Photographer: Dhiraj Singh/Bloomberg

Modi Budget May Put Consumers Before Taxes to Spur India Demand

  • Income tax rates seen to lower in Feb. 1 budget announcement
  • Excise levy may have to be reduced as fuel costs increase

Taxes are anything but certain for Indian Prime Minister Narendra Modi.

Faced with a slump in demand after his shock clampdown on cash, he’s expected to lower taxes in the Feb. 1 budget to spur consumption. The risk is that a cut will rob Modi of a short-term revenue spurt, which his administration had been touting as proof of success of the currency policy change.

"Economic growth is unlikely to accelerate in the near term on its own so the situation for the government is such that in order to improve their own credibility, the government will have to improve demand for goods and services," said Nihal Kothari, executive director at tax firm Khaitan and Co. in Mumbai. "So the personal income tax slabs or rate may be reduced in the budget to give higher purchasing power to consumers."

We assess the sustainability of the tax revenue surge amid expectations from the budget.

INDIRECT TAXES

Net revenue from customs, excise and service taxes rose 25 percent in April-December from a year earlier, meeting 81 percent of the government’s budgeted target for the year through March 31. The bulk of this however came from a surge in excise collections, underpinned by nine increases in the levy on gasoline and diesel since Modi came to power in 2014. Imposing this tax was relatively simple while global oil prices were low, but could become politically difficult as crude costs rebound.

"The government may be forced to roll back some of the excise increases on fuel as this could feed into inflation," Kothari said. "So additional tax revenues will come from greater compliance as we near the GST regime and the threat of scrutiny rather than economic growth."

  • For instance, net indirect tax collection through November 2016 grew 26.2 percent due to higher tax rates and other special measures and just 8 percent after you strip out these effects
  • Service tax numbers too are flattered by an increase in the rate to about 15 percent last year from 12.4 percent in April 2015
  • Customs collections may dip as Modi’s cash ban crimps demand for gold, one of India’s biggest imports
  • Lobby group Associated Chambers of Commerce in India has sought cuts in customs duty rates on aluminum and iron to boost local production of machinery while raising the levy on basic electronic goods such as microwave ovens and air conditioners
  • Assuming the government doesn’t announce special measures, growth in tax collections will settle between 12 percent to 14 percent compared with about 17 percent to 18 percent in the past years, according to Edelweiss Financial Services Ltd.

DIRECT TAXES

Net revenue from corporation and income taxes rose 15.1 percent April-November from a year earlier, helping meet about 49 percent of the government’s budget goal. Collections rose to 65 percent of the target in December, the government said Jan. 9.

What’s unclear, though, is how much of this came from two amnesty programs offered to citizens, implying a one-time gain in collections. Another distortion is the government’s decision to allow corporations to collect tax payments in invalidated bills, which may have prompted early payments.

  • From the budget, Assocham’s seeking a road map for the government’s promised reduction in corporate tax rates to 25 percent from about 30 percent
  • Tax breaks may be offered to those who invest in funds that contribute to building crucial roads, ports and highways
  • Lowering the personal income tax rate would boost compliance and since less than 1 percent of the population pays this tax, revenue losses would be limited, according to Kotak Securities Ltd., which calls for a cut. Currently individuals earning more than 1 million rupees a year pay the top rate of 30 percent tax plus surcharges
  • There’s also speculation that the government may raise the threshold before income tax is charged to as high as 500,000 rupees from 250,000 rupees

"One of the main reasons for India’s stunted tax base is the lack of trust between the government and taxpayers," analysts at Kotak, including Sanjeev Prasad in Mumbai, wrote in a Jan. 17 report. "We expect the government to gradually deliver on its vision of moderate tax rates and a broad-based taxation system over the next one or two years with a start in the union budget on Feb. 1, 2017."

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