The Hits And Misses Of Arun Jaitley

Which targets did Jaitley hit in the past year and which did he miss? While he has certainly introduced reforms which couldn’t have happened if not for him, there have been a few disappointments on some fronts.

Is the trenchant criticism on economic management directed at the Bharatiya Janata Party-led National Democratic Alliance (NDA) government fair? At one level, perhaps yes. The government has failed to meet the expectations of India Inc. and many economists who hoped for more radical economic reforms (at least as radical as privatizing Air India). But when the NDA’s performance in the past one year is compared to several years of the United Progressive Alliance (UPA), it certainly comes out shining.

Union Finance Minister Arun Jaitley’s press conference on 22nd May highlighted some of the achievements of the government: bringing greater transparency in government functioning, promoting co-operative federalism not just by implementing the Fourteenth Finance Commission’s report but also through giving the proceeds of coal auctions to the states and better fiscal consolidation and stabilizing important parameters like current account deficits, growth rate, revenue figures.

Jaitley certainly deserves credit for some of these developments as they may not have happened but for him. However, he has disappointed on some fronts like his handling of the issue of taxes on capital gains or meddling with the central bank’s autonomy. Fortunately, even though these issues attracted a lot of flak, they have not derailed the broader growth agenda of the Narendra Modi government.

Below, we take a look at some of Jaitley’s sixers in the past year as well as the ducks he scored.

 His hits

1)  A balanced, growth-oriented, inclusive first 2015-16 Budget

The Modi government’s first budget – for 2014-15 presented soon after it came to power last year – was keenly watched for signalling the direction of economic reforms under Jaitley. Disappointment quickly set in as it hardly carried any bold reform measure; most of the reforms were precipitated outside the budget. The savings rate of the economy had dived from over 38 per cent of gross domestic product (GDP) in 2008 to 30 per cent in 2012-13. So it was a welcome step that Jaitley raised basic tax exemption limits in the 2014-15 to encourage savings. In 2015-16 budget, he also increased deductions available under Section 80C, all though marginally.

The manufacturing sector was sought to be given a boost through several tax benefits like concessions for equipments used as inputs in the setting up of solar and wind energy projects, reduction of investment ceiling for claiming investment allowance (from Rs. 100 crore to Rs. 25 crore) to encourage small and medium enterprises to invest in manufacturing; reduction of excise duty rates for consumer durables, capital goods, and the automotive sector. Most importantly, his step to extend the medium term fiscal deficit target of 3 per cent by three years to 2016-17 was seen as positive step as it is expected to give more leeway to the government to give a big push to public spending on infrastructure. Wealth tax (which did not garner much revenue but was costly to enforce) was abolished, tough penalties for tax evaders introduced and service tax raised from 12.36 per cent to 14 per cent to boost revenue generation and smoothen the transition to the goods and service tax (GST) regime.

The General Anti-Avoidance Rules was deferred by two years and it was announced that minimum alternate tax (MAT) – which was the source of heated controversy in recent months – will not apply from this year. A new bankruptcy code which makes it easier to do business was proposed (and reiterated in his press conference today) and a new law on black money announced (and tabled in Parliament during the budget session itself).

In a major effort to clean up the tax system, Jaitley proposed to reduce the corporate income tax rate to 25 per cent from the current 30 per cent over the next four years and simultaneously phase out a host of exemptions that only led to litigations and tax disputes and did not garner revenues. This two-pronged approach is expected to increase transparency, make domestic industries globally competitive and encourage them to make higher capital investments in projects.

2)  The relentless push for GST

The first moves for GST came from the first National Democratic Alliance government of Atal Behari Vajpayee in 2000 and it has been in the works ever since. The UPA introduced a Bill to usher in GST in 2011 but that lapsed with the dissolution of the 15^th Lok Sabha. Jaitley tabled a fresh Bill in December 2014, which made significant changes in the 2011 Bill.

There are three main differences between the two Bills. First, the 2014 Bill keeps an origin tax of 1 per cent on the supply of goods in interstate trade for two years. Even though this retains elements of the Central Sales Tax, which the GST was supposed to replace, it will be temporary and is aimed at assuaging the concerns of the states about losing revenue. Second, the GST Council will be the decision making authority and will have a democratic representation from all states. This will therefore dilute the veto power of the Centre to balance it with that of the states. Third, the GST Council will be empowered to provide a range of rates between which the states can levy the tax (instead of a single rate). Evidently, this will grant flexibility to the states in determining the SGST.

In addition, the Finance Ministry has announced Rs. 11,000 crore as part payment of dues towards compensation for phasing out of Central Sales Tax which was pending from 2010-11 (this is one-third of the total dues); the remaining amount will be paid starting next year. By incorporating these changes, Jaitley has focused on alleviating states’ concerns on revenue sharing and balance of power, thereby helping promote Modi’s commitment to encouraging co-operative federalism.

3) Fiscal consolidation

The fiscal deficit number for 2014-15 came in at 4 per cent of GDP as against the budget target of 4.1 per cent. The revenue deficit also stood at 2.8 per cent of GDP as against the revised estimate of 2.9 per cent. This was a marked improvement from the 2013-14 figure of 3.2 per cent of the GDP.

The fiscal deficit figure is particularly encouraging given the fact that Jaitley had, on several occasions, spoken about the challenges that would inevitably accompany the task of containing deficit. This view was reflected in tax collection figures for 2014-15, which were bleak. In that year, the government missed the overall revised tax collection target by Rs. 2,288 crore. Also, the fact that a substantial amount of oil subsidy burden – as much as Rs. 35,000 crore – was carried forward from the UPA’s last year in power did not give an optimistic outlook either.

