North Block mandarins would be busy fine-tuning the Union Budget 2017. The year 2016 was blemished with political tremors in the global and domestic environment. On the domestic front, government's impromptu economic reform,'demonetisation' of high value currency, caused a virtual loss of the Winter Session in Parliament coupled with uncertainty in the rollout of GST, besides holding back legislative business.
FULL COVERAGE: UNION BUDGET 2017-18
The other key developments in 2016 include passage of Constitutional Amendment Bill for GST, dedicated action to deal with the menace of black money [Income Declaration Scheme, 2016 (IDS), amendment to Benami Property Transactions Act, etc.] and concentrated efforts to improve the tax administration. The impact of such tectonic changes would be underscored and largely determine the policy framework in Budget 2017.
FULL COVERAGE: RAILWAY BUDGET 2017-18
Majority of the policy announcements are expected to focus around changes to the economic architecture to address the post demonetisation policy framework. This could mean reduction in tax rates for corporate as well as individual taxpayers, though the fiscal health will guide the extent to which the Finance Minister(FM) can bet. Most experts believe that the FM will avail another year to meet the overall fiscal deficit target of 3 per cent, on the back of healthy tax collections.
In the 2015 Budget speech, the FM had proposed lowering of corporate tax rate from 30 percent to 25 percent over a period of four years, coupled with simultaneous phasing out of tax incentives. While the 2016 budget laid down a roadmap for phasing out of tax incentives (and announced few new tax exemptions), reduction in corporate tax rate was not implemented, other than a concessional rate for new manufacturing companies and marginal rate cut for start-ups.
Industry is expecting a realignment of Minimum Alternate Tax (MAT) rate, which was re-introduced in Finance Act, 2000 and was charged at 7.5 percent when the corporate tax rate hovered around 35 percent. Since then, while the corporate tax rate has declined to 30 percent, MAT rate has increased to 18.5 percent. Considering that the government has announced a roadmap for reduction in corporate tax rate, there is a case for the government to review the MAT rate given that it should bear semblance with the prevailing tax rates.
The larger plan for tax rate realignment seems to be in line with the recommendations of expert groups, particularly Justice (Retd.) Easwer Committee and administrative reforms suggested by the Tax Administration Reform Commission (TARC). On the global front, President-elect Donald Trump has proposed slashing of corporate tax rate in the US to 15 percent.
This marks a tectonic policy shift in the Unites States, which has average income-tax rate of around 39 percent. Similarly, UK already having walked path of low corporate tax rate of 20 percent is now proposing to further reduce to 17 percent by 2020. India's corporate tax is much higher even as compared to Asia's average tax rate of 20.14 percent (weighted average rate of 26.20 percent).Thus, lowering of tax rates would be in line with global trends and reinforce India's claim as a competitive investment destination.
Similarly, given the need to reverse the sombre mood due to artificially imposed cash-crunch, increase the disposable income of the households and revive the consumption story, the FM is expected to reduce tax rates for individual taxpayers and advance other tax sops, while refraining from populism.
While doing so, it has to be borne in mind, as pointed out by Economic Survey, that India's tax-to-GDP is 5.4 percent, much below comparable markets, and just 15 percent of national income is reported to the tax authorities.
Though hiking tax-exempt income or bringing back standard deduction, as recommended by the Justice Easwer Committee, appears to be the popular choice, this will obviate the need to file tax returns for around 15-20 lakh taxpayers. Hence, a more reasonable approach would be to keep the basic exemption limit intact and increase the 10 percent slab rate from the current ?5 lakh to say, ? 8 or 10 lakh.
That said, under both the scenarios (whether basic exemption limit is enhanced or 10 percent slab rate is increased), the government could fall short of meeting its fiscal deficit target of 3 percent for financial year 2017/18 as the tax revenues could possibly be impacted in the short term. This would need to be compensated by steadily increasing the taxpayer base. According to the government, IDS and Pradhan Mantri Garib Kalyan Yojana (PMGKY)are likely to contribute to this objective.
As per a recent press release of January 9, 2017, this has seemingly manifested in 12 percent increase in direct tax collections up to December, 2016 vis-à-vis corresponding period last year. However, increase in taxpayer base because of such schemes may not be sufficient to make up for tax revenues foregone due to rate cuts or extending tax sops, and would require other measures.
The government should focus in simplifying the tax regime and bring in new taxpayers into the tax net through effective enforcement. Recommendations made by the TARC, like increasing the scope of presumptive taxation, use of technology, providing incentives for people who disclose information about large non-compliance, re-introduction of Fringe Benefits Tax and Banking Cash Transaction Tax etc, need to be considered and implemented.
A corollary to India's problem of low taxpayer base is the composition of tax revenue, which is skewed in favor of the indirect taxes. The composition of India's tax revenue as compared to other economies / regions reflect certain trends - (a) the proportion of indirect tax in the total tax collections is very high; and (b) income-tax collections from individual taxpayers is low.
The reasons for the two are intertwined. Successive Indian governments have opted for a low-hanging fruit in the form of increasing the rate and scope of indirect taxes because of the relative ease with which indirect taxes can be collected, rather than expand the net of direct tax payers. This hampers India's fiscal capacity by restricting the overall increase in tax to GDP ratio and is undesirable given the regressive nature of indirect taxes.
However, indirect taxes continue to contribute a major chunk to the total tax collection in India. For financial year 2015/16, indirect taxes constituted around 65 percent of the total tax collections (including total tax collections of centre and state governments) in India.
With global commodity prices still low, windfall gain from IDS, benefits from demonetisation and national elections two years away, this perhaps is the right time for the government to reorganize tax rates and provide a roadmap for increase in tax-GDP ratio to strengthen its overall fiscal capacity. This could help break India's long standing and unwarranted position of under-taxing and under-spending.
(Assisted by Amit Bablani)
Author is Managing Partner, BMR Legal. Views are personal.