A huge hike in indirect taxes will cause a fall in both savings and consumption, achieving the opposite of what was intended.
The national budget for the financial year 2012-13 is noble in words and wrong on numbers, where bad numbers wage a war against the genuine intents of the Finance Minister. The budget declares laudable objectives, but works for the very opposite. For example, the Finance Minister says that a principal objective of the budget is to “focus on domestic demand driven growth for recovery.” The other objectives of the budget seem dependent on this. If the Finance Minister has to spur domestic demand, he would have cut taxes and left more money to spend in people's hands. But see what he does. With most of his direct tax imposts and cuts concerning only non-corporates, he puts into consumers' pocket Rs 4,500 crore by net cut in direct taxes, but he picks their pockets almost by Rs 46,000 crore by raising indirect taxes. It needs no seer to say that this will erode, not promote, domestic demand.
The Finance Minister expects his budget to produce “lower inflation and higher savings”. This is a contradiction in terms. In theory, a rise in savings, without higher growth rate, means lower demand and consumption. But, if a budget releases inflationary forces by a huge rise in indirect taxes, as the present budget promises to do, it is the cost of goods, not the real sale of them, that will rise — causing fall in both consumption and savings. The hike in indirect taxes will cause price rise and reduce savings. And when prices rise, both savings and real consumption will fall. This is what happened in 2010-11, as the Economic Survey 2012, laid by the Finance Minister himself the day before the budget, notes that inflationary tendencies during 2010-11 caused reduction in household savings.
Moreover, the unprecedented government borrowings of Rs. 4,70,000 crore projected for 2012-13 will dry up liquidity and force up interest rates. The Finance Minister has himself made provision for a huge rise of Rs. 44,000 crore in interest payment to Rs. 3,20,000 crore for the budget year. There is already a liquidity crunch, with banks borrowing heavily from the Reserve Bank. If interest rates, already high, rise further, that will also force down consumption. The effect of the Finance Minister's efforts to moderate this eventuality by allowing FIIs to invest in government and corporate bonds can only be marginal. So the budget delivers lower, not higher, savings and consumption, achieving the very opposite of what the Minister intends. The domestic demand drive he relies on for recovery is thus a non-starter.
With revenue deficit (4.4 per cent of the GDP) and fiscal deficit (5.9 per cent) hitting the roof, the Finance Minister seems to have turned to chartered accountants for ideas to make his balance sheet appear less inelegant. The result is the innovation of “effective revenue deficit,” which bears the stamp of some multinational accounting firm rather than our conservative civil service. Effective revenue deficit is to be arrived at by deducting from “the revenue deficit” all grants made — not only to state governments and constitutional authorities, but also to NGOs — for creation of capital assets not owned and held by the government. This innovation is being legalised by amending the FRBM Act itself. Look how this window-dressing tries to make the deficit more acceptable. In the coming year, from the revenue deficit of Rs. 3,50,000 crore, the grants for capital assets of Rs. 1,65,000 crore are deducted to arrive at the effective revenue deficit of Rs 1,85,000 crore. This psychologically moderates the effect of the effective revenue deficit of 3.5 per cent of GDP to 1.8 per cent.
The Finance Minister appears to have been poorly briefed on numbers. He says that the gross tax revenues proportionate to GDP was 10.4 per cent in 2011-12, and will rise to 10.6 per cent in 2012-13. There is actually a fall in the gross tax to GDP ratio in the last two years. While the ratio of gross tax receipts to GDP is 10.6 per cent in 2012-13, it was over 12 per cent in 2006-07, 13 per cent in 2007-08 and 11.5 per cent in 2008-09. So the revenue in proportion to GDP has actually fallen in the last three years.
From the perspective of resource mobilisation, the Finance Minister has made bold to levy substantial taxes. But he has raised taxes which he should not have and shied away from levying taxes that he ought to have imposed. The turnover of equity, financial and commodity derivatives has grown to huge levels in recent years. A tax on them is overdue not only to raise huge revenue, but also to moderate speculation. A tiny impost of 0.1 per cent on the equity derivatives alone would yield some Rs 30,000 crore. This would never cause inflation, nor rob people's buying power, like indirect taxes. When actual sales and purchases of equity are taxed, it is not clear why there cannot be a tax on futures and options. A levy of 0.1 per cent tax, as on actual equity transactions, on derivatives could have netted a revenue of Rs. 70,000-80,000 crore. Instead of taxing the derivatives, the Finance Minister has, for no reason, cut the tax on equity transactions from 0.125 per cent to 0.1 per cent in the budget.
There are more positive signals in the Finance Minister's speech than in the budget proper. The Minister should be congratulated for bringing the Hutch-Vodafone deal to tax by retrospective amendment to law. The idea of a holding company for financial arms of the government to raise resources is novel, but it has to be carefully structured to part with economic but not ownership interests. Direct delivery of subsidies is another good move. But these are policy measures, not budget provisions.
Yet, it has to be conceded that the Finance Minister has struggled in unenviable conditions to make some sense out of the helpless situation in which he has been placed by his party and government. See his predicament. When he is already battling falling revenues and rising expenditure leading to huge revenue and fiscal deficits, he is forced to foot the cost of the food security law — the pet project of the head of his party who is also the UPA and NAC chairperson. Bound by loyalty to his leader, the Finance Minister has declared that the government is committed fully to providing for food subsidy even if it cannot afford it. Yet, he has not provided a single penny for the food security project! PS: But, does she know it?
(The writer is a chartered accountant and corporate consultant.)