But Jaitley’s fiscal prudence, reflected in lower spending, seems to have helped rein in the deficit. In 2014-15, total spending was around Rs.16 lakh crore, which was down by nearly 2.2 per cent over the revised estimate. Of this, non-plan spending (interest payments, subsidies, etc.) was 1.8 per cent lower than the revised estimate and plan expenditure was down by 3.1 per cent of the revised estimate.

On the face of it, this is welcome news though one will have to wait for more detailed data to see how this fiscal consolidation has been achieved.

 His misses

1)  Mishandling of the Minimum Alternate Tax (MAT) issue

In April, the tax authorities raked up a storm by sending tax notices to foreign institutional and portfolio investors, which, according to some estimates, could amount to a staggering Rs. 40,000 crore. The government said these investors were required to pay a Minimum Alternate Tax of 18.5 per cent on their profits from investments and notices were issued because they had not done so. This happened even though these investors were exempted from long-term capital gains taxes and many belonged to countries that had signed Double Taxation Avoidance Agreements (DTAA) with India. The government later clarified that investors from these countries need not pay MAT but by then the government’s commitment to a stable and non-adversarial tax regime had come under a cloud that still persists.

As I mentioned in an earlier article, the actual cause of this problem was the Authority of Advance Rulings (AAR), whose rulings on the MAT issue had been inconsistent in the past. The government’s fault was that it chose to cherry-pick one ruling in order to justify its tax notices to foreign investors. Jaitley’s abolition of MAT from this financial year applies prospectively, while the tax notices were issued for past transactions, setting off a sense of disquiet.

Related to this is the lack of administrative reforms in tax administration. These reforms are equally important lest, as Jaitirth Rao wrote in his open letter to Jaitley last week, “citizens lose faith in the State as a benign influence in their lives.”  Laws are still continually misused by tax officers in a bid to exhibit unwarranted command and supremacy over for-profit corporations. Needless summons are issued to top company executives over tax issues. Collection targets given to tax officers are abused to issue arbitrary tax notices (as happened in the case of the MAT row). These issues cannot be resolved through merely issuing circulars (such as the one that the Ministry of Finance issued in January). Robust mechanisms must be developed that incentivize the tax officers to act in a prudent and taxpayer-friendly manner.

2)  RBI’s autonomy and independence in jeopardy?

In his 2015-16 budget, Jaitley announced a new monetary policy framework and the setting up of a monetary policy committee, which will fix inflation targets for the Reserve Bank of India (RBI). Currently, the target is set at below 6 per cent for January 2016 and 4 per cent by January 2018. Given that the mechanism of inflation targeting has not contained price rise in countries that have adopted it in the past, there is little hope that it would be any more successful in India.

There is also the contentious issue of the composition of the monetary policy committee. Many experts are worried that the autonomy of the central bank could be compromised if most committee members are from the government. This tussle relating to the balance of power between the Finance Ministry and RBI is not new. They have not had a particularly amicable relationship in the past too, owing to obvious conflicts of interest. For instance, while the government may want the RBI to reduce the policy rates to spur growth, the central bank may be reluctant to do so if it is not convinced about lower inflation prospects.

This conflict of interest was reflected in the budget announcement about the setting up of a Public Debt Management Agency (PDMA) to manage government securities and public debt. Currently, government debt is managed by the RBI. The issue, therefore, raised legitimate questions about the government stripping away some of the regulatory powers of the central bank,. The move was later withdrawn amid concerns from various quarters that the government does not yet have the capability to manage the ballooning public debt. Also, the Budget was silent on how the PDMA would manage the debts of states (currently, the RBI performs this task).

3)  His reluctance to shun protectionism

Make in India is a promising initiative, but it will not help long-term growth if it becomes an excuse for protectionism. Jaitley reduced customs duty on as many as twenty-two items in the 2015-16 budget but he raised it on several other items such as natural rubber, sugar, steel, to name just a few. While the increases can be discussed on the merits of each case, it does appear that more than relying on sound economics, Jaitley seems to be giving in to pressures from industry lobbies.

An increase in import duties may help some domestic industries by reducing competition, but what about those industries for which these commodities may be raw material or intermediate inputs? And how about consumers who can benefit from cheaper goods?

4)  Lack of public sector reform

Seeking to assuage the fear of trade unions that had been protesting against the disinvestment drive of the government, Jaitley confirmed that Coal India and Indian Railways would not be privatised. “The focus of the government is to create more jobs and employment opportunities, besides safeguarding the existing jobs,” he said.

If more jobs are what we seek, then what is better suited to promote that end than the private sector? As for safeguarding existing jobs, all industries go through disruptions that temporarily replace existing jobs. These jobs eventually get absorbed in other private businesses. The government could, however, find ways to ensure that the transition is made easier – perhaps by providing a safety net – for the temporarily unemployed. If the past year is anything to go by, then Jaitley’s statements on privatisation have been tepid at best.

However, he did hint at changing the ownership structure of public sector enterprises “in due course”.  At the World Economic Forum summit, he had said that even though the present policy will continue for now, “going forward, I will be open to look at companies which are on the verge of closure and will do much better in private hands.”

The disinvestment programme, a major source of windfall revenue for the government, can hardly be called successful. A majority of the stake – as much as 40 per cent — in the offer-for-sale of Coal India and Steel Authority of India was bought by Life Insurance Corporation of India (LIC), a government entity. Even though the life insurer’s investment could have been bona fide, it is not prudent for a public sector entity to buy a majority of the stake in another public sector entity, while the government keeps hailing it as a successful disinvestment programme.