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A sharp cut in tax rates would do more to boost business sentiments than all government spending
February, 25th 2016

The expectations on the third budget of the NDA government which the finance minister Arun Jaitley would present to parliament on next Monday is muted. With the new BJP led government showing no signs of radically departing from the fiscal policies of the UPA government in the first two budgets it is difficult to envisage any change of tracks especially when the government is almost midway through its term.

While the timing of the first budget immediately after the election gave the new NDA government hardly any time to radically revise the numbers collated by the previous government the second budget also did not pursue any radically different path expect for cutting down subsidies, duly aided by the fall in international oil prices, and marginally pushing up capital investments from the rock bottom level of 1.5% of the GDP to which it had sunk in 2014-15. The only major change on the fiscal front in the second NDA budget was the extension of the fiscal consolidation targets by a year.

At the macroeconomic level one finds that the finance minister had taken a taken a very contrarian stance in the second budget by pushing down the total expenditure of the central government to just 13.1% of the GDP, the lowest level ever touched in recent times. This is partly on account of the larger transfer of tax resources to the states by the fourteenth finance commission and the sharp reduction in the number of centrally sponsored schemes.

One major worry voiced by fiscal experts is whether the finance minister would once again give the go by to fiscal consolidation efforts and attempt to boost growth by substantially hiking up capital investments to crowd in more private investments. The other worry is that the NDA government’s inability to meet the ambitious disinvestment targets and the burden of implementing the pay commission recommendations in the next budget will send the deficit levels soaring up once again.

The argument raised from some quarters that the finance minister may push the brakes on the fiscal consolidation efforts and make an attempt to boost growth through larger government investments is an option whose impact is vastly exaggerated given that government investments financed through the central budget is less than two percent of the GDP and which includes transfers to the states. Even a substantial step up in such investments is unlikely to boost business sentiments as the time lag for converting budget announcements to actual investments is fairly long and is more likely to end up to adding to the government resources locked up in low productivity assets.

In such a scenario a better alternative open to the finance minister is to boost investor and consumer sentiments by cutting down both direct and indirect tax rates to leave more surplus in the hand of both consumers and investors. A cut in tax exemptions and reduction in tax rates over a five year period is a promise that the finance minister has already made in the last budget speech. But this proposal can run into serious problems as a gradual reduction in tax exemptions and tax rates will unleash considerable bad blood as investors jostle to delay the cut in tax exemption on their industries to the last year thereby creating more problems for the finance minister than it solves.

A more viable option in such circumstances would be to fast forward the cut in tax exemptions and end it one go or at best over a maximum of two phases. This will have not only an immediate impact on the balance sheets of the investors but also end up putting more money in the hands of the consumers. More importantly it will boost the business sentiment of both foreign and domestic investors which is especially important during a time when the government is accused of levying retrospective taxes or even resorting to tax terrorism from certain quarters.

The numbers on tax collections in the first nine months of the current year shows the scope for a cut in tax rates is very encouraging as the gross tax collections have picked up by as much as 21.1% which is far in excess of the 15.8% growth targeted in the budget. In the case of direct taxes the growth of corporate tax collection is in line with budget estimates and a cut in direct tax exemptions will provide substantially more space for reducing tax rates.

Possibilities of reducing the indirect tax rates, which fall on consumers, are also substantial. Numbers for the first nine months of the current fiscal year shows that both customs and excise duties are rising much faster than the budget estimates. This is especially true of excise duties where collection has gone up by a stupendous 68% as against the 24% targeted in the budget. Thus a cut in both direct and indirect taxes, especially corporate taxes and excise duties, will leave a larger surplus in the hands of both investors and consumers and help in reviving both investors and consumer sentiments than all government spending on any account.

 
 
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