High Tax Breaks, High Gross Tax Revenue Projections! my article

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High Tax Breaks, High Gross Tax Revenue

Projections!http://esamskriti.com/html/inside.asp?cat=698&subcat=697&cname=high_tax

By Sanjeev Nayyar, August 10, 2004

Successive Finance Ministers have continuously used the bogey of low tax revenue

(gross) GDP % ratio to justify raising existing tax rates and/or levying new

taxes. Let me explain.

Consider, first of all, that the national GDP figure includes three sectors i.e.

industry, services and agriculture while tax revenues include two sectors i.e.

industry and services because agricultural income is tax-free - no state

government having as yet displayed the courage or the imagination to levy a tax

on agriculture. Most people are unaware that income tax on agriculture is within

the domain of State Governments not the Centre. Therefore, the numerator (tax

revenues) comprises of two sectors and the denominator (GDP) includes three

sectors. In a country where agriculture contributes about 22% of India's GDP,

its inclusion in the total GDP figure can only depress the tax GDP ratio.

If we were to use the current method of indicating tax / GDP ratio the Revised

Estimate for 2003-04 is 9.2% (Gross Tax Revenues Rs 2,54,923 crs, GDP at Rs

27,72,194 crs - current prices per Central Statistical Organization data).

However, if agriculture and allied sector's GDP (22.1%) is excluded from the

total GDP, the tax GDP ratio shoots up by 28.2% to 11.8%. In years when

agriculture constituted in excess of 30% of India's GDP the actual tax GDP

ratio was higher.

The latest Budget has also used low tax GDP ratio % to justify fresh taxes /

introduction of new ones. Further it has made some aggressive assumptions w.r.t

increase in revenues. This article seeks to analyze the estimated increase,

benchmark it with past trends and look at the revenue impact of specific direct

tax proposals.

We now turn to a detailed analysis of the assumptions for increase in gross

revenue. The table throws up some interesting analysis. (BE is 2004-05, RE is

2003-04, 2002-03 is Accounts). To see table click

http://esamskriti.com/html/inside.asp?cat=698&subcat=697&cname=high_tax

Gross Tax Revenues are assumed to go up by 24.6% in BE vs. 17.9% in RE and 15.6% in 2002-03.

Corporation Tax is assumed to go up by 40% in BE vs. 36% in RE and 26% in 2002-03.

Taxes on Income other than corporation tax are assumed to go up by 26.5% in BE v

9.3% in RE, and 15.1% in 2002-03.

Union Excise duties are assumed to go up by 18.2% in BE vs. 12.2% in RE and 13.4% in 2002-03.

Customs are assumed to go up by 9.9% in BE vs. 10% in RE and 11.4% in 2002-03.

Starting 1995-96 only once i.e. in 1999-2000 did gross tax revenue grow at close

to 20%. That too was on a lower base of Rs 143,797 crs in 1998-99 as compared to

a higher base of Rs 254,923 crs in RE 2003-04. Further gross revenue growth at

17.9% in RE 03-04 is based on a real GDP growth of 8.2% while the economy is

expected to grow at 6.5% in BE. Hence, Finance Minister Chidambaran's

assumption that tax revenues will grow by 24.6 % in the coming year seems

far-fetched, even after considering the increase in the existing service tax

rate, the extension of the service tax to a larger universe, the 2% education

cess and the increase in excise on steel from 8% to 12%.

The core question is: Can the economy grow at 8% again? Remember, that besides

2003-4, an 8% plus growth rate was achieved only thrice in the last fifty fours

years - 1967-68 (8.1%), 1975-76 (9.0%) and 1998-89 (10.5%). Moreover, the

Finance Minister's projected growth rate of 6.5% assumes inflation staying

within the 5.5% range. Inflation is currently hovering around 6.5 %. The

Congress led UPA government has increased petrol prices by 8.55 % (Mumbai Rs

38.83 to Rs 42.15) in two months. And mind you, the full impact of increases in

oil prices and service tax rates is yet to be felt.

Interestingly a continuous increase in global oil prices and depreciation of the

rupee might ensure that the Finance Minister's meets his tax revenues targets.

"And each dollar increase in global prices nets the government Rs 250 crs more

of customs revenue, Rs 600 crs of excise, and around Rs 800 crs of additional

corporate taxes". Business Standard editorial of August 2,2004.

Coming to Corporation Tax some of you might argue that, inspite of a fall in GDP

growth; a 40% growth in revenues is achievable since industry growth rate is

likely to be maintained at 6.7%. Conversely, in 2002-3 industry grew at .3

points lower i.e. 6.4% yet revenues from corporation tax were Rs 46,172 crs or

52% of BE projections. Another reason why direct tax targets might not be met

are the various tax concessions given by the current and previous budgets. Some

of them are discussed below.

Budget 2003 introduced a Tax holiday in respect of certain undertakings in

Himachal Pradesh, Sikkim, Uttaranchal & North Eastern states (section 80IC

applicable from assessment year 2004-05). If the conditions laid down in the

section are satisfied 100% of the profits and gains of the industrial

undertaking are exempt from tax for atleast five years. Not only that but also

all units set up in Himachal & Uttaranchal enjoy 100% excise exemption for ten

years. The full impact of this concession might be felt only this year since it

takes time to set up a factory there. Typically non-core sector industries like

fast moving consumer goods, pharma and consumer durable companies are most

likely to set up their factories in these states. Hence, industrial growth need

not necessarily result in tax growth.

