Increase the base, not the rate

Feb 28 2013, 00:47 IST
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SummaryRaising the tax rate will reduce tax compliance and lead to greater tax evasion. Instead, the FM should try to look at how to widen the tax base.

How does one say whether a Budget is good or bad? The general reasoning for a good Budget is that it is one that contains the fiscal deficit, carries on with the necessary reforms, beefs up planned capital expenditure and curtails non-planned spending while increasing the revenue receipts. Controlling the budget deficit is an important factor from the perspective of sovereign rating, with countries with higher fiscal deficits generally losing out in terms of investor attractiveness. For the last fiscal year, India’s fiscal deficit (Centre-state combined) was around 9%, highest when compared with other BRIC economies—China’s 1%, Brazil’s 2.8% and Russia’s minus 1%. A lower foreign capital inflow on account of a higher fiscal deficit has broader implications in terms of deteriorating foreign exchange reserves, depreciating rupee, and even higher inflation, something that will make policymakers worry.

For the benefit of the reader, it may be recalled that the government Budget has two broad headings, namely, the revenue account and the capital account. The revenue account corresponds to income gained and expenditure incurred during the course of any fiscal year. Typically, in the revenue account, the expenditures are consumption-oriented, and do not have long-term asset and liability consequences. The capital account, on the other hand, consists of expenditure meant for creating long-term assets, such as building roads, ports, hospital, research and development, etc. Controlling the fiscal deficit, therefore, is to control both the revenue and capital deficits.

Although most of the discussion on the Budget is centered on controlling the fiscal deficit, it is the revenue deficit that is more important. This is because the revenue deficit arises out of the current consumption-oriented expenditure of the government (including interest payment for the earlier deficit), which does not augment the productive capacity of the country. For India, the Centre-state combined deficits have been growing rapidly during the past few years. A large part of the growth in the combined deficit can be attributed to the states’ fiscal deficit. The interest payment component on the earlier deficit is increasing. It also implies that cumulative government debt is increasing. Following reforms, there is now a limited scope for the monetisation of the deficit (or printing money to finance the deficit) and this has led to an increase in market borrowings by the central government. The rising proportion of internal debt has become more acute, especially with fewer disinvestment opportunities, and less recoveries of loans.

The rising

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