Month: February 2016

Employees’ Unions Criticise Budget Plan to Tax Provident Fund

Right and Left unions plan to protest government proposal to impose a tax on part of the EPF

Provident Fund is the only social security system for Indian workers and employees. From now on, withdrawals will be liable to tax. credit: Shome Basu

Provident Fund is the only social security system for Indian workers and employees. From now on, withdrawals will be liable to tax. credit: Shome Basu

New Delhi: The proposal in the budget to impose a tax on 60% of the corpus of an employee at the time of withdrawal of his Employee Provident Fund has come in for a scathing attack from various workers’ unions who have termed it a gross injustice.

Talking to The Wire, senior Communist Party of India leader and general secretary of the All India Trade Union Congress Gurudas Dasgupta said the move was little more than a case of double taxation. “It is an attack on the savings of the people and we will oppose it. I plan to speak to the trade unions and firming up the next course of action,’’ said the former Member of Parliament.

Finance Minister Arun Jaitley’s plan to tax a part of Employee Provident Fund (EPF) withdrawals from April 1, 2016, also drew strong condemnation from Right-affiliated trade unions.

Virjesh Upadhyaya, general secretary of the Bharatiya Mazdoor Sangh, said: “What has happened is very wrong. How can they impose such double taxation? When the gross salary has already been taxed, how can a component of it which has been set aside as a saving be taxed again?”

Declaring that BMS would take up the matter with the Government, Upadhyaya said if need be the BMS would also come out on the streets to protest against this “gross injustice” to the nearly 6 crore EPF account holders.

Dr. G. Sanjeeva Reddy, president of the Indian National Trade Union Congress, said the government had been unable to ensure minimum wages to the workers and instead had resorted to taxing their savings in a most unjustified manner. “To tax PF withdrawal is a criminal act and we will protest against it.”

M K Gandhi, president of the All India Tax Advocates Forum, however, had a different opinion. He said the tax on the EPF withdrawals would not amount to double taxation since a tax rebate is received by the employees on their provident fund deductions every year.

While explaining the rationale behind imposing this tax, the explanatory note in the Budget document states that “to bring greater parity in tax treatment of different types of pension plans, it is proposed to amend section 10 so as to provide that in respect of the contributions made on or after April 1, 2016 by an employee participating in a recognised provident fund and superannuation fund, up to 40 % of the accumulated balance attributable to such contributions on withdrawal shall be exempt from tax.”

The government’s proposal brings all the pension schemes at par with each other and makes the Employee Provident Fund (EFP) and National Pension Scheme (NPS) withdrawals on retirement partially taxable.

The EPF had until now followed an exempt-exempt-exempt (EEE) taxation structure which meant that there was to be no tax on investment, on interest accrued and on withdrawal. On the other hand, in the case of NPS, the entire corpus was earlier taxed on withdrawal. The Economic Survey this year had suggested a shift to the EET regime, which meant taxing the withdrawals while exempting the investment and interest accrued. The move to tax the EPF withdrawals also appears to be a step in the same direction.

Mister Jaitley’s Mid-Course Correction

It should now be clear that when it comes to economic policy, there is no major difference between Modi and his predecessors

It should now be clear that when it comes to economic policy, there is no major difference between Modi and his predecessors

Finance minister Arun Jaitley and MoS Jayant Sinha en route to parliament house with the budget speech. Credit: Shome Basu

Choosing between two fiscal decisions: Finance minister Arun Jaitley and MoS Jayant Sinha en route to parliament house with the budget speech. Credit: Shome Basu

Imagine if finance minister Arun Jaitley’s budget speech of February 2016 had been read out in July 2014. Large parts of the speech could have been stated then. Apart from the nine pillars of development, the foundational pillar of fiscal management – if defined two years ago the way it has been done now – would have given the finance minister greater leeway in managing the persistent drag on the investment front.

There could have been several reasons why Jaitley took two years to arrive at where he is now. First, there was an under-estimation by the Narendra Modi government of the magnitude of the ‘investment strike’ – the weak ‘animal spirits’ of private enterprise – that had contributed to a slowdown in India’s investment rate in 2012-14. There was also an under-estimation of the fiscal capacity of the Central government. Equally, there was an over-estimation of the likely impact on the economy of a political change at the Centre. There was also an under-estimation of the negative impact on the Indian economy of global headwinds and uncertainty.

