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Budget: Populism at its worst

July 09, 2004

From the structural point of view, this Budget is a retrograde one because it is populist, exemption-oriented and subsidy-driven. Those reforms and simplifications in the tariff structure of the 1990s, when the present prime minister was the finance minister, have been given the go by.

In customs there are now 19 rates of duty and many specific rates with several thousand exemptions, 47 lists and 93 conditions. In central excise also, there are innumerable exemptions, many of them area-specific.

Economists who have been fondly advocating a single rate of duty with a minimum number of exemptions will find it difficult to stomach many more exemptions and the continuation of even the area-specific ones.

The most populist exemption is for tractors. It is avowedly for helping agriculture. In reality, the effect is the opposite. The inputs for making a tractor -- namely steel, paint, electrical fittings, plastic padding and so on -- pay excise duties that amount to at least 9 per cent (on TV today, a big manufacturer claimed it to be 12 per cent).

So, if a tractor pays a duty of 16 per cent, the actual burden would be only 4 per cent. Since a tractor is sold with passing on of the duty burden of 16 per cent, the ultimate effect on a tractor would be to be rid of both the input duty of 12 per cent and the 4 per cent duty on the value added.

But now, because of the exemption, a tractor will have to bear a duty of 9 to 12 per cent, which it cannot pass on. Thus, an exemption is more detrimental to tractors than a 16 per cent duty that could be passed on.

Economists know that exemption is not the same as zero-rating. Exempting tractors and claiming that the move will help agriculture draw claps and table-thumping only from the uninitiated.

Similarly, to say that withdrawing central value-added tax from processed textile fabrics would free millions of handlooms and powerlooms from the clutches of central excise inspectors is also unsound.

For years attempts were made to bring all sectors of the economy under Cenvat. And when it was achieved and evasion largely controlled, the new Budget says that it is necessary to free handlooms and powerlooms from central excise control!

So, if this tradition is continued, the government will first introduce value-added tax to cover the millions of traders and then, when a new government takes charge, it will "free" the traders from the clutches of the sales-tax officers. With this attitude of the Central government (which will also percolate to the state governments), VAT will end up in ruins.

Why are we going to have VAT? Because it is a neutral tax, because it expands the tax base to the retail trade and because there will be more revenue.

But if the attitude, as is explicit from this Budget, is to smash the Cenvat chain by thousands of exemptions, and to come out from the VAT chain, if only to free millions of people from the clutches of excise and sales tax officers, then we shall have a VAT that will be fractured by exemptions, subsidies, deferrals, options and the like.

It will make a nonsense of the concept of neutrality, which is so much trumpeted about as a big virtue of VAT.

In customs, the finance minister has not reduced the so-called peak rate of 20 per cent, but has reduced duties of several metal alloys and minerals from 20 per cent to 15 per cent.

This is justified, because in January 2004, this peak rate was reduced from 25 per cent to 20 per cent. Here it may be pointed that 20 per cent is not the peak rate since there are 12 rates varying from 30 per cent to 150 per cent above the so-called peak rate of 20 per cent.

The finance minister has said that it is his "intention to align India's tariff structure to those of the ASEAN countries". Here I would like to clear a prevailing misconception about the ASEAN average rate of 15 per cent.

The truth is that while the basic customs duty (in the ASEAN rate) is 15 per cent, another tax varying between 10 per cent and 45 per cent is levied separately as a special custom duty; and this is not the same as our additional duty, which is Cenvat-able.

In addition, the ASEAN countries also levy 10 per cent VAT. Thus, while a car is supposed to pay a customs duty of 35 per cent, the total duty works out to be 110 per cent. If the finance minister wants to reduce customs duty to make domestic industry competitive, it is welcome, but not in the name of "aligning" with ASEAN rates.

Service tax has been extended to some 14 more items such as business exhibition services, airport services, opinion poll services and risk cover in the life insurance service.

Here I must compliment the finance minister for having followed the path of "selectivity" rather than following the path of introducing an "all-comprehensive service tax with a negative list".

The latter option of comprehensive tax was recommended by the Kelkar committee and also by the committee on service tax in 2001. But that option would have brought immense confusion at the point of implementation.

The finance minister has also done well to combine the credit of service tax and excise duty across goods and services. This will make it an integrated goods and service tax

However, we have yet to examine the fine print. If it is made into a full-fledged GST, to begin with, there will be a severe revenue loss.

For example, the service provided by a gymnasium is subject to 8 per cent service tax (now it will be 10 per cent). A gymnasium usually buys exercise equipment worth several lakhs of rupees and the Cenvat duty on that will be 16 per cent, which will be far more than the service tax to be paid by a gymnasium for several years to come.

Taking all this into account, it is not quite certain whether the claim of the finance minister that the tax proposal on the indirect taxes side will be revenue-neutral, is well-founded.

It is likely that all his bounties in the shape of exemptions, subsidies and combining input credit for goods and services will lead to a huge revenue loss, which will also affect his calculations of the fiscal deficit.

In excise, an important clarification is being added to the tariff that wire pulling is also manufacture.

The writer is former member, Central Board of Excise and Customs

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Number of User Comments: 1

Sub: Mom-u-lism !

Correct. Now that Vajpaijee has been sent into hibernation, you should say this budget is: "Mom-u-lism at its worst" ! ...

Posted by Dara Acidwalla


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