The long road to tax reform

The Budget Session of Parliament concluded earlier this week. While it was disrupted as on many earlier occasions, the Finance Bill was at least discussed in both Houses. Union Finance Minister P. Chidambaram, in fact, made several changes in the bill, responding to the discussions in the Lok Sabha, most of them with an anti-inflationary bias.

Some sceptics even remarked that it was a mini-budget, but government must have the flexibility to change policies when needed. From the time the budget was introduced in late February to the present time, the domestic pre-occupation has changed from growth to inflation, from energy security to food security. This has echoed global concerns as well, although sub-prime mortgage, financial uncertainties and the contagion effect of a US slowdown occupies centrestage.

Chidambaram conceded that Budget 2008 was expansionary, given the general thrust in providing breaks to small and middle-class earners, higher threshold of tax exemptions, and large increases in public outlays. If this is designed to be contra-cyclical, fearing impact of a global slowdown and based on pre-election compulsions, it may be understandable. Nonetheless, if inflation and demand management is the short-term goal, its appropriateness remains debatable. In the medium term, there is merit in nudging the economy away from an increasingly consumption-led growth to an investment-propelled growth. This is good for fiscal management, sustaining higher growth and making it more inclusive.

The centerpiece of the Finance Bill are the revenue and the expenditure components. Let me comment on the revenue budget.

Tax reforms, beginning in the early 1990s and accelerating during the latter part of the decade, have concentrated in moderating rates. Personal income tax has just three slabs of 10, 20 and 30 per cent, and combining it with an improved tracking system has resulted in better compliance. Similarly with corporate tax, rates were moderated even though they remain somewhat misaligned with global averages. With customs duty, peak rates are well on their way to replicating average Asian rates. Central excise has achieved high convergence through CENVAT and a road map has been articulated for a general tax on goods and services. In short, high revenue buoyancy is the outcome of moderate rates, keeping them stable, improving information network and bench-marking with best practice.

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