The yearly drama of the annual budget ceremony in the Indian parliament happened today. It starts with a sombre, grey / silver haired Finance Minister walking into the parliament with the ceremonial suitcase (always with the suitcase) filled with goodies (if its an election year) or generally inconsequential policy tweaks (especially if the finance minister happened to be Pranab Mukherjee, the hon. President of India).

There was a lot of hope this year with P. Chidambaram, a Harvard MBA presenting his first budget. He is widely regarded as a pro-market reformist and a general pragmatist.

While the author has not disambiguated the entire budget, here are some thoughts.

a) 10% surcharge on the super-rich: For those making more than Rs. 1 crore a year (approx. $ 190,000), there is a surcharge now. According to the FM, the total number of people impacted across the nation is 42,800. Take a look at these 2012 numbers of luxury car sales in India (I am just picking 3 brands – BMW, Audi, MB – each of which is above Rs. 1 crore):

BMW: 9375

Audi: 9003

Mercedes Benz: 7138

That amounts to ~ 25,000 cars across just BMW, Audi and MB (not to mention Aston Martins, Jaguars, Land Rovers and even Rolls that are increasingly visible on Indian roads). Am I to believe that 42,800 folks bought 25,000 cars?

Moral of the story: This blogger is not averse to taxing the rich – they have had a disproportionate amount of benefits allocated from the state – but widen the tax base. It is egregious to have the Finance Minister of India to say that there are 42K people in India making more than a crore. We need to widen the tax base. I know real estate in India is primarily dealt with black money – so its difficult to identify the perpetrators who make multi-crore deals – here’s an easy solution – get the names of all the people who have bought a car more than Rs. 70 lakhs and co-relate that to the incomes they declare. Have them investigated. I doubt legitimate small business owners would add a Rs. 1 crore car as a business expense (which is what most people do when they buy these cars). Widen the tax base. Really what we are doing here is a classic case of perverse incentives. We are increasing taxes on those who were honest (or just too rich) to report that their income was Rs. 1 crore or more. In effect, we are incentivizing the dishonest behavior of the millions of others who mis-report their incomes by not penalizing them. This is not sustainable. We need to broaden the tax base. Nothing else will work.

b) Rs.2000 tax credit for incomes upto Rs. 5 lakhs: This author thinks it is a good idea – especially given the rate of inflation in India. However, it would have been well served to couple these credits with further cut in subsidies for diesel and petrol – these subsidies tend to cause disproportional benefits to the rich and wealthy (aka a diesel powered SUV driver or a trucking company owner). The FM seemed to have suggested that such discussions (around reducing gas subsidies) are very much in the offing.

c) Increased “luxury tax” – Customs on high end luxury cars, motorcycles, yachts etc. And on high end dining: No issues there. As mentioned in point a), most consumers of such products are people who under-report their incomes. So its only fair. However, increasing service tax on “air-conditioned” dining seems a little regressive.

d) TDS for real estate transactions: A good first step to counter the chronic undervaluing of real estate prices across the nation to reduce property taxes etc. However, the more endemic problem remains un-addressed – the core institutional reasons as to why a parallel, underground economy exists in the first place (more on that later).

e) 14% increase in defense spending: While, for a country with a higher child mortality rate than sub-saharan africa and immunization and malnutrition rates worse than Bangladesh or Pakistan, the defense spending of Rs. 2 Trillion seems exorbitantly high, the unfortunate reality of a very challenging defense scenario exists in South Asia. And to that extent, the defense spending increase is unavoidable.

f) A number of pro-business policies: While this post isn’t intended to go through a point-by-point review of the budget, some of them are pertinent enough to mention:

1. Simpler SEBI rules:Securities and Exchange Board of India to simplify procedures for foreign portfolio investors. This is a step in the right direction. We need to increase our levels of investment to get upto the 6% GDP growth range. 

2.Tax-free infrastructure bonds of Rs.50,000 crore to be issued: Again, step in the right direction. Its not entirely clear to me if the bonds will only be issued at the federal level (which is probably the case, since this is the central budget). A much more effective institutional change would be to allow municipalities to issue infrastructure and development bonds (much like how it works in the United States). This would allow the markets to decide where to invest (as opposed to a top-down mandate of investment emanating from the central government). For e.g. If Gurgaon and Faridabad were both allowed to issue infrastructure bonds – the market can decide which is a more attractive area to develop infrastructure by deciding on bond yields. This, to me, is much more effective way to allocate limited resources compared to a central government deciding where to invest in. 

3. Regulator to be appointed for road projects: While conceptually this is a great concept, the challenge is that the implementation will probably be similar to many other government appointments. If this is a political appointee, he / she will likely be influenced by entrenched interests of politicians – destroying the whole premise of having a regulator. That post will just become a proxy of entrenched interests. To avoid this, the appointment should strictly be done by technocrats (comprised of public and private stakeholders).

Overall, the budget is definitely more courageous than one expected one year before elections. There was a slowing down on expenditures (esp. in defense), distinctly lacked electoral sops that have unfortunately become the hallmark of budget in the recent past.  And at least it targets to keep budget deficits to ~5% of GDP.

However, there needs to be a larger debate on the role of government in a country like India. For e.g. as I mentioned earlier in the post, what are the core reasons that India has one of the largest parallel “black” economies in the world. Why is it that only a laughable 40K people in the country report an annual income of Rs. 1 crore and above. Why is it that there are so many unregistered businesses in the country? What does the role of government play in corruption that has become so endemic in the country. And what fundamentally needs to change – in the government and in bureaucracy – to create conditions to propel India to the next level.

More to follow.

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