Budget 2015: Third-generation reforms needed to galvanize economy

February 19, 2015

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

There were no major policy changes in last year’s budget, perhaps because the new government lacked the time to prepare. But Finance Minister Arun Jaitley has indicated that the upcoming budget on Feb.28 will bring India’s tax system in line with international practices to facilitate and encourage investments.

There are several factors that will make budgeting a little easier this year – inflation is down, crude prices have nearly halved, and a bullish stock market will absorb disinvestment by the government.

But there are also limitations. The 14th Finance Commission has recommended an increase in states’ share of tax revenues. Also, except for the United States, major world economies are struggling, which is bad for the country’s export sector.

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It is within these parameters that Jaitley will have to frame his budget. Surely, the government will have to take a long-term view to ensure that industrial growth is gradually pushed up in order to generate employment and increase revenue for the government in future budgets. This will call for a broad spectrum of changes in the tax system.

A couple of reasons why industrial growth slowed down and foreign investment declined were the introduction of GAAR and retrospective taxation. The tax system should be cleaned of such provisions and made transparent and clear-cut.

Presently, corporate tax is high in comparison with other Asian countries where the tax rate is around 25 percent – a level that can be reached at best in two successive budgets. In the next budget, either surcharges or cess will have to be removed as a first step, or the rate of corporate taxation correspondingly reduced. This will stimulate growth and generate employment.

Exports need the government’s support considering weak international markets and excessive competition. Hence it is imperative that the profitability of export earnings be restored by reducing tax on export profits. More specifically, MAT in respect of export profits will have to be reduced.

Another reason why investment has been sluggish is that domestic demand is not strong enough. In 2014-15, consumption of durable consumer goods declined 9 percent and the total manufactured consumer goods increased a mere 0.7 percent. To energize demand and at the same time provide relief to taxpayers from inflation, the exemption threshold for income taxation has to be raised and tax relief for home loans increased.

The budget has to introduce third-generation reforms to galvanize the economy. Governance (rules and regulations) should be made almost automatic without requiring approval from the government.

Expenditures need to be reduced in order to trim the fiscal deficit as planned, and that is possible if subsidies, which currently constitute about a fifth of revenue budget, are aggressively cut and leakages plugged. These measures will put the budget on a sustainable path and become a starting point for high growth.

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