Budget 2015: Goodies only for corporates. Why no personal tax cuts, Mr Jaitley?

Fostering Public Leadership - World Economic Forum - India Economic Summit 2010Vivek Kaul

As far as goodies for the common man are concerned, there was nothing much there in the budget presented by the finance minister Arun Jaitley today.
The tax deduction allowed on the payment of health insurance premium was increased to Rs 25,000 from the current Rs 15,000. This will lead to tax savings of Rs 1,010-Rs 3,030, depending on which tax bracket you fall into. For senior citizens this limit was increased to Rs 30,000 from the current Rs 20,000 per year.
Also, for very senior citizens of the age 80 years or more, who are not covered by health insurance, a deduction of Rs 30,000 per year has been allowed on expenditure incurred on their treatment. For expenditure incurred towards specified diseases of serious nature, very senior citizens will now be allowed a deduction of Rs 80,000, in comparison to the earlier Rs 60,000.
The one good development has been an increase in the limit of deduction allowed on investing in the National Pension Scheme(NPS) to Rs 1.5 lakh from the current Rs 1 lakh, under Section 80CCD.
In fact, Jaitley has also proposed an extra deduction of up to Rs 50,000 for investing in the NPS, over and above the Rs 1.5 lakh.
Oh, and the transport allowance exemption has been increased from the current Rs 800 to Rs 1600. That should be a huge help indeed.
Hence, net-net the budget does not have much to offer to the middle-class taxpayer. The question that arises here is that why should the budget have goodies to offer to the middle-class taxpayer every year? Ultimately, a stable income tax policy is also very important.
That is indeed a fair point. Nevertheless, when the government is working towards bringing down the tax rate for corporates, why shouldn’t something be on offer to the middle-class tax payers as well? That’s a question worth asking.
The finance minister
Arun Jaitley in his speech said: “The basic rate of Corporate Tax in India at 30% is higher than the rates prevalent in the other major Asian economies, making our domestic industry uncompetitive. Moreover, the effective collection of Corporate Tax is about 23%.”
Along with bringing down the tax rate for corporates, Jaitley also said that “we do not get that tax due to excessive exemptions. A regime of exemptions has led to pressure groups, litigation and loss of revenue. It also gives room for avoidable discretion.” The suggestion here was that along with income tax rates coming down, the exemptions that are allowed to corporates will come down as well. The idea seems to be that at lower rates more corporate taxes can be collected.
Along with the budget every year, the government also releases a document called the statement of revenue foregone. “The estimates and projections are intended to indicate the potential revenue gain that would be realised by removing exemptions, deductions, weighted deductions and similar measures,” the statement points out.
As can be seen from the above table, the revenue foregone number of the central government for this financial year is Rs 5,89,285.2 crore. This is higher than the fiscal deficit of Rs 512628 projected for this financial year.
Nevertheless, it is important to point out that the revenue foregone number is based on certain assumptions. “ The estimates are based on a short-term impact analysis. They are developed assuming that the underlying tax base would not be affected by removal of such measures…The impact of each tax incentive is determined separately, assuming that all other tax provisions remain unchanged. Many of the tax concessions do, however, interact with each other. Therefore, the interactive impact of tax incentives could turn out to be different from the tax expenditure calculated by adding up the estimates and projections for each provision.”
So the revenue foregone figure needs to be looked at with these limitations in mind. Having said that, the government of India is losing out on revenue because of the exemptions and deductions. There is no denying that.
As can be seen from the above table, corporate India is a major beneficiary of all the exemptions and deductions. If one adjusts for personal income tax, the revenue foregone for the central government still comes in at a whopping Rs 5,48,850.6 crore for 2014-2015. While this number maybe notional, there is clearly no denying that corporates benefit immensely out of the deductions and exemptions that have crept into our tax laws over the years.
In fact, bigger the corporate the more deductions and exemptions they take. Corporates which make an operating profit within the range of Rs 0-1 crore have an effective tax rate of 26.89% Those in the Rs 50-100 crore range have an effective tax rate of 24.29%. Whereas those making a profit of greater than Rs 500 crore have an effective tax rate of 20.68%.
The overall rate is 23.22%. Jaitley wants to push up this rate of “actual tax” paid by bringing down the corporate tax rate to 25% from the current 30%, over the next four years. The hope also seems to be that at lower tax rates more taxes will eventually get paid.
The question is why can’t the same logic be applied to individual tax payers? Around 3% of Indians pay income tax. If more corporates are likely to pay more tax at lower rates, can’t the same assumption be made for individual tax payers as well? Further, like the corporates income tax laws, can’t the personal income tax laws simplified as well?
This is something that the finance minister Arun Jaitley needs to answer. May be he will in the days to come.

