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Hoping against hope

The promised tax cuts may not materialise in Budget 2008-09.

Shalini S. Dagar        Print Edition: February 10, 2008

P. Chidambaram: Will he keep his promise to taxpayers?
P. Chidambaram
Read my lips; no new taxes,” said George H.W. Bush, father of the incumbent US President. Many believe that one statement won him the 1988 presidential race and ensured his place at the White House.

Just short of an election year (if the government lasts its full term, and it seems it will, Finance Minister P. Chidambaram will get a chance to present a vote-on-account next year), does the same economics have a chance of working in India? Chidambaram has been very consistent with his stance on taxes over the last few years—if there is increased voluntary compliance, there is a case for moderation in rates.

Well, compliance has been improving over the past few years, both due to reasons of strong economic growth as also more stringent tax administration. Now, the compliant seek the promised carrot. As the Budget process got underway in the first week of January, there has been a build-up of expectations of tax concessions in the coming Budget. But the Finance Minister has tried to temper this sentiment.

 The guessing game

To cut or not to cut taxes, that’s the question. There are sound economic arguments for both courses of action. Which ones will Chidambaram buy?

A few reasons to reduce taxes

  • Revenue collections have been buoyant

  • The FM has been promising moderation in return for voluntary compliance. Compliance is certainly up

    Many reasons not to do so

  • Oil prices are hovering at higher levels; the pass through of the real oil prices yet to happen

  • Global food prices, too, are reigning firm

  • Off-Budget items such as market stabilisation bonds, oil bonds, etc., still a big threat to fiscal consolidation

  • The proposed Sixth Pay Commission is around the corner; it’s a pre-election year; and political considerations may upset the apple cart
Yet, for the compliant, tax-paying middle class, there is clearly a case for some relief. Salaries may have risen but so have outgoings, whether through additional levies such as the education cess, or service tax on a phalanx of services. “There is surely a case for reduction in the tax incidence on individuals, which is already quite high,” says T.K. Bhaumik, Chairman (Economic Affairs), ASSOCHAM.

Income tax on individuals is a component of direct taxes, the other major chunk of which is corporate tax. Till mid-December, direct tax collections grew 40 per cent over the figure for the corresponding period of the previous financial year. Indirect taxes (mainly service tax and customs and excise duties) grew over 15 per cent till October 2007.Subir Gokarn, Chief Economist, Standard & Poor’s Asia Pacific, however, wants the coming Budget to leave tax rates alone. “One should not underestimate the threats to fiscal consolidation,” he says, expressing concern about burgeoning oil bonds, market stabilisation bonds and rising food subsidies, among other things.

To top it, the government also faces the Sixth Pay Commission recommendations. The Fifth Pay Commission resulted in a payout of Rs 53,000 crore and was considered the single largest shock to public finances; the economy took more than a few years to recover from that shock. This one is expected to be more of the same.

In terms of direct taxes, at least on the corporate side, Indian rates are comparable to international benchmarks. Hence, India Inc.’s call for lower taxes may not get the patient hearing that it wants—except that economic growth, the basis for the current round of government prosperity, is showing signs of weakening.

Manufacturing is turning out to be a laggard. For the first eight months of this financial year, manufacturing growth stood at 9.8 per cent, down from 11.8 per cent during the same period last year. And to spark consumer demand, the Prime Minister’s Economic Advisory Council, too, suggests fiscal incentives.

Chidambaram will then have to walk this fine line between matching expectations and ensuring fiscal discipline. Among the choices that seem probable are, higher exemptions on the personal income tax (Bhaumik calls it a low-cost measure), possible reductions on the excise front and a spate of schemes pitching for an inclusive India. Broadly, the tax rates and slabs are likely to remain where they are. Was it Benjamin Franklin who said, “In this world, nothing is certain but death and taxes?”

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