Higher tax revenue from higher growth
(Any opinions expressed here are those of the author and not of Thomson Reuters)
The 2013-14 budget got completely out of hand because of a whopping shortfall in tax revenue. Development outlays had to be drastically cut to manage the fiscal deficit.
The key to the budget is revenue. The ratio of gross tax revenue to GDP reached a high of 11.9 percent when GDP growth was at its peak of more than 9 percent in 2007-08. Since then, both declined and the ratio has been in the narrow range of 10-10.7 percent. GDP growth is a painless way of raising revenue.
Not all sectors, however, contribute to tax revenue to the same extent as they do to GDP. Agriculture, for instance, generates 18 percent of India’s GDP but is out of the tax net. More than 60 percent of tax revenue is derived from industry in the form of corporation tax, excise and customs although it generates less than 20 percent of GDP. Industrial growth is an effective vehicle for tax revenue.
The 2013-14 budget was unbalanced because there was no real industrial growth, but only an increase in prices. As a result, tax revenue was 6.3 percent short of the target. The fall was mainly in respect of corporation tax, which is about a third of the gross tax revenue.
One reason, apart from policy paralysis, why industrial growth stopped was investment climate being tarnished by retrospective taxation, proposed in the 2012 Budget to bypass a Supreme Court decision, and the Land Acquisition Act of 2013. These measures scared investors and not only reduced investment, but also depreciated the rupee. Chidambaram, then finance minister, could not fully repair the damage done and was forced to trim expenditures to bring down the deficit.
The new National Democratic Alliance (NDA) government has emphasized the importance of industrial growth, mainly to generate employment. If the government succeeds in elevating industrial growth, there are good chances that tax revenues will also increase. How then can the budget for 2014-15 energize industrial growth?
First, the policy damage that has been done by retrospective tax and the Land Acquisition Act needs to be repaired. That seems to be very much on the NDA agenda and the budget to be presented in July can be the right time to announce it.
Second, the finance minister should initiate forward-looking reforms to open most sectors to foreign direct investment through the automatic route, subject to maximum shareholding by foreign investors. Good governance is already under way. There is also tremendous scope for disinvestment and even privatization of a number of public sector units (PSUs). The Securities and Exchange Board of India (SEBI) has also mandated that a minimum of 25 percent of the share capital of PSUs should be held by the general public.
Even if industrial production increases at a modest 5 percent, at the going inflation rate, gross tax revenues will be up by about 20 percent or 2.3 trillion rupees. Growth deserves closer attention.