The author teaches at the University of Warwick, United Kingdom
Finance ministers all over the world probably spend sleepless nights in the weeks just before a budget has to be announced to the public. While there have been a few exceptions — the most recent one in India being P. Chidambaram’s “dream budget” — almost all budgets seem to attract harsh criticism from several quarters. Perhaps, Indian finance ministers have an even more difficult task because their freedoms are severely curtailed. They cannot merely prepare a document which facilitates the attainment of genuine economic goals and objectives. They also have to ensure that they do not ruffle the feathers of party functionaries. Surely, Jaswant Singh must be regretting his move from the comfortable foreign ministry to the hot seat in North Block.
Perhaps the most important and difficult task confronting the finance minister is the need to raise additional resources. In a recent article in this column, I had written about the failing health of the public exchequer and how the paucity of investible resources in the hands of the government was constraining growth. To give some idea of magnitudes, the planning commission is reported to have asked for Rs 134, 000 crores as budgetary support from the Central government during the next financial year for the tenth plan. But, newspaper reports suggest that the finance ministry’s grant will fall short of this figure by as much as 30 per cent.
This projected shortfall is not surprising at all because Singh has simply not been allowed the freedom to use all possible instruments to raise resources. The most obvious example of this has been the fiasco with the efforts to sell off the government’s holdings in the oil majors, Hindustan Petroleum Corporation Limited and Bharat Petroleum Corporation Limited, as well as in National Aluminium Company. These should all have been sold off during the course of this financial year, but it is now anybody’s guess as to when the process will be completed. What has been particularly disappointing is the almost complete lack of economic logic in all the arguments put forward to oppose the disinvestment exercise.
The same pattern is being repeated in the context of the Kelkar report for tax reforms. The finance minister requested his special advisor, Vijay Kelkar, to head a task force to prepare reports on reforms in the system of direct and indirect taxes. Departing from usual government practice, the finance minister also made the Kelkar committee reports available in the public domain. Perhaps he felt that informed debate on important issues would enable the government to obtain useful advice. Unfortunately, there has been very little “informed” debate, with all political parties including Singh’s own party, essentially tearing the Kelkar reports to bits in efforts to further their own political ends.
Most of the flak has been directed at the Kelkar report on direct taxes. One of the recommendations which has been shot down almost immediately is the proposal to introduce some tax on agricultural incomes. According to current income-tax rules, income derived from agriculture is not subject to any income tax. Several economists feel that this represents a violation of a fundamental principle of taxation — the need to maintain horizontal equity. This principle essentially says that two individuals with the same level of incomes should pay the same level of taxes. The failure to tax agricultural incomes violates this principle since rich farmers can get away without paying any taxes, while those deriving same incomes from non-agricultural activities are subject to income taxation.
Apart from this violation of horizontal equity, the absence of an agricultural income tax means that a substantial part of national income is not subject to any income tax, and so reduces the scope for raising tax revenues substantially. Moreover, the failure to tax agricultural incomes also allows individuals with non-agricultural incomes scope for tax evasion — they could reduce the incomes subject to tax by claiming that a part of their income was generated from agricultural activities. So, there are compelling reasons to introduce some form of agricultural income tax. Unfortunately, the farm lobby has tremendous political clout. With elections not so very far away, the Bharatiya Janata Party and its allies possibly felt that it would be political suicide to even contemplate the introduction of an agricultural income tax. The debate on this issue has been closed even before it started.
The other important vote-bank is the middle class. While rich farmers would have been adversely affected if the Kelkar committee’s recommendations had been accepted, large sections of the middle class would have gained, or at worst been unaffected, if the recommendations were accepted in full. The committee suggested an increase in the exemption limit for personal income tax to Rs 1 lakh, and also lowered marginal tax rates. Of course, these recommendations would benefit all taxpayers, and, not surprisingly, there was no objection to these recommendations.
However, the committee also recommended that all income-tax concessions currently available on savings in certain instruments be withdrawn. The latter recommendation made sense because the income-tax concessions meant that the effective rate of return on these forms of savings was absurdly high. To the extent that the economy does not generate such high rates of return on investment, there is clearly an implicit subsidy involved when savers are given such high returns.
For the vast majority of people, the gains from the higher exemption limits and lower tax rates would have been sufficient compensation for the loss incurred on account of the withdrawal of tax concessions on savings. Perhaps, people (for instance, those who have retired) who derive the bulk of their incomes from returns on savings may have been adversely affected. In view of this, it made sense to contemplate special provisions for the latter class. However, the consensus amongst politicians of all hues is to completely reject the recommendations relating to withdrawal of tax concessions on savings, but accept those recommendations which involve loss of tax revenue to the government.
Of course, if the finance minister actually toes the line laid down by political parties, then the fiscal situation will deteriorate even further. Will he have the political courage to formulate a budget which is designed to promote long-term economic growth even if this has an adverse effect on some groups in the short-run' Since economic policy-making in India has increasingly become more of an exercise in furthering the political goals of the ruling parties, Jaswant Singh may not be allowed to take any such initiatives.