India at 75: Prudent public finance policy still remains a challenge

Among other things, making the direct tax regime less confusing and bringing in expenditure reform are crucial challenges for the central government

The Centre has come a long way in improving its finance over a period of time, especially after the presentation of the dream budget by the then finance minister P Chidambaram in 1997-98, enactment of the Fiscal Responsibility and Budget Management Act (FRBM) in early 2000 and introduction of the long-awaited goods and services tax (GST) in 2017, besides embarking on direct benefit transfer (DBT) and pruning subsidies.

However, several challenges confront the Centre in all these aspects as the country celebrates the 75th anniversary of its independence.

Direct Taxes

The tax slabs had more or less stabilised at 10-20-30 per cent after 1997-98 till 2016-17. Then Finance Minister Arun Jaitley further reduced the lowest income tax slab to five per cent for those having annual income of over Rs 2.5 lakh to Rs 5 lakh. To neutralise the effect on revenues, he levied a surcharge of 10 per cent of tax on those earning taxable income between Rs 50 lakh and Rs 1 crore. There was already a surcharge of 15 per cent on those earning more than Rs 1 crore. Then from 2020-21 onwards, the Budget gave an option of a lower tax regime to those earning up to Rs 15 lakh, provided they forgo some exemptions. The new tax slabs now stand at 5 per cent, 10 per cent, 15 per cent, 20 per cent, 25 per cent and 30 per cent. The old regime has the same 10-20-30 per cent slabs. Meanwhile, the surcharge on income tax went as high as 37 per cent for those earning over Rs 5 crore in a year.

Even if a taxpayer opts for a new tax regime, certain exemptions such as money received for gratuity, leave encashment, voluntary retirement scheme etc., are still available. There are also various deductions still available, such as conveyance allowance for expenditure incurred for travelling to work, investment in notified pension schemes, any allowance for travelling for employment or on transfer, gratuity, leave encashment, voluntary retirement scheme etc.

Even then, the base of individual and Hindu Undivided Families (HUF) has remained more or less the same. As many as 58.3 million returns were filed till the deadline of July 31 for the assessment year 2022-23 against 58.9 million till December 31, 2021, the last date for the previous assessment year.

Yeeshu Sehgal, head of tax markets at AKM Global, said, "Despite the lower tax rate, the tax base does not seem to have increased significantly since the new tax regime has not been attractive to a large segment of individual taxpayers who have been paying rent, EMIs for home loans, life and medical insurance, tuition fee for children and other avenues to save their taxes."

He said the government should continue with the new and lower rate regime. "Having both options of the old and new regime leads to confusion in the mind of taxpayers which is one of the reasons behind instability of the tax regime. It is best to have only one option," he said.

The same applies to corporation taxes as well. Corporation taxes were slashed for those opting out of exemptions to 22 per cent from the existing 30 per cent, while for new manufacturing companies, it was cut down to 15 per cent from 25 per cent in 2019.  

A finance ministry official said any further reform in direct taxes could be thought of at the time of making the next budget only. He said further removing exemptions is a tightrope walk since some income taxpayers would be affected by the move. So one section might like it, while the other may not.

Goods and services tax (GST)

While GST collections have been robust in the current financial year so far and towards the last few months in the previous financial year, there are still unfinished reforms in the indirect tax system. The monthly GST collections have remained above Rs 1.4 trillion for five months in a row now. The latest figure stood at Rs 1.49 trillion in July 2022, 28 per cent higher than the same month last year.

According to SBI Research estimates, even inflation-adjusted GST revenue shows that the average monthly collections have been around Rs 1.20 trillion till July in FY23. It said that this is a 26 per cent jump in inflation-adjusted GST from the pre-pandemic level of Rs 95,000 crore.

"In simple terminology, this shows that even after accounting for higher inflation, GST collections have remained robust and this increase could be the pure consumption impact," said SBI group chief economic advisor Soumya Kanti Ghosh.

Though the GST Council has taken the much-needed administrative reforms by putting in place e-way bills and e-invoicing and continuously bringing down the threshold for the latter, the long-awaited reforms of fewer slabs and including petroleum, real estate and electricity under it remains a pipe dream. Last year, the GST Council meeting in Lucknow discussed the issue after the Kerala High Court directed them to do so. However, it decided against the move because it involves high revenue implications and requires larger deliberations. Besides, the Council said it would be difficult to bring petroleum products under the GST regime.

A division bench of the Kerala High Court later said it was not satisfied with the reasons pointed out by the Centre and the GST Council on why petroleum products could not be brought under the GST regime.

The court observed, “We are not satisfied with the reasons. There should be some discussion and genuine reasons as to why petroleum products cannot be brought under the GST regime. Further, the pandemic period cannot be cited as a reason. It is well known that even during the pandemic, several decisions were taken involving revenue, after deliberations.”

Non-GST taxes on petroleum constituted almost 19 per cent of the Centre's gross tax revenue (before devolution to the states) in 2021-22 (Budget Estimates), while those accounted for 14 per cent of states' own tax revenues.

