Finance Minister Pranab Mukherjee on Tuesday announced a stimulus package for the economy, the third this financial year, cutting excise duty and service tax two percentage points each, effective midnight, and extending previous excise cuts beyond March 31, 2009.

Service tax has been cut across the board from 12 per cent to 10 per cent and the excise has been reduced by the same margin only for items that currently attract the 10 per cent rate.

Consumers are expected to benefit significantly from this latest cut in indirect tax, since over 90 per cent of excise duty collections come from the 10 per cent slab rate, which is levied on white goods, metals, commercial vehicles, iron and steel and cement. Tyre makers have already responded by announcing a two percentage point cut in prices.

Overall, consumers can expect a more than 2 per cent reduction in retail prices if the excise and service tax cuts are passed on fully. This is because the Value-Added Tax, which is levied at the state level, is applied over and above the excise duty, said Vivek Mishra, partner, Ernst & Young, an auditing and consulting firm.

Most items attract 4 per cent or 12.5 per cent VAT rates. At 12.5 per cent, a two percentage cut in indirect tax will lead to a 2.3 per cent reduction in retail prices.

Today's package, which India Inc had anticipated in the Interim Budget presented on February 16, comes a few days ahead of an expected announcement of general election dates by the Election Commission. Once these dates are announced, a model code of conduct kicks in, preventing the government from announcing such fiscal giveaways.

The stimulus package � which Mukherjee announced in Parliament in his reply to the debate on the Interim Budget that was later approved by the Lok Sabha �  will cost the Central exchequer revenue of Rs 29,100 crore. Service tax will account for Rs 14,000 crore, excise duty Rs 8,500 crore and customs duty (because of reduction in countervailing duty) Rs 6,600 crore.

Tuesday's cuts will increase the fiscal deficit for the next financial year by 0.48 per cent of GDP, taking it to near 6 per cent levels for the next fiscal, against the budgeted figure of 5.5 per cent and more than double the 2.5 per cent mandated under the fiscal responsibility law.

The tax sops, first to fight inflation and then to boost demand, will cost the government Rs 52,000 crore in the current fiscal. Two previous packages were announced in December and January. The government has already revised downwards the gross tax revenue target in the current fiscal by over 8 per cent.

Duty cut not factored in this year's revised estimates:
The duty cuts, however, have not been factored in the revised estimates for the current fiscal because the government did not anticipate a reduction in indirect taxes as  part of the pre-Budget exercise.

However, P C Jha, Chairman, Central Board of Excise and Customs, which administers central indirect taxes, said: "The department is hopeful of achieving the revised excise duty target of Rs 1,08,000 crore for the current fiscal." In the revised estimate, the government cut the excise target by Rs 29,000 crore from the budget estimate of Rs 1,37,000 crore.

"We expect the benefit of the duty cuts will be passed on to consumers by way of price reductions," added V Sridhar, member, Central Board of Excise and Customs.

In terms of a deficit-financed stimulus, economists said cutting indirect taxes is more effective than government spending. "By cutting taxes, the government has put more money in people's hands rather than spending on its own," said D K Joshi, economist with Crisil Ltd [Get Quote], a ratings and advisory firm.

Agreeing that indirect tax cuts are more effective in stimulating demand than direct tax cuts, Abheek Barua, chief economist with HDFC Bank [Get Quote], said, "Cutting income tax rates, for instance, often leads to higher savings instead of increased spending, as precautionary savings increase when people are faced with uncertainty".

Tax cut a move towards GST?
The reduction in general excise duty seems to point to a 16 per cent goods and service tax (GST) rate, which is expected to be implemented from April next year. The unified GST regime will subsume all states' sales taxes and central taxes except customs duty.

Highly placed sources familiar with Centre-states negotiations on GST say that the unified GST rate will consist of a central GST of 8 per cent and state GST of 8 per cent. The central government is also expected to reduce service tax rate further to 8 per cent in course of time.

"It is also our objective that the dispersal between the Central VAT rate and the service tax rate is reduced, with a view to move towards the stated goal of a uniform GST," Mukherjee said in Parliament.

States allowed to borrow more
The government has also allowed states to exceed the 3 per cent fiscal deficit target in the next fiscal. That will allow them to borrow more from the market. In the current fiscal the government had allowed states to borrow an additional 0.5 per cent of their GDP and the fiscal deficit was allowed to go up to 3.5 per cent.

The government also extended full basic customs duty exemption to naphtha imported for generation of electric energy, to beyond March. This exemption was part of the first fiscal package announced on December 7 last year and was available up to March 31.

Mukherjee also said anomalies in tax treatment under Section 10AA of the Income Tax Act, which provides exemption on export profits to units located in a Special Economic Zone (SEZ), would be removed.

The export profits are currently computed on an assessee's total turnover. This has resulted in discriminatory treatment of assessees in units located both in SEZs and the Domestic Tariff Area (DTA) vis-�-vis assessees in units located only within the SEZs. Changes will be made in the Act, Mukherjee said, to remove this anomaly.