The concept of tax has always been that it creates revenue for the government. However, in various ways the duty of the government is to spend that income in stimulating growth and development of the country. In this context, the government uses tax expenditure as a tool to channel tax revenue into various industries and to facilitate certain industries (emerging or sunrise sectors, industries which suit the growth of the country, employment generating sectors) and certain specific activities (charity, research etc.)
In the ‘Statement of Tax Forgone’ included in the Union Budget, the introduction states with respect to tax expenditure;
“The amount of revenue raised is determined to a large extent by tax bases and tax rates. It is also a function of a range of measures (such as) special tax rates, exemptions, deductions, rebates, deferrals and credits – that affect the level and distribution of tax. These measures are sometimes called ‘tax preferences’. They have an impact on government revenue (i.e., they have a cost) and reflect the policy choices of the Government.....Tax expenditures are spending programmes embedded in the tax statute.”
Thus, when the government makes provisions for deductions, rebates, refunds etc., the government has effectively given up the money due to it, for certain purposes, so it is said to be tax expenditure. Hence, tax expenditure and revenue forgone are interchangeably used.
Summary of foregone tax revenue for the financial year (FY) 2008-09:
The ‘Statement of revenue forgone’ clearly states that the government is worried about the growing tax expenditure.
Here’s why the foregone revenue is a concern:
Makes industries more dependent on government subsidies
Consequently, the reduction of fiscal deficit is more difficult
As a proposed solution, the government has proposed to widen the tax base in the Union Budget this year. This was probably the most feasible step for the Finance Ministry because a rise in tax rates would push up inflation and dent the industrial output. Nonetheless, we shall get a clearer picture once the budget session of the parliament ends and new notifications come out. But the government seems to have taken a minor gamble with the way the taxes have been positioned. The government has not given tax collections a push, rather it has pinned its hopes on higher profits in the coming year. As a result, more taxes and revenue would accrue while also keeping the GDP growth on target.
Source : Union Budget 2010-2011 Annex 12
Benefits to Manufacturing
The government has continued trying to push the manufacturing sector, not only through its policies but also in the taxation pattern. This is clearly visible in the consistent rise is manufacturing output over the past 12 months as shown in the graph.
Source : Union Budget Statement 2010-2011 Annex 12
Source : Government of India Ministry of Statistics and Programme Implementation figures
If we assess the distribution of the tax expenditure, we notice that there has been a major push towards growing manufacturing in the past year. For one, the government’s tax expenditure has been higher for excise and customs. Even here the highest increase has been for excise duty. Excise duty directly affects all domestic manufacturing activity and so companies which are in the manufacturing of goods are the ones to whom this benefit is targeted. Also, the rates that affect manufacturing have been kept more or less intact except for a two basis point increase in the excise duty, so that the impetus given to manufacturing post the global slowdown is not abruptly withdrawn. This hike was however necessary considering the deficit targets set by the government.
Wider net of Indirect Taxes:
The significant change this year will be in the behaviour of the service tax. Even though the base rates remain the same, the tax base has been increased. As a proportion of tax collected, the revenue forgone may remain the same, however in absolute terms, the services sector will yield more tax as the scope of service tax has been widened. This is in line with what is stated in the statement and does not harm the services sector as it is composed today, as only new services will be added to the basket. However, lowering of tax expenditure majorly dents the incomes of companies from the mid and small-cap segments. The rise in Minimum Alternate Tax (MAT) would also impact smaller companies with more volatile accounts (books).
Major sectors that will be hit by the Excise policy change are:
- Automobile and Auto parts
- Drugs and Pharmaceuticals
- Engineering goods
- Fertilizers, Chemicals and Paints
- Petroleum and Petrochemicals
- Power and Energy
Direct versus Indirect Tax:
Usually, the corporate sector gets a good share of favourable tax rebates and tax expenditure. The interesting point to note is that when figures come in for the next year, the biggest beneficiary would be the individual taxpayer.
Over the past year, the rising prices of food articles have put an immense pressure on the government to pacify the common man which is shown by the extension in the personal income tax slabs. The Budget states that even though higher exemption limits and more deductions for the individual taxpayer will result in a Rs. 26,000 crores loss this will be recouped by the additional indirect taxes, especially the MAT and the Service Tax. Overall, this will add Rs. 45,000 crores to the tax kitty.
As a result, net profit will take a hit even though revenues may rise. This may affect the earnings growth of certain companies. Thus, the early 2008 or late 2009 highs in the markets may be pushed back for a while. This is not what tax expenditure will cause, but rather, this is what tax expenditure and allocation of such expenditure reflects.
2010 seems to be the year of investment. With higher deductions and savable incomes in the offing, the income generation instruments for the individuals will benefit. With more money available in the individual’s hands, he or she should preferably start investing if not already underway. Within mutual funds, liquid funds having low to average risk exposures can be considered for short-term along with exposure to equity albeit keeping in mind the uncertainty and volatility of equity asset class.
The tax forgone statement was presented with the budget for the first time in FY2006-07. However, it has not really gained much importance as an economic indicator. At least in the macroeconomic sense, it gives a great overview of how the government plans to look at its taxable entities and that pretty much defines its yearlong approach to industries and individuals.