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Run-up to the Budget 2010 »Budget Columns»Budget Columns Details
Budget Columns Details
Budget 2010

Fiscal reform likely to top the Budget agenda

Mukesh Butani / New Delhi 22 Feb 10 | 12:37 AM
23 Replies

As Finance Minister Mukherjee prepares to deliver his second budget in the midst of competing expectations of stakeholders, it will be interesting to observe his approach and policy directives for achieving balanced growth keeping in line with economic realities.

From what is evident in the CSO data for GDP growth and fiscal deficit forecast for the current year, it appears certain fiscal deficit management and measures to push growth beyond 7% will be on top of the agenda. This could mean policy makers shall take a hard look at concessions, an impact thereof on the macroeconomy and of course, strategies for greater tax revenue mobilization.

Fiscal stimuli roll-back – is the timing right?

The economy has seen a remarkable turn-around and its now been consistent for three quarters. In fiscal 2008-09 when global economies witnessed slowdown, the impact was felt in India. Our GDP growth dipped from an average of over 9% in the previous three years to 6.7% in 2008-09. While the economy demonstrated tremendous resilience, tentacles of slowdown are deep-rooted than what figures may indicate.

To tide over short term economic realities, the government put together stimulus packages. The fiscal stimuli thrown-in to keep the economy afloat has been estimated at 3.5% of GDP (Rs 186,000 crore). The tax concessions aggregated to Rs 42,000 crore.

The stimulus packages have indeed pepped up economic activity, though, it has contributed to alarming fiscal deficits. Budget estimates indicate fiscal deficit of a whopping 6.8% this fiscal, highest in last 15 years. The question staring at the FM is whether or not to continue with the stimulus package.

Given the backdrop, while withdrawal of stimulus packages is on the cards, I hope the FM will not let complacency overtake prudent economic doctrines and announce a phased exit of stimuli. The timing for phasing out the stimulus will be an important point of reflection for the government and businesses.

It is important to highlight the surge in inflation (WPI) over last 10 months. The CSO data for December 2009 pegs WPI inflation at 7.3%, with food inflation at 19.2%. While inflationary trend is primarily food price rise and supply driven, the emerging growth-inflation trade-off is an important input in deciding the pace, nature and timing of exit. A bullet withdrawal could be a knee-jerk reaction as it may perhaps supplement the current supply side inflationary trends with sagging demand.

I am again hoping that the Budget announcements on exit of fiscal stimulus will adequately weigh the impact of such withdrawal given the demand-supply dynamics as the FM and his team aim to contain prices without hurting growth.

While from a macro-economic standpoint, managing the fiscal deficit and containing inflation remain worries, the Finance Minister has other equally challenging tasks – ushering in the era of tax reforms and ensuring efficient administration.

Rationalise tax rates
Given the average global corporate tax rate of 25.5%, the current rate in India at 34% is amongst the highest. Further, levy of dividend distribution tax @ 17% makes statistics worse, as the effective corporate tax rate hovers at 40-45%. Inevitably, such rates add to the overall cost of doing business besides being a roadblock to attracting foreign investment and hampering competitiveness. There is hence a need to rationalise corporate tax rates to more competitive level say 25%.

One can however not lose sight of an urgent need to thwart the deficit through revenue-driven approach than resorting to cost-curtailment manures. Given the immediate compelling need, I am not hopeful of cuts in corporate tax rates. Yet a rate cut, if announced, will be a bold reformist move. Elimination of surcharge and cess would certainly be welcome.

From individual taxpayer's standpoint, the current tax exemption threshold appears modest.

Tax incentives
Over the past few years, the Government resorted to a near-sighted approach in extending tax holidays to IT/ITeS sector. Considering the growth in the sector and industry expecting a 13-15% growth, it may be justified to announce a long term policy for tax incentives for the sector. While tax incentives for sunrise sectors (renewable energy, healthcare and education) are anticipated to be on the agenda, tax breaks for R&D could be surprises we may see.

Roadmap to DTC
Evidently, the highlight this year was introduction of the draft Direct Taxes Code bill, a major policy initiative that attracted heated debate. While, the draft code is undergoing a revamp by the working group to incorporate feedback from all stakeholders, it is anticipated that Budget 2010 could herald important provisions deemed as necessity by the law makers. As regards April 2011 date to roll out a brand new code, I am skeptical given the changes proposed on issues and our track record for administering changes in the tax code. My reference is to treaty override provisions, control and management test, general anti-avoidance, introduction of gross assets tax and capital gains tax provisions. Having said that, there are good elements in the code, particularly reduction in the overall corporate tax rate that merits to be highlighted. It is anticipated that the Budget will lay down timelines for implementation of the New Tax Code.

Tax administration reforms
The focus of the government, though, is likely to be management of macro-economic situation and rationalisation of tax incentives, need for simplifying tax administration would continue to be challenging in the short to medium term.

Institution of Dispute Resolution Panel in the last Budget for speedy disposal of specified Income Tax disputes may not prove effective given the conflict and composition of resolution panel. Having said that, we have a plethora of pending tax disputes and tax demand locked up (approx Rs 200,000 cr) which warrants immediate attention. What is required is a game plan and target to reduce tax demands stuck in litigation. It will auger well if targets are laid and evaluated on an annual basis. Otherwise, it will lead to ballooning of dispute figures.

Alternatively, policy makers may reflect a need to revitalise the defunct Settlement Commission as an alternate forum for speedy disposal of tax disputes. At present, recourse to Settlement Commission is available where the proceedings are pending before the assessing officer. This limited recourse has rendered the Commission redundant. We need an arbitration feature comprising of members from Executive, judiciary and independent experts to settle disputes.

GST rollout – roadmap expected
In the last Budget, the FM had reaffirmed a mandate of GST implementation by April 2010. It almost appears that the GST will miss the timeline originally set for implementation.

Budget 2010, is however, expected to signal likely GST rates at least at the federal level and announce broad contours and revised timelines for GST becoming a reality. Recent presidential reference under Article 143 seeking the SC's opinion on proposed amendment demonstrates commitment of the Government to GST regime. I do not anticipate the forthcoming Budget to major policy initiative.

Budget of future policies!
There are expectations from the Budget as businesses look forward to consolidate and grow. While improving macro-economic outlook could suggest roll-back of some of the stimuli, the economy is still on its way to recovery and will need calibrated Government support for first part of next fiscal.

(The author is a Partner with BMR Advisors and views are entirely personal)

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