The column originally appeared on www.firstpost.com on Feb 28, 2015 

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek) 

What Jaitley is doing to meet the Rs 1,05,000 crore tax collection gap

Fostering Public Leadership - World Economic Forum - India Economic Summit 2010In the Mid Year Economic Analysis released in December 2014 it was estimated that the government will run short of the projected tax revenues by Rs 1,05,084 crore. As I have suggested in the past, this means that the government will have to slash its expenditure big time, in order to meet the fiscal deficit target of 4.1% of the GDP that it had set for itself when it presented the budget in July 2014.
deeper reading of a newsreport in The Economic Times suggests that this will now partly happen on its own. The government expenditure is essentially categorized into two categories-plan and non-plan. Plan expenditure is essentially money that goes towards creation of productive assets through schemes and programmes sponsored by the central government.
Non-plan expenditure on the other hand is an outcome of planned expenditure. For example, the government constructs a highway using money categorised as a plan expenditure. But the money that goes towards the maintenance of that highway is non-plan expenditure. Interest payments on debt, pensions, salaries, subsidies and maintenance expenditure are all non-plan expenditure.
Data released by the Controller General of Accounts(CGA) suggests that during the first nine months of the financial year the period between April and December 2014, the government spent Rs 3,52,631 crore or 61.3% of the Rs 5,75,000 crore plan expenditure that the government had budgeted for.
A government rule does not allow it to spend more than 33% of the plan expenditure in one quarter. At the same time the government cannot spend more than 15% of the plan expenditure in March. 

Given this, how do the numbers stack up? 33% of Rs 5,75,000 crore, the budgeted plan expenditure for the year, amounts to Rs 1,89,750 crore. The government has already spent Rs 3,52,631 crore between April and December 2014. Hence, for the current financial year as a whole, it cannot spend more than Rs 5,42,381 crore (Rs 3,52,631 crore plus Rs 1,89,750 crore).
This means that the government will automatically end up not spending Rs 32,619 crore. In fact, the 33%/15% rule applies at the ministry, department as well as scheme level. Given this, the actual number can be slightly different from the overall number arrived at.
What this means is that the government will have to further slash plan expenditure in order to meet the tax gap of Rs 1,05,084 crore. This shouldn’t come as a surprise given that in the last two financial years, this is exactly what the government did.
The plan expenditure target of the government during the last financial year was at Rs 5,55,322 crore. The actual plan expenditure came in at Rs 4,75,532 crore, which was close to Rs 80,000 crore or 14.4% lower. This is how the fiscal deficit of 4.6% of GDP was achieved.
A similar strategy was followed in 2012-2013 as well. In 2012-2013, Rs 5,21,025 crore was budgeted towards plan expenditure. The final expenditure came in 20.6% lower at Rs 4,13,625 crore.
The Economic Times suggests that the plan expenditure this time around will be Rs 80,000 crore lower. The paper goes on to suggest that this will be Santa’s late gift to finance minister Arun Jaitley.
This can hardly be the case given that plan expenditure is asset creating. In an environment where private investment continues to remain slow, if the government expenditure is also cut dramatically, it can’t be good for the economy. But given that the government’s revenue projections have gone dramatically wrong there is nothing much it can do other than slashing plan expenditure, given that non plan expenditure cannot be easily slashed.
The bigger problem here remains that India’s tax collections are very low in comparison to its gross domestic product. Analysts Ritika Mankar Mukherjee and Sumit Shekhar of Ambit Capital in a recent report titled 
Modi’s ambitions will reshape India’s fiscal construct show that India’s tax collections are abysmally low as a proportion of its GDP. The next exhibit shows that clearly. 

