Will Chidambaram make us richer?

Will he or won’t he? Rose petals are unlikely to help you with this one. Because the question is
whether Finance Minister Palaniappan Chidambaram will make us richer and continue his love affair with taxpayers. He has done it in the past, wooed them in 1997 with such élan; showering goodies like reduced income tax rates, that they were left craving for an encore.

He has been less flamboyant in his second stint at the North Block which started in May 2004. The thrust has not been so much on increasing disposable incomes as on generating a favourable saving and investment environment. But in the fourth year of his second stint as finance minister, things seem just right for another dream budget. The GDP is growing at an annual rate of 9% and above, fiscal deficit finally seems under control and tax collections have beaten the target. The sore areas are rising inflation and galloping public expenses, especially the ones on hard-to-track heads. Chidambaram would be looking to give a further boost to the already buoyant spending and savings. Maintaining the spending spree is essential to continue the economy’s demand-driven dream run. The increased savings and investments are needed to ensure that supply of goods and services match up to the demand. In short, the finance minister has to ensure that more money finds its way into our pockets.

In some ways the time is right to revise income tax slabs and perhaps even lower the rates. The Kelkar Committee recommendations submitted in 2002 can be a good reference point. It had suggested that the number of tax slabs be reduced to just two (20% and 30%) The new tax return form 2F that is likely to be made mandatory for all categories of taxpayers requires all assessees to give summary details of their expenditure. The ministry officials estimate that this disclosure alone could generate about Rs 5,000 crore in additional revenues for the government. How about lowering the rates to compensate honest taxpayers who will have to put up with the inconvenience of filling up Form 2F?

Besides, Chidambaram has taken away much from our pockets through higher rates and more wide ranging service taxes, fringe benefit tax (FBT) and the 2% education cess on all taxes Indians pay. These measures have given him handsome revenues while adding to the tax burden of the urban middle class. Kaushik Mukerjee, executive director, PricewaterhouseCoopers remarks, “The tax collection through FBT is much higher than what would have been collected from actual benefits received by employees.” Also, the finance minister is aware that there is nothing like lower rates to induce people to pay taxes fully. His 1997 Budget was one of the best demonstrations of this.

Even if the tax rates or slabs are not tinkered with, there is a high probability—and rationale—of increase in the tax exemption limits under Section 80C of the Income Tax Act. The current limit is Rs 1 lakh a year. Chidambaram is thus in a position to give pay cheques of India Inc an increment, without having to cut rates.

A slight dampener is the anticipated increase in service tax rates. New services are also set to be added to the list. There are speculations that education cess may be hiked to 4%. Both these moves will drain resources out of middle-class households. Chidambaram proposes to introduce the goods and services tax (GST) by 2010 which will subsume excise and customs duties, service tax and several other taxes. What’s the need to experiment with new taxes and cess four years before the grand phase out? The proposal to introduce the Exempt-Exempt-Tax (EET) regime wherein withdrawals from savings schemes will be taxed unlike now when deposits, interest accruals and withdrawals are exempt (EEE) has caused some jitters. To be fair, the finance minister had expressed the intentions and explained the rationale for EET in his last budget itself. But with inflation running at 6-8%, the hope is that he will wait before revisiting the issue.

So are we stretching our expectations from Chidambaram? A scrutiny of his second stint as finance minister reveals that we aren’t asking for the moon. Chidambaram’s policies have definitely left us richer in the past three years. What made our pockets significantly heavier was the introduction of Section 80C in place of Section 88. The shift to the system of tax deduction from that of tax rebates is both efficient and enriching— especially for those who know how to invest smartly. Raising of the threshold exemption to Rs 1 lakh and the removal of inner ceiling on investments meant that the taxpayers could enjoy more tax relief and invest in instruments based on their discretion and not the government’s.

The senior citizens savings scheme with 9% annual interest rates, which was much higher than the bank deposit rates two years ago, showed Chidambaram’s sensitive side. It’s another matter that he was the finance minister when RBI bonds (an old favourite of the retired) were reintroduced at a substantially reduced rate of interest of 6%. The entry of fixed deposits of five years and higher tenure under Section 80C also made it easier for the conservative investor.

What pinched pockets was the introduction of the fringe benefit tax, education cess and the ever north-moving service tax rates. Employers had to pay tax on collective fringe benefits given to employees in varying proportions of the expenses incurred as well as at varying rates. This translated into a new effective tax of 6-8%.

Some rolled back measures of the past hint Chidambaram’s intention of going after honest taxpayers in his attempt to unearth black money. The 2005 proposal to tax cash withdrawals of more than Rs 10,000 in a day is one such example. Despite enormous pressure, Chidambaram refused to scrap the tax altogether but revised it to be applicable only to transactions over Rs 25,000 from current accounts.

The bottom line is that if Budget 2007 is vintage Chidambaram, taxpayers shouldn’t be in for a rude shock. Even if he does not deliver on all our expectations, he shouldn’t make us any poorer—as he woul not want to disrupt the momentum in the markets and economy at large. The booming economy has created unprecedented wealth and wealth creation opportunities for people. As long as he helps people leverage these opportunities for personal benefit, everybody will be richer—the people and the government. So don’t feel jilted if Chidambaram doesn’t say it openly. He is likely to woo the common man, only with more subtlety.

PREDICTABLY UNPREDICTABLE

Predicting the stock market’s response to the most important financial statement of the year, the Budget, is as difficult as predicting the markets. They have reacted sharply within the first few hours of the budget presentation,more often than not negatively. This is hardly related to the merit of the budget; many reformist budgets have resulted in a downslide in the markets. Chidambaram has had better luck. Of the three budgets he has presented in his second stint, only once have the markets skidded—in 2005. Surprisingly, this was the people friendly budget where income tax slabs were revised and Section 80C was introduced. Sensex capers during budget days are largely determined on market expectations and the immediate interpretation of the budget speech. While rumours can send the Sensex rushing up or down, market fundamentals take over by the end of March and that is the best time to gauge how the budget affected the markets. The upshot: fundamentals such as earnings, investments and exports drive the market—and the economy—much more than the budget.