proposal for priority lending to minorities by banks.
Finance Ministry mandarins are tightlipped about
the direction of the Budget, but the heartening point is that
the government is making all the right (and responsible) noises
about it. The indications are that Chidambaram will use this opportunity
to initiate changes that are critical for long-term revenue buoyancy.
And political backing for such changes was provided by none other
than Prime Minister Manmohan Singh himself. "In the long
run, our tax regime should not have too many exemptions which
make tax administration an unnecessarily complex exercise vulnerable
to misuse," he told an industry forum recently.
The focus on removal of exemptions comes with the
need for lower taxes. And there is quite a clamour at least for
lower rates on the direct taxes front. Recently, in an open letter
to the Finance Minister, investment bank CLSA Asia Pacific Markets
argued for a 3-4 per cent reduction in effective tax rates on
income for corporates and individuals. His department's bulging
coffers gives him sufficient room to grant this wish, and still
spare some for correcting the fiscal imbalance. Though the Budget
target for fiscal deficit will be easily attained this year, more
clearly needs to be done on this score. Standard & Poor's
Credit Analyst Sani Hamid points out that India's fiscal position,
including its deficits, debt and interest payment liabilities,
is still among the weakest of all the countries rated by the global
credit rating agency. "India's average general government
deficit, of 8 per cent over financial years 2003-2007, is well
above the deficit of 2.2 per cent and 2.9 per cent for the bb
and B medians, respectively, for the same period." S&P
rates India bb+, just a notch below investment grade. Higher tax
collections will give the Finance Minister space to begin fixing
this problem as well.
"It is imperative that this (buoyant)
trajectory be held. All that India needs to do is just stay the
course," says Deutsche Bank's Sanyal. And the best part is
that this time, Chidambaram can afford to please both the populists
and the pragmatists.
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