Exhibit 1:India’s tax-to-GDP ratio remains
abysmally low at 11% as per FY15 Budget Estimates

Source: CEIC, Ambit Capital research, Note: Data is presented on financial year basis


At the same time, as the next exhibit shows, the tax to GDP ratio of India is lower than that of other emerging markets 

Exhibit 2: India’s tax GDP ratio is lower
than that of most emerging market peers

Source: World Bank, Ambit Capital research, Note: Data is presented on calendar year basis


Given this, it is very important that the government figure out ways of improving its tax collections. This is especially important in light of the fact that the government seems to have huge plans for spending money on improving India’s pathetic public infrastructure. 
As the Ambit Capital analysts point out: “India’s tax-to-GDP ratio has been range bound between 8% and 12% over the past two decades. Furthermore, a comparison with peers as well as with developed countries like the UK points to the vast tax revenue-generating potential in India which suffers from large-scale tax evasion.” 
The Ambit analysts also feel that boosting India’s tax-to-GDP ratio will be one of the major things that the Narendra Modi government will do over its term. As they point out: “Our discussions with well-placed policy experts suggest that enhancing India’s abysmally low tax-to-GDP ratio is likely to be one of the primary objectives that Modi will pursue over his five-year term.” 
One way of improving the tax-to-GDP ratio is to go about reducing the total amount of black money in the Indian financial system in a systematic way. While the government has made a lot of noise about bringing about all the black money that has left the Indian shores, it hasn’t had much to say about the black money floating around in India, which would be significantly easier to recover. Going after the black money in India would be the quickest way to significantly improve the country’s abysmally low tax-to-GDP ratio. 
The other major area that needs to be looked at are the tax rates and exemptions that come with them. As Swaminathan Aiyar pointed out in a recent column in The Times of India: “Currently , India has among the highest tax rates in Asia, but also hordes of exceptions.” 
Along with the budget every year, the government releases the revenue foregone number. This number for the last financial year 2013-2014 was estimated to be at Rs 5,72,923.3 crore. “The estimates and projections are intended to indicate the potential revenue gain that would be realised by removing exemptions, deductions, weighted deductions and similar measures,” the statement of revenue foregone points out. 
In the table that follows it can be clearly seen that the Indian corporates benefit the most out of all the exemptions and deductions available under the various tax laws in this country. The businesses benefit the most with corporate income tax, excise duty and customs duty foregone, forming a bulk of the revenue foregone by the government. 

Tax

Year

(in Rs crore)

2012-2013

2013-2014

Corporate Income Tax

68,720.0

76,116.3

Personal Income Tax

33,535.7

40,414.0

Excise Duty

2,09,940.0

1,95,679.0

Customs Duty

2,54,039.0

2,60,714.0

566234.7

572923.3

Source: Annual budget


The revenue foregone number is based on certain assumptions. As the statement points out ” The estimates are based on a short-term impact analysis. They are developed assuming that the underlying tax base would not be affected by removal of such measures….The cost of each tax concession is determined separately, assuming that all other tax provisions remain unchanged. Many of the tax concessions do, however, interact with each other. Therefore, the interactive impact of tax incentives could turn out to be different from the revenue foregone calculated by adding up the estimates and projections for each provision.” 
Nevertheless, it is too big an amount to be ignored. In fact, the number is bigger than the projected fiscal deficit of Rs 5,31,177 crore for this financial year. Given this, the government needs to go through these exemptions carefully and figure out whether they are really needed. 
Of course, this exercise may not be possible to carry out before the budget, but it needs to be taken up seriously. Lower tax rates along with fewer deductions and exemptions should go a long way in improving India’s tax-to-GDP ratio.

(The article originally appeared on www.equitymaster.com as a part of The Daily Reckoning on Feb 6, 2015)

Warren Buffett’s favourite business book tells us what is wrong with India’s tax system