Incidentally, such tax holidays were provided in the past too to undertakings in

Sikkim but offering such incentives in the newly carved state of Uttaranchal is

a different Matter altogether. Earlier tax holiday states were situated in the

hills; far away from consuming markets meaning companies had to incur huge

transportation cost to transport raw materials to factory and thereafter

finished goods to consumers. By virtue of parts of the state being in the

plains and proximity to North Indian markets transportation cost are low in

comparison meaning Uttaranchal could be a perfect investment destination for

certain corporates. From their perspective it is perfectly legitimate and

sensible to increase operating margins and post tax profits by shifting

manufacture of high margin products to these states.

An earlier budget by the NDA government allowed a deduction of 100% profits to

an undertaking developing and building housing projects if a local authority

approved the housing project before 31st March 2005 (section 80 IB). Some of

the key conditions are that development of the housing project should have

commenced after 1/10/1998; plot size was to be a minimum of one acre. What this

means that builders who satisfy prescribed conditions do not have pay tax on all

new housing projects.

As if the above tax breaks were not enough the Finance Minister has introduced

another provision to help Mumbai's builders. It is a relaxation in the

condition of minimum plot size of one acre in case of housing projects, as long

as the projects are implemented in accordance with a scheme for reconstruction

or development approved by the Central/State Government. What this means is

that profit made from redeveloping Mumbai's slums and probably mill lands would

be tax-free. Although this provision will take effect from 1/4/2005, with the

millions of square feet being developed in Mumbai the tax loss could be

significant. Critics might argue that it is a price for coalition politics but

then we should not be complaining about low tax GDP ratios.

How many of us know of these tax provisions? One is yet to hear of a builder who

has passed on this tax break to the consumer.

It is not my intent to blame companies who take advantage of legitimate tax

breaks. The point being made is that such tax concessions impact revenues

adversely forcing the Government to levy new taxes on all taxpayers alike. Two

recent examples are the 2 % education cess and increase in service tax rates.

The Government needs to rethink its policy of using tax breaks to promote

growth. A number of companies are already shifting their manufacturing

facilities from the erstwhile tax havens of Daman/Silvassa to Himachal &

Uttaranchal. Is giving tax breaks the only way to promote regional growth,

development of backward states?

Tax sops and a depreciating rupee should cease to be a source of competitive

advantage for sections of India's manufacturing and Information Technology

industries. As some sectors have shown innovation, quality and improved service

levels should be the new mantras for success.

For reasons referred to above the ordinary man or aam aadmi perceives the more

vocal & powerful taxpayer to get tax concessions while he is being increasingly

taxed (now indirectly through widening of service tax net and increase in

rates).

The Finance Minister has stated that the gross tax revenue projected by him

assumes a realization of Rs 18,000 crs of undisputed arrears from direct and

indirect taxes or about 17% of total tax arrears. It is surprising that he did

not reveal even a part of the logic or strategy of how he hoped to collect such

a large sum within the next nine months. Should the common man then be prepared

for another amnesty scheme that will once again reward the dishonest sections

of our society?

Revenues from Turnover tax in its original form were expected to yield Rs 7,000

crs. Its watered down version would generate revenues of about Rs 1,000 crs.

This implies a straight 1.89% reduction in the Centre's BE gross tax revenues

of Rs 317,733 crs.

Overall, the revenue estimates are very optimistic. If not met the resulting

deficit would impact both Central & State governments.

Rs 82,227 crs or 25.87% of the BE gross tax revenue is the states share of

central taxes. What happens if the projected increase in gross tax revenue is

not realized? Besides increasing the Centre's fiscal deficit it would reduce

transfer of funds to states.

For e.g. Bihar is allocated Rs 9,535 crs being 11.60% of the states share of

central taxes ie Rs 82,227 crs. It has committed expenditure based on BE

transfers. If these funds are not transferred the State could either cut back

committed expenditure or make up the shortfall through market borrowings.

Another example is the state of Karnataka. Its budget for 2004-05 projects a

surplus of Rs 474 crs as against a deficit of Rs 471 crs in the previous year.

Besides additional resource mobilization of Rs 450 crs the turnaround is mainly

due to the sharply hiked central devolution by Rs 350 crs. In case actual

transfers to the State are less than Rs 350 crs it would result in a lower

surplus.

By calling for early elections, not listening to their inner voice, the NDA has

made the nation go through avoidable pain caused by a quickly prepared UPA

budget. If only general elections were held as scheduled the country would have

had one more year of consistent policies. The Budget could have capitalized on

public support, a successful disinvestment program, higher FII inflows and an

8.2% GDP growth to help India realize its potential, come closer to fulfilling

its dream of becoming an economic power.

Having said that, the NDA occupy the opposition benches today. For India's sake

let us hope the Finance Minister meets his targets to truly become India's

Sapno ka Saudagar.

end of matter.

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