Budget may bring tax hikes to stabilize government’s financial health

Two macroeconomic factors are striking for the government in the preparation of budget 2012-13. First of them is the slowdown pressures the economy is facing at present. It needs government’s policy attention. Tax concessions and expenditure enhancements are the practical solutions to counter the slowdown.  At the same time, secondly, the government finances are worsening. If the government is ending the fiscal stimulus type tax cuts, which still exists in the case of excise duties and service taxes, it will help the government to soften high fiscal deficit and unbearable levels of borrowing.

            So, the most difficult decision for the government is to select a course of action in the budget 2012-13.  Whether to continue with the tax cuts to incentivize the economy especially at a time when a downtrend is appearing or to stabilize its own finances in the wake of mounting fiscal deficit.

The government has reduced excise duties from 14% to 8% and service taxes to 10% to promote consumption and investment in the economy on the backdrop of slowdown in two budgets from 2008 to 2010. Both taxes are maintained at 10% during the last budget. The return of service tax to 12% and excise duties to 14% are expected when the economy is stabilized at the comfortable rate of 8 to 9%. This means a full exit from the fiscal stimulus measures the government has made two years back.

On this aspect, the Prime Ministers’ Economic Advisory Council yesterday has suggested the government to bring back excise duties and service taxes back to the pre-crisis level. The PMEAC’s radical suggestion of steep increase of excise duty to 14% is an over stepping type of policy especially given the adverse growth trends. But it shows that policy makers are getting consensus on raising the tax rate though the extent of tax hike is to be clarified only on March 16th.

            The most likely chance is that the government may proceed on exiting the fiscal stimulus by raising both excise duties and service taxes to 12%. This is the middle position rather than a sudden and steep exit by raising the excise duties to 14% from the current 10%. Adverse factors existing on other fronts like mounting subsidy bill, slow tax revenue growth, under-realization of disinvestment target and higher likely fiscal deficit for the current year than the estimated, all of these may encourage the government to raise the excise duties and service taxes.