Warren_Buffett_KU-crop,flip

Vivek Kaul

Business books are soporific. They put me to sleep.
Nonetheless, now and then, one does come across an excellent business book as well. These days I am reading John Brooks’
Business Adventures. The book is a collection of 12 long articles that Brooks wrote for the New Yorker magazine.
In July 2014, Bill Gates wrote a blog titled
The Best Business Book I’ve Ever Read. As he put it : “Not long after I first met Warren Buffett back in 1991, I asked him to recommend his favorite book about business. He didn’t miss a beat: “It’s Business Adventures, by John Brooks,” he said. “I’ll send you my copy.” I was intrigued: I had never heard of Business Adventures or John Brooks. Today, more than two decades after Warren lent it to me—and more than four decades after it was first published—Business Adventures remains the best business book I’ve ever read.” This blog by Gates sent the book to the top of the best-sellers lists almost everywhere.
The third chapter of the book is called
The Federal Income Tax. Brooks makes several points in the chapter about the income tax system in the United States as it had prevailed in the fifties and sixties. Some of the points I feel are as applicable to the general tax environment in India today as they were in the United States back then.
As Brooks writes in the context of the federal income tax in the United States: “A good deal of the attention given to the income tax is based on the proposition that the tax is neither logical nor equitable. Probably, the broadest and most serious charge is that the law has close to its heart something very much like a lie; that is, it provides for taxing incomes at steeply progressive rates, and then goes on to supply an array of escape hatches so convenient that hardly anyone, no matter how rich, need pay the top rates or anything like them.”
Long story short: The rich were “supposed” to be taxed at a high rate, but at the same time enough loopholes were built into the income tax laws ensuring that they did not pay the highest tax rates in reality.
A similar sort of scenario prevails in India when it comes to the Income Tax Act in particular and taxes in general. Along with the budget every year, the government of India
puts out a statement of revenue foregone under the central tax system.
What is the purpose of this system? “The estimates and projections are intended to indicate the potential revenue gain that would be realised by removing exemptions, deductions, weighted deductions and similar measures,” the latest statement of revenue foregone points out.
The deductions, exemptions and other measures lead to a loss of revenue for the government. As can be seen from the accompanying table the revenue foregone for the government during the year 2013-2014 has been estimated to be at Rs 5,72,923.3 crore.

Statement of Revenue Foregone

TaxYear(in Rs crore)
2012-20132013-2014
Corporate Income Tax68,720.076,116.3
Personal Income Tax33,535.740,414.0
Excise Duty209,940.0195,679.0
Customs Duty254,039.0260,714.0
566,234.7572,923.3


A simplistic way of looking at it is that the revenue foregone number is greater than the fiscal
deficit of the government for 2013-2014, which stood at Rs 5,42,499 crore.
Nevertheless it needs to be pointed out that the statement of revenue foregone is based on certain assumptions. As the statement points out “ The estimates are based on a short-term impact analysis. They are developed assuming that the underlying tax base would not be affected by removal of such measures….The cost of each tax concession is determined separately, assuming that all other tax provisions remain unchanged. Many of the tax concessions do, however, interact with each other. Therefore, the interactive impact of tax incentives could turn out to be different from the revenue foregone calculated by adding up the estimates and projections for each provision.”
So the revenue foregone figure needs to be looked at with these limitations in mind. Having said that, the government of India is losing out on revenue because of the exemptions and deductions. There is no denying that. As can be seen from the above table corporate India is a major beneficiary of the same, like the rich were in the United States, around the time Brooks wrote about the federal income tax.
Getting back to Brooks, he also points out that laws and the regulations were so vast that the critics thought it was an “undemocratic state of affairs, for only the rich can afford the expensive professional advice necessary to minimize their taxes legally”.
This is what is happening in India as well. Companies have an army of chartered accountants and lawyers, working towards legally minimizing taxes, whereas most individual tax payers find it difficult to afford the services of a good chartered accountant who can help them.
Brooks also talks about the favoured treatment of capital gains. This is something that really helps the rich because they are the ones primarily investing in stocks and bonds. In India short term capital gains on equity gets taxed at 15%. There is no long term capital gains tax on equity i.e. if you buy and then sell a share after one year, you don’t have to pay a tax on the capital gains you make when you sell the shares. Equity mutual funds are treated in a similar way.
In case of debt mutual funds, long term capital gains come into the picture if the investment is held for a period of more than three years. Long term capital gains are taxed at either 10% or 20% with indexation, whichever is lower. Indexation allows inflation to be taken into account while calculating the cost of purchase. This brings down the tax significantly.
Now compare this to the common man’s investment—the humble fixed deposit. In this case the interest earned is taxed at the marginal rate of tax. Why is there a favourable treatment for investing in equity? I have often been told that this is because the investor investing in stocks is taking on more risk than the fixed deposit investor, and hence needs to be encouraged through a favourable tax treatment.
This I guess is “bullshit” (pardon my French!) of the highest order perpetuated by those who invest in equity and do not want to pay any tax on it. The amount of risk that an individual wants to take on with investments, is his or her personal preference and should have nothing to do with the prevailing income tax system. Nevertheless that’s the way things stand. Equity gets preferential tax treatment all over the world.
Other than this, the Indian Income Tax Act has a very interesting provision for those taking on a home loan to buy a home. In fact, the Act encourages people to speculate in real estate. T
here is no restriction on the number of homes against which you can claim a tax deduction on the interest paid on the home loan to fund the property. Only one of these properties needs to categorized as a self-occupied property. On this self-occupied property, an interest of up to Rs 1.5 lakh can be claimed as a tax deduction.
But this limit does not apply to the remaining homes that an individual may choose to buy. Any amount of interest paid on home loans can be claimed as a deduction as long as a “notional rent” is added to the income.
We all know that these days “rents” are relatively low in comparison to the EMIs that need to be paid in order to repay the home loan. Hence, the interest component tends to be massive during the initial years and helps people with two or more homes, claim huge tax deductions.
In a country where a large number cannot afford to buy a home what is the logic in having a regulation like this one?
The Direct Taxes Code, which is supposed to be replace the Income Tax Act, in its original form simplified the income tax system. In fact, I remember reading a large part of it when it first came out and was very impressed by its simplicity.
But a simple tax code doesn’t benefit those who currently make money out of the Income Tax Act being as complicated as it is. These include chartered accountants, tax lawyers, corporates and the income tax officers. Over the years, the Direct Taxes Code has been revised and from what I am told by those in the know of such things, it has become more or less as complicated as the Income Tax Act currently is.
To conclude, the tax system in India currently favours those who need to pay more taxes. This is something that needs to be addressed in the days to come.

