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  • OUTLOOK ARENA  >>   VIEWS ON NEWS >>  FEBRUARY 21, 2007

    Another year, another budget...more taxes?
    MYSTOCKS | FREE NEWSLETTER

    Budget and the common man are linked by the third most important certainty in life after birth and death: taxes. Last decade has generally been good to Indians - the peak rates on direct and indirect taxes were reduced gradually across the board, more so on goods that would be further processed in the factories.

    But new taxes were added - service tax, fringe benefit tax, security transaction tax; Mr. Chidambaram tried to broaden his tax base. The finance ministry felt tax revenues of both Centre and states combined in FY03 were low at 16% of GDP. This ratio has gone up in three budgets to 19.3% of GDP in FY07. The logic is that as manufacturing and agriculture take a back seat to services sector (CSO estimates for FY07 show it to be 64% of GDP), it will be suicidal for the government's finances not to tax these services. It is indirect taxes they were talking about. Every time you purchase any merchandise, you also pay for excise, sales, VAT and a myriad other duties and taxes, which are inbuilt into the retail price. But the government did not get any revenue from income generated by services like banking, management consultants, decorators, beauty parlours, credit rating agencies, travel and tourism and advertising.

    All these income earners would pay income or corporate taxes as individuals/entities, but their relationship with the buyer of their service was not taxed. Though service tax was introduced a decade ago, it has built steam only in the last four years as the net was widened to secure more and more services. Presently, 96 services are taxed and the list may yet increase as many service providers like the medical and legal fraternity is still beyond the ambit of service taxes. The rate also has gradually inched upwards to the current 12% plus the 2% education cess, and Mr. Chidambaram might increase it to 14% and reduce basic excise to 14% from 16%. This will ease the way towards a more simplified regime of a general Goods and Services Tax (GST) that will be common across the country and help manufacturers take credit for taxes paid on all inputs.

    The number of taxpayers in India is a minuscule 1.5% of its population. So, to improve tax collections, expenditures can be taxed to generate revenues. But what happens to these 20-odd million honest tax-paying individuals?

    Using the all-India data on Private Final Consumption Expenditure, we tried to calculate the effects of this changed tax regime to calculate a household's effective tax rate. Assuming an average monthly salary of Rs 35,000, and assuming they save 40% of income - both through the ELSS, PPF compulsory savings of Rs 100,000 and some more, we expect a monthly spend of Rs 20,433.

    Items of expenditure % of total Expenditure (Rs) Indirect taxes paid (Rs)
    Food, beverages & tobacco 37.1 7,287 607
    Recreation, cultural services 4.1 861 173
    Clothing & footwear 5.0 1,050 121
    Rent, fuel & power 11.8 2,478 1,673
    Furniture, furnishings, appliances & srs 3.6 756 215
    Medical care & health services 6.5 1,365 164
    Transport & communication 19.0 3,990 1,042
    Education 2.5 483 -
    Miscellaneous goods & services 10.4 2,163 87
    Total 100.0 20,433 4,081
    Source: Equitymaster Research

    Thus on a regular basket of goods and services, we pay tax amounting to Rs.4,081 every month. This is over and above the income tax paid out and the taxes on investments. Altogether, we estimate an average household of five with one bread earner will shell out Rs 13,933 every month to the government out of their Rs 35,000 salary, i.e., the effective tax rate is 39.8% of income.

    The road ahead
    Will this burden reduce? In fact, with more services being taxed, it will lead this ratio upwards! However, to improve the investment climate, the import duty peak rate may be reduced from 12.5% to 10.0%. The excise duty structure might get reduced from the current six slabs ranging from 8% to 42% to four (0% for essentials, 4%-6% for the mass consumption items, 12%-14% basic rate, and 36% for luxury goods). If these rate cuts are passed on (depends on the finance ministry to use muscle-power in this regard so as to reduce inflationary pressures), there will be some relief.

    We also expect the government to announce a slew of measures to make investment in areas of long gestation and high capital intensity fiscally more attractive. Though it will stand to lose future revenues in absolute terms, the potential generation of incomes will beget more tax revenues. Also by allowing the entry of private sector, the government will reduce its own expenditures in these sectors - a win-win situation.

    The short-term capital gains tax can be used as a weapon to reduce stock market volatility - it was brought down from the general tax rate to 10% in the last budget. Compliance, especially in excise collection, will also be a matter for consideration, as duty collections have not kept pace with the growth shown by the manufacturing sector thus far in FY07.

    Finally all said and done, no matter how much the tax revenues yield (have been extremely buoyant with income tax collections reaching almost full year target by December 2006 itself), the economy will be better off with them being ploughed back in the real sector, than in paying off interest on government's wastefulness.

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