Article by Deepanshu Mohan on "With Budget 2017, Modi Government Has Taken Key Steps to Improve India’s Tax Structure" - The Wire

February 02, 2017 | Prof. Deepanshu Mohan

The finance minister’s announcements on moving towards a more progressive direct tax structure and tax incentives for MSMEs are heartening.

In a recent analysis on the Budget (part one of this series) covering the fiscal expenditure side, I examined the budgetary approach used by the finance minister and his team in announcing increased rural spending while neglecting the evidence presented from (un)achieved outcomes on existing social security welfare schemes for areas like agriculture sector, rural education, healthcare and skill development. However, if we study the announcements made on the fiscal revenue side, the minister’s approach this year brings more positive news, based on the tax proposals announced with more incentives provided for small businesses and the MSME (micro, small and medium enterprises) industrial base.
 
For any successful counter-cyclical fiscal spending policy to be in place, it is critical to ensure a wider tax base for a reliable source of tax revenue, a fairly distributive weight of tax structure (between direct and indirect taxes) and a consistent level of business confidence across sectors to raise government’s revenue capabilities (discussed here). The job of any big government here becomes important more as an enabler than merely act as a regulator or planner.
 
In India’s own economic history of policymaking (since independence), the government has largely projected itself as a planner and regulator for most of the times while acting as an enabler for a handful of sectors (like telecom, IT, automobile, pharmaceuticals and so on). With this Budget, we see a change in that attitude, from an economic policy roadmap presented while strengthening its fiscal revenue side of the balance sheet.
 
A smooth passage for the GST over the coming months will hopefully streamline some unwarranted indirect taxes, cesses, surcharges and so on in fairly distributing weight of taxes between the direct and indirect tax structures (discussed in an earlier article). This, of course, follows from an assumption that the government will continue to gradually increase its direct tax base by reducing tax rates in various income slabs over the coming years (similar to the ones announced for this year) and compliment it with a reduction in overall the indirect tax rate structure while more people are encouraged to pay direct taxes where the incidence of tax remains progressively sloped. This process will surely take time, but ensure a more progressive tax structure and administration base.
 
The table below offers more details on tax rates, slabs and filing of tax returns that reflects government’s seriousness in addressing the tax structure by reducing the direct income tax (for slab between Rs 2.5-5 lakh) to 5% of taxable income and putting a surcharge on the super-rich.
 
Additionally, in driving growth from greater physical capital accumulation, a 25.4% overall increase in capital spending on infrastructure combined with the abolishment of the Foreign Investment Promotion Board will be seen as a net positive for foreign investors keen in investing within India over the next few years.
 
A word of caution
 
Albeit, one area where the government should remain cautious is not to become over-reliant on foreign sources of investment over time in trying to bridge the domestic savings-investment gap (explained in an earlier article here) or ignore the trends of under-consumption currently prevailing across sectors in a post-demonetisation economic landscape.
 
The finance minister also seemed to make most of his tax proposal and fiscal outlay announcements partially based on a shaky hypothetical assumption of a widening tax base (as a result of demonetisation, discussed below). This further warrants a confab on the Economic Survey report on demonetisation that perhaps allowed the minister to make such announcements.
 
A few caveats: Reflections from the Economic Survey study on demonetisation
 
 
While this year’s survey can be complimented for its solid data analysis and raising key macroeconomic challenges for the Indian economy in the future, some questions can be raised on its chapter on demonetisation where some of the assumptions on widening the tax base (as a result of demonetisation, digitisation and the formalisation of the economy) were linked with a weak axiomatic reasoning in the model framework used for assessing demonetisation impact.
 
On the short-run impact of demonetisation
 
The economic assessment of demonetisation offered in this year’s Economic Survey is perhaps the first official government account that objectively seeks to analyse three sets of broader questions raised in recent months by the public debate on demonetisation; on assessing the administrative design and implementation of the initiative, the short and long run impact, and “its implications for the broader vision underlying the future conduct of economic policy”.
 
While the focus of analysis provided in the survey seems to look more at the latter two aspects, what seems missing in the analytics provided by Subramanian and his team, on the short-run impact of demonetisation, was the lack of a distinct sectoral focus on areas of agriculture, labour markets in the construction sector, real estate sector and so on, most affected under the government’s projection of demonetisation as a therapy that involved a vacuum suction of cash liquidity driving these sectors.
 
For instance on the real estate sector, the survey states, “An equilibrium reduction in real estate prices is desirable as it will lead to affordable housing for the middle class, and facilitate labour mobility across India currently impeded by high and unaffordable rents”. It is easy to see this observation as more of an opinion backed by hope of ceterus paribus (or all other factors remain constant) or an expectation of a linear direction without any reasoning provided for it.
 
While we do see a steep fall in real estate prices (from eight major cities) in India, the projected rise in demand of housing (stated above) over time remains conditional on factors like availability of home loans at affordable rates (assuming banks cut rates in expectation with rising demand amongst concerned income groups), a persistent rise in overall income and an easing of procedural formalities in property registration (which mandates state-level reforms), which are neither discussed nor included in a model of speculation.
 
In fact, the survey accepts the ambiguous nature of analysis on any short-term assessment on demonetisation by stating, “…demonetisation represents a large structural shock so that underlying behavioral parameters of the past will be imperfect indicators of future behavior and hence outcomes”, which somewhere makes it difficult to put much faith in the analytics of assessment done.
 
One cannot blame either Subramanian or his analytics team for this, as the information available on the collection of data needed for doing any cost-benefit impact of demonetisation remains a work in progress. It may take more than six months to realistically know its actual short-run impact.
 
However, what remains troubling is the focal point of assessment provided in the survey in its approach and the subtle negligence on studying the likely impact of demonetisation on the dynamics of the agriculture sector (where most of the rural workforce is still occupied) and the informal segment of the construction sector where most of the semi-urban low skilled labour force gets employment.
 
A mere industrial firm-level focus in any short-term impact assessment without studying the most cash-intensive sectoral areas offers a weak analytic base.
 
Despite some of these shortcomings, overall, in making an effort to formalise India’s market economy and trying to improve its complicated tax structure, the 2017 Budget takes a key step forward.
 
Deepanshu Mohan is assistant professor of economics at Jindal School of International Affairs, O.P. Global Jindal University.