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Budget: a sense of deja vu
May, 17th 2010

The budget session has ended with the passage of the Finance Bill. The Finance Minister announced some concessions with a monetary value of nearly Rs.400 crore while moving the official amendments to the budget.

It is not the first time that a Finance Bill in India has been passed without much debate and deliberations. There could of course be many reasons for this for instance, sensational developments such as the IPL issue and telephone tapping that relegated the Finance Bill to the background.

On many occasions in the past too interest in the budget had waned once the contours of concessions and reliefs were announced.

A key statement
That is a pity. The budget is much more than a statement of government income and expenditure. The point has been made several times before that the large general interest that the annual exercise commands is not confined to announcements of tax concessions, reliefs and so on. The budget is the most important economic statement of the government. Therefore, its reference to and elaboration of policy measures (for instance) matter as much as the tax proposals.

A more detailed discussion of the budget proposals in Parliament will be educative for the general public too. It goes without saying that dissemination of information concerning public policies is a vital function in any democracy and will make for better decision making in the public sphere too.

Distortions from reliefs
A second point of criticism has to do with the relatively meagre' reliefs Rs.400 crore in a Rs.10-lakh crore Central budget. However, it is not the size but the nature of reliefs that should matter. In fact, reliefs and concessions in relation to the original proposals do not represent a strategic retreat on the part of the Finance Minister to facilitate the larger goal of seeing the Finance Bill through.

The real point of criticism is that the post-budget concessions are selective, obtained by industry and lobby groups.

By their very nature, reliefs and concessions distort the tax proposals in the budget and create individually tailored tax regimes. Thus, they militate against the medium-term goal of simplifying the tax structure characterised by uniform tax rates and as few exemptions as possible. When two major tax reform measures the Direct Tax Code for direct taxes and the Goods and Services Tax for indirect taxes are to be introduced from the next financial year, one would have thought that this year's budget would lay the foundations, if not draw a road map for these initiatives. But this year's Finance Bill as enacted adds to the clutter and makes next year's tax reforms that much more difficult to implement.

It is conceded that no single budget exercise can reverse the trend of handing over sops, concessions just before the Finance Bill is voted. It is also true that various compulsions, including political ones, are behind those. In any case, these sops and concessions do not enhance the efficacy of the fiscal policy.

The National Institute of Public Finance and Policy Director and a doyen of public finance, M. Govinda Rao, in a recent article in a business daily, has explained how Indian tax policy has become extremely complicated because, unlike in most other countries, it is burdened with multiple objectives, some of which are unique.

Almost all countries have tax systems that seek to accelerate investment, encourage savings and promote exports.

In India, tax policy seems to achieve other objectives such as industrialisation of backward areas, development of small scale industries and infrastructure projects and SEZs.

These objectives distort the tax structure in that they require various exemptions, differentiation in rates and preferences. Inevitably the tax system becomes extremely complicated leading to evasion and avoidance of taxes.

Ironically, many of these incentives remain despite being found ineffective in various studies. They lead to loss of revenue and distort resource allocation without achieving any of the stated objectives.

Taking the specific case of backward area concessions, Mr. Govinda Rao has cited World Bank reports among others to show that factors such as stable governance, sound macroeconomic policies and infrastructure are more important in decisions concerning location of an industry than just tax benefits. In any case, tax incentives by themselves cannot make up for the absence of other factors.

A good tax policy should minimise the three costs associated with it cost to the exchequer, the compliance cost and the cost of economic distortions. The burden on the exchequer adds to the cost of administering tax preferences besides the larger cost of revenue foregone.

Tax preferences are like subsidy payments except that they are non-transparent and are poorly targeted. Widespread tax preferences raise compliance costs for businesses that enjoy the preferences.

Finally, tax incentives and concessions by causing price distortions impact on resource allocations across sectors as well as regions.

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