It is tempting to speculate on what Finance Minister P Chidambaram will do by way of taxes in his budget. Will he tax the super-rich more? Will he remove corporate exemptions to improve revenues?
Will capital gains and dividends attract more tax, since these are seen as favouring the rich more than the less well off, and hence inequitable? Will he impose an inheritance tax on properties or wealth transferred after death?
The first thing we need to accept is this: if he is sensible, he will not try to upset the markets too much, since a buoyant market is his only hope of getting the economy back on track. In fact, he has excelled in tickling the bulls in the right places in the four-and-odd months he has been FM.
A buoyant market will achieve these things for the finance minister: enable him to sell more public sector equity; it will allow corporates to also raise more equity, which means they will be more optimistic about investing. And when corporates are optimistic, they will take more risks and invest ahead of demand despite a slowdown – including participate more boldly in the forthcoming spectrum auctions in March.
One of the reasons why Chidambaram has been upset with the Reserve Bank of India over interest rates is precisely because of the markets: he wants to use a rate cut to enthuse the markets further, but the RBI Governor has refused to play ball. Duvvuri Subbarao sees his job as taming inflation first (though he may change his mind now that growth is crashing through the floor).
The recent partial deregulation in diesel is intended to convince Subbarao to do his item number before the markets on 29 January, and help Chidambaram play more to the gallery of bulls.
But let’s look beyond 29 January as check Chidambaram’s own options in the budget. Chidambaram’s political economy challenges are the following:
One, he has to start fixing the budget deficit first, and for this he needs the markets to help out with resources. Without market buoyancy, neither disinvestment nor spectrum revenues can hold up.
Two, he needs to find more resources for political giveaways – the Food Security Bill is the next item on the party-government agenda before the budget. It will require huge resources.
Three, he has to keep the rating agencies happy, as a downgrade will not only spook the markets, since India will move below investment grade, but also raise borrowing costs from abroad. The key to keeping the rupee steady is foreign flows, which could dwindle if reforms are not to be seen on track. The markets are key to attracting both debt and equity investments from foreign investors.
Four, taxing the super-rich is tantamount to hitting the markets on the head with a blunt instrument. The rich always have options for their cash. A lot of the FII money coming in through the Mauritius route is essentially Indian illegal money held abroad. Chidambaram cannot afford to upset the super-rich too much, or else the so-called FIIs flows will dwindle.
Five, dividend tax and short-term capital gains taxes are key to market sentiment. They are also important for small and medium investors, whom the government wants to entice into the markets. The last thing the government can do is send all the remaining retail investors (not to speak of promoters) packing from the markets by raising dividend and capital gains taxes. The FM can try and tinker with marginal changes in these taxes, but he cannot afford to make significant increases without damaging stock sentiment.
Six, significantly higher corporate taxation will be counter-productive when companies are anyway not investing and are squeezed on margins in a slowdown. Small changes in the minimum alternate tax, and surcharge on income-tax are more likely than any significant increase in tax rates, or the creation of a super tax.
Seven, the FM’s best bet will be to raise excise and service tax, while extending the service tax to more areas. This will bring in more revenues than specifically targeting any group of rich taxpayers, whether individuals or corporate.
Eight, the FM’s biggest tax weapon is the unseen one of inflation. When the consumer price index is rising 10 percent, it means even with existing rates, more people will come into the tax net through bracket creep, assuming their earnings are keeping pace with inflation. By not raising the tax-exempt income – or raising it below the rate of inflation – he will earn more without sacrificing too much goodwill.
Nine, the inheritance tax will be a dud even if it is introduced. Estate duty was abolished in 1985 because it was generating almost no revenue. Now, in a globalised world, it is even easier to shift your wealth to corporate entities – that is, your wealth will be held in inter-locking corporate entities, or shipped abroad to tax havens – effectively defeating the purpose of the tax. Far from stopping the generation of black money, it will actually encourage it.
Ten, the FM’s best bet – as we have noted earlier – is to try and bring black money into the tax net through an amnesty scheme. Though there are no verifiable ways of estimating black money in the economy – not to speak of money stashed away outside – one estimate by a JNU professor, Arun Kumar, is that 40 percent of GDP is black.
In 2012-13, India’s GDP will be around Rs 10,159,884 crore according to the last budget – that is Rs 101 lakh crore.
Forty percent of that means Rs 40 lakh crore. Getting even 10 percent of that amount into the tax net means Rs 400,000 crore of income will pay tax at 34 percent (the top rate now, including surcharge etc). It’s like obtaining Rs 1,34,000 crore with one measure.
Sure, not all the money may come in in Year One. But that’s the kind of booty the finance minister should be salivating over. Going after the rich or super rich is like trying to chase the pennies when the dollars are flying away.
My best guesses on Budget 2013 are these: all talk about taxing the super-rich is intended to prepare the taxpayers for pleasant surprises.
In short: no big changes in tax rates, barring changes in excise and service taxes. The surprise may be on black money taxes.