Jaitley was wrongly advised in 2014-15 to remain committed to the path of fiscal consolidation while at the same time taking on the burden of implementation of the recommendations of the Fourteenth Finance Commission, the Seventh Pay Commission and the adoption of the principle of one-rank-one-pension for the armed forces. On top of these fiscal commitments, the government has been forced to increase social development expenditure as well as funding schemes for the welfare of farmers and weaker sections.

The Fourteenth Finance Commission increased the quantum of devolution from the Union to the states from 39% of gross revenues to 42%. Had this been based only on the transfer of Central plan schemes to the states, there would have been no difficulty. But, the commission went further and made its own determination of which of the subjects, that fall within the concurrent list of the constitution, would continue to be the joint responsibility of the Centre and the states and which, it considered, would be better dealt with by the states. It transferred the Central revenues for the latter to the states.

Anticipating the fiscal problem this would pose to the central government, one member of the commission (Abhijit Sen) appended a minute of dissent to the report in which he recommended: The share of tax devolution be set at 38% of the divisible pool in the first year of the award period and maintained at that level unless there is agreement in the new institutional mechanism to revert to the 42% share of tax devolutions.

The government should have accepted the report of the commission subject to this minute of dissent. There is a precedent for this in the case of the Third Finance Commission, where the note of dissent was accepted by the government of the day.

It was against this background that some in government initiated a debate on fiscal deficit management. Opinion became divided between fiscal and monetary conservatives, who urged the government to stay the course defined by the Fiscal Responsibility and Budget Management (FRBM) Act, and fiscal liberals who emphasised the importance of public investment in stimulating demand and growth.

Jaitley had three options before him: to be fiscally responsible and stick to the path defined by the FRBM Act (which is what he said he would do in last year’s budget speech); to be fiscally accommodative and seek a dilution of that commitment; or, to seek a change in the FRBM Act itself.

The finance minister was even advised to announce the appointment of the Fifteenth Finance Commission so as to secure a rollback of the Fourteenth Commission’s excessive award, as some saw it. There is a precedent for this too, going back to 1969. But he has resisted that temptation.

It appears Jaitley has tried to walk on two legs by reaffirming his commitment to the FRBM Act and, at the same time, seeking a dilution of that Act. His decision to constitute a committee that will examine the idea of moving from a fixed number to a range, for the fiscal deficit, suggests that he has opened a window after closing the door. This will come in handy when the government moves closer to election year.

This was the big fiscal issue in this year’s budget and it has been directly addressed. On the reform front, the finance minister has taken several important steps but the initial impact of his bold and creative decisions was lost in a poorly drafted budget speech.

The nine pillars of macroeconomic policy and development priorities are all well considered. They do not miss out on anything. In the end, what impact this budget will have on the economy will depend on the government’s fiscal capacity, the speed of improvement of the ease of doing business and of investment in infrastructure.

Taken together the policy announcements relating to investment in infrastructure, tax reforms and the reform of industrial policy constitute a mid-course correction. In undertaking this correction the government has tried hard to maintain a balance between its social commitments and investment in the rural economy, on the one hand, and the ease of doing business and promotion of small and medium enterprise, on the other.

How credible is the fiscal arithmetic underpinning the budget’s growth strategy? Much will depend on the rate of growth of the economy and how the global economy and commodities, especially crude oil, prices behave in months ahead. If there was a year in which Jaitley could have taken a risk, it is this. If growth falters, if inflation revives and if the global economy slows down, all bets would be off.

Whatever the views of the government’s critics, Prime Minister Narendra Modi has chosen to tread the middle path like any Congress-led or Third Front government would. It should now be clear that on economic policy and foreign policy there is no major difference between Modi and his predecessors. At the end of the day, the difference between the BJP and its critics is essentially on social and cultural issues.

Whether Modi goes into the 2019 election claiming achievements on the economic front or whether he pushes hard line ideological issues to the fore would depend on how the economy responds to the incentives for investment and growth provided this year.

The political bottom line, however, is that Modi and Jaitley have to work together to ensure that the investor, the consumer and the job-seeking youth remain optimistic about India’s future