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Budget 2013: Need to review tax incentives

February 13, 2013

(Any opinions expressed here are those of the author and not those of Reuters)

It’s going to be a tight budget this year and Finance Minister P. Chidambaram will be looking to save every rupee in revenue to reduce the budget deficit, to which he has committed. One option would be to withdraw tax incentives which have outlived their purpose.

The finance ministry is only too aware of revenue lost from tax incentives. In 2011/12, it was a loss of 5.29 trillion rupees. If tax incentives are withdrawn, the 2013/14 budget would be in surplus. Nothing would amuse the finance minister more.

What really are these incentives? For the ministry, it is the revenue loss caused by the difference between the generally prescribed rates and effective rates of taxation. That exaggerates and even distorts the meaning of incentives.

The loss from taxation of corporates, firms and individuals is estimated at 936 billion rupees. That includes “accelerated depreciation” leading to a loss of 364 billion rupees. In the United States and many other countries, this is an accepted accounting principle.

There is revenue loss of 148 billion rupees from the corporate sector for incentives such as infrastructure development and scientific research. What needs to be identified is whether these incentives have really been effective, and if not, they need to be changed and the ones no longer necessary should be withdrawn.

There was revenue loss of 284 billion rupees from individual tax payers from savings incentives under section 80C of the Income Tax Act. The intention behind some of these concessions is not really to encourage savings but to divert those savings to the government kitty. The price is too heavy. The government and public sector units can certainly borrow from the market and pay the market rate of interest.

But the major loss of revenue is from excise and customs — 4.35 trillion rupees. The loss in excise is the difference between tariff rates and effective rates and the exemptions are in respect of areas and commodities. The loss in area-based exemptions (Northeast states, Uttaranchal, Himachal Pradesh, Jammu and Kashmir and the Kutch district of Gujarat) was 128 billion rupees while commodities accounted for 1.99 trillion rupees. The latter was mainly a device to counter inflation.

The government has powers to exempt under section 25(1) of the Customs Act to prescribe duty rates lower than tariff rates. That results in loss of revenue of 2.42 trillion rupees. The bulk of the loss has been in respect of imports of crude oil and edible oils and was deliberately incurred to lower costs.

Surely exemptions and incentives have specific objectives such as promoting exports, defusing inflation or benefiting backward areas. The question is — should we tamper with the tax system and the benefits arising from grants and subsidies? In any case, the government needs to review tax exemptions and incentives, and identify those that have outlived their purpose.

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