The article originally appeared on www.equitymaster.com on Dec 2, 2014

India Inc. benefits from complex tax laws even as it demands simpler ones

The Narendra Modi government will be presenting its first budget in about a month’s time. It is that time of the year when business lobbies meet the finance minister and present him with their wish-list of what they expect from the budget. This year, among other things, the lobbies seemed to have asked for a simpler tax regime. “A simple, transparent and non-adversarial tax regime, bereft of complexities and ambiguities, would go a long way to strengthen business sentiment and restore faith of the foreign investor in the India growth story,” Ajay Shriram, president of Confederation of Indian Industries (CII) told the media. It’s hard to argue with that demand. But a closer examination will reveal that the companies represented by such industry bodies benefit the most from a complex tax system, which allows for a slew of exemptions and loopholes. Do do Indian businessmen really mean it when they say they want a simpler tax regime?
Along with the budget every year, the government of India releases the “statement of revenue foregone”. The statement for the financial year 2013-2014 provides some interesting information about the income tax paid by Indian companies during the 2011-12 fiscal.
The statement considered the tax expenditure of 4,94,545 companies for an interesting bit of analysis. While the statutory tax rate was 32.445%, the effective average tax for these companies came in at 22.85%. What explains this difference of ten percentage points? The complex tax regime. How? We shall see in a moment.

Interestingly, the greater the profits made by a company, the lower was its effective rate of income tax. As can be seen from the table above, companies which made a profit of between Rs 0-1 crore had an effective tax rate of 26.26%. For companies which made a profit of greater than Rs500 crore, the effective rate fell to 21.67%.
More than half the companies in the sample (around 53.2%) had an effective tax rate of up to 20% of their profits. “In other words, a large number of companies (263,315) contributed a disproportionately lower amount in taxes in relation to their profits,” the statement points out.
So, why is there such a huge difference between the statutory rate of income tax and the effective rate that the companies are paying? The only explanation for this is the huge number of deductions allowed by the Income Tax Act, 1961. Every deduction that has been added to this Act over the years has made it inherently more complicated, and less simple. And companies have been taking advantage of this complexity and ensuring that they do not have to pay tax at the statutory rate.
The revenue foregone, or the money that would have flown to the exchequer if all companies paid statutory tax rates, has been rising. The figure was Rs 81,214.3 crore for 2011-2012 and was expected to be at Rs 89,446.6 crore for 2012-2013.
The effective rate of income tax that companies pay has marginally risen over the years. It went up from 20.55% in 2006-2007 to 24.1% in 2010-2011 and fell to 22.85% in 2011-2012. The rate of increase in the effective rate of income tax paid by companies has been very slow.
When companies complain about the complex tax regime, what they mostly mean is that they want a less aggressive income tax department. The complexity in rules translate directly into more money for companies, and in general, they have not been known, anywhere in the world, to lobby hard so they could make less money.

The article originally appeared on qz.com on June 18, 2014