Similarly non-inclusion of electricity in GST is harming the interests of both companies and consumers. Saurabh Agarwal, tax partner at EY, said the levy of GST on electricity would primarily help in reducing the cost of electricity for consumers due to unblocking of input tax credit which today gets added to the cost of generation, transmission and distribution.

“If the said reduction in tariff is shared with different kinds of consumers ( domestic consumer, agriculture consumer, commercial & industrial consumer etc) after factoring the revenue neutral rate of electricity duty to the states, it is likely to help in reducing the cost of electricity for all segments with minimal loss to the central and state exchequer,” he said. 

Though the rate rationalisation under GST is being looked at, the GST council could only decide on imposing GST on pre-packaged food items, irrespective of whether they are branded or not, besides some rejigging in some other items.

A group of ministers, headed by Karnataka Chief Minister Basavaraj Bommai, is currently looking at broad GST rate rationalisation.  

A four-rate structure exempts or imposes a low rate of tax of 5 per cent on essential items and levies a peak rate of 28 per cent on luxury and demerit goods. The other slabs are 12 and 18 per cent.

A cess is also imposed on the highest slab of 28 per cent on luxury, demerit and sin goods. This was used to compensate the states till June 30 this year and would now be used to pay back the debt raised for meeting the shortfall in revenues for the states during the Covid-19 pandemic. This cess will now be imposed till March 30, 2026.

Expenditure reforms

Successive governments tried to reform the expenditure system of the country by setting up panels, but much success did not come in their initial attempts. The then finance minister P Chidambaram tried in 1996 to set up a commission, but it remained a dream after his predecessor Jaswant Singh declined the offer to chair it. He later came out with a discussion paper on subsidies classified as merit and non-merit. Subsequently, Yashwant Sinha, P Chidambaram, this time as finance minister of the UPA government and Arun Jaitley set up commissions to reform expenditure. Emphasis later was made on reforming expenditure through direct benefit transfer (DBT) to prune subsidy leakage.

The initiative did yield results. As much as Rs 1.64 trillion has been transferred through DBT in 2022-23 in 314 schemes. The government says there were estimated gains of Rs 2.23 trillion through this. However, DBT on food is yet to materialise. The government made attempts by trying it in Chandigarh and Puducherry, but the move did not make progress from there.

Similarly, the proposed DBT in fertilisers remained on a wish list as farmers have to give a total amount for fertilisers upfront and then claim subsidies.

Food subsidies, which ballooned to Rs 5.41 trillion during the Covid-struck year of 2020-21, came down to Rs 2.89 trillion a year later. It is pegged at Rs 2.07 trillion for the current financial year. However, the free food scheme for 800 million people was extended till September this year, which may increase the subsidy burden. It would be offset by savings from lower wheat procurement as the crop was damaged. Going forward, the government has to withdraw or rationalise food subsidies as Covid-induced lockdowns are no longer there.

According to some estimates, the fertiliser subsidy, pegged at Rs 1.05 trillion for FY23, may increase to Rs 2.5 trillion as the ongoing Russia-Ukraine war made imports costlier.

The government did not give petrol subsidies which are now confined to LPG and kerosene.

Over the years, the government did rationalise centrally sponsored schemes too. These have been reduced by half for the last two years -- 130 such schemes have been pruned to 65. Many experts say there is still scope for rationalising these schemes.

Fiscal Consolidation

Successive governments made remarkable achievements after the FRBM Act was enacted in 2003. However, its target of reducing the Centre's fiscal deficit to three per cent of GDP, initially by 2007-18 and then by the following year, was never achieved. The deficit doubled to over six per cent of GDP in 2008-09 when the collapse of Lehman Brothers had a ripple effect on India's economy. The target of three per cent was prescribed later as well as by Chidamabaram in line with the Vijay Kelkar panel's recommendation. Chidambaram prescribed it to achieve by 2016-17. Later the N K Singh committee prescribed it to be achieved by 2019-20 and then slowly cut it to 2.5 per cent by 2022-23. The government, however, pegged the deficit at 3.3 per cent for 2019-20 and then revised it to 3.8 per cent using an escape clause suggested by the panel. The following year, the deficit was pegged at 3.5 per cent, but it was revised to 9.5 per cent as the government brought various below-the-line expenditures to the forefront and spent much more than budgeted to lessen the burden of Covid-induced lockdown on the poor and put the economy on the path of recovery.

This year, the target is still 6.4 per cent of GDP against the NK Singh panel's suggestion of 2.5 per cent. Even this seems difficult to meet, even as the government is collecting much more tax than pegged in the Budget. It imposed a windfall tax on fuel production and exports of fuel, as expenditure on food and fertiliser is expected to exceed the budget estimates.

The International Monetary Fund (IMF) suggested that India should withdraw fiscal stimulus given during Covid times. It would be a challenge for the government to do so. Here it should be interesting to know whether the states would agree if the Centre also withdrew their stimulus. They were allowed to breach the fiscal deficit of 3 per cent of their respective gross state domestic product (GSDP) to go up to 4 per cent in FY23. While 3.5 per cent is unconditional, 0.5 percentage point is conditional on various reforms that the states need to undertake. This seems difficult as the states, particularly those run by the opposition parties, charge the Centre with not paying their dues when facing a resource crunch.