Every year, before the presentation of the Union Budget, people from different economic segments in the country voice their demand to the Finance Minister (FM) and expect him to give some sops. This year the demand for a tax-cut from a vast majority of salaried people and corporates has become more intense as the government is sitting a on a huge pile of cash.

The expectation of a moderation in tax rate gathered momentum as the Finance Ministry (Finmin) officials are expecting that country’s gross tax revenue collection will double in 2007-08. Based on nine months tax collection data till December 2007, the government is likely to mop up Rs 600,000 crore in 2007-08 as against Rs 304,958 crore in 2004-05. At this level the gross tax income will be a record 13 per cent of country’s GDP.

Buoyancy in collection 

Main contributors to the bulging tax revenue are personal income tax, corporate tax and service tax. As per the Finance Ministry figure, the corporate tax collection during April to December 2007 jumped up by 40 per cent to Rs 127,683 crore from the same period previous year. Personal income tax too grew by 50 per cent to Rs 77,380 crore.

A closer look at trends in tax collection reveals that except excise duty, all other direct and indirect taxes are likely to exceed budget estimates. Booming economy, leading to larger corporate profits and higher personal income, was the main reason behind the sharpest growth in tax collection.

Tax experts feel that if Mr Chidambaram is sitting so comfortably on a huge cash pile, he should loosen his purse string a bit for those who were instrumental in contributing to the booty. Even the FM himself has hinted that there could be cases for moderation of tax rates.

Growing need

Another argument for a reduction in the tax rate, especially in excise duty, is that country’s sluggish manufacturing sector which is hit by the high interest regime, needs a demand-pull stimulus for consumer goods.

Even the high-powered Economic Advisory Council (EAC) for the Prime Minister has strongly recommended boosting consumers’ disposable income by slashing excise duties on consumer durables. 

(On the eve of presentation of the General Budget 2008-09 the EAC headed by former RBI Governor Dr C Rangarajan has suggested to the government to soften tax rates to encourage people to spend more on consumer goods.)

Currently the average rate of excise duty on most of consumer goods is pegged at 16 per cent. “There could be some adjustment in indirect taxes to stimulate growth in consumer durables,” says Dr C Rangarajan head of EAC. On the direct taxes, including income tax, the EAC has suggested that there is room for adjustment in tax slabs. 

Possible sops

Many now expect that the maximum rate of income tax could be set at a higher range of income level thus giving relief to middle income group in the range of Rs 3 lakh per annum to Rs 5 lakh. Some others feel that there is a scope for a cut in tax rates both direct and indirect taxes. Gaurav Taneja of Ernst &Young says, good performance of the economy coupled with high level of tax compliance has led to buoyancy in the tax collection.

“We are comfortably placed to meet our targets for the fiscal and revenue deficit for 2007-08. In my opinion, there are three reasons why the government should look at reducing taxes in the forthcoming budget,” says Taneja. Firstly, in terms of both direct and indirect taxes, tax incidence in India is on the higher side.

While a restructuring of the income tax slabs and reduction in the highest applicable rate, would increase purchasing power of the individuals, a reduction in excise duties would boost demand through lower prices, argued Taneja. Secondly, the economic turmoil in some developed countries may lead to a slight slowdown in India in 2008 and in 2009.

An effective way to counter these developments is to infuse a dose of fiscal stimulus in the economy.Another argument in favour of tax cut is that the principle of ‘fewer and lower taxes’ always lead to higher collections due to better compliance.

Boost compliance

In India, we need to focus more on improving compliance rates and the best way to address this issue is through a reduction in taxes and simplification of procedures, explains Taneja.  Noted tax expert O P Vaish suggests, “The moderation in the overall tax rates especially in corporate tax, personal income tax and central excise will provide the fiscal stimulus to sustain the ongoing growth momentum.” Agreed G Srivastava-Head of Economic Policy Division of CII, who feels that the buoyancy in tax collection in the recent years has been due to widening the tax base and moderation of tax rates.

“With higher tax collections during the year 2007-08, the Finance Minister could consider a favourable taxation policy to reduce the overall tax burden and provide greater stimulus to higher GDP growth,” he suggested.

Will he budge?

The pertinent question is: Can Mr Chidambaram afford to cut tax rates? As the guidelines for the prudent management of economy suggests he can experiment with moderation of tax rates as long as he manages to keep the overall fiscal deficit — the net difference between the expenditure and income of the government — within the target set by the Fiscal Responsibility and Budget Management (FRBM) Act. If the FM is to keep the fiscal deficit within the FRBM target, it will be a tight-rope walk for him.

The political compulsions can be another constraint. The Budget for 2008-09, expectedly, will be the last full budget of the UPA government before the general election in the middle of next year. 

As a populist move the government may have to allocate huge funds for numerous popular social schemes. Besides, there are several non-plan expenditure, which he cannot avoid. To name a few these include interest payment on the market stabilisation bonds, which are used to sterilise foreign exchange reserves, interest payment on the oil bonds, which are being floated to compensate state-owned oil marketing firms incurring under-recoveries by selling petroleum products below cost prices and last, but not the least, the likely burden arising out of the implementation of the Sixth Pay Commission.

Difficult choice

All these will require allocation of massive funds, which Mr Chidambaram will have to mobilise. If he is going for any major moderation of tax rates he stands to lose revenue.

But at the same time if he wants to sustain the growth momentum, which is already under strain, he will have to send the necessary fiscal stimulus through reduction in tax rates — of course on a selective basis.

Analysts feel despite mounting pressure to contain fiscal deficit the FM still can experiment with moderation of tax rates from overall tax reforms point of view. He can attempt at realignment of overall tax rates if some of the existing plethora of tax exemptions are either scrapped or curtailed.

As per an estimate the government is losing tax revenue to the tune of Rs 158,661 crore per annum because of numerous tax exemptions. Most of these have outlived their utility, but these manage to exist for one political reason or other.

Clearly, there is scope for moderation of tax rates without compromising the overall principle of fiscal consolidation. The question is: Does the government have the political will to pursue the course of tax moderation exercise? We will get a clear answer in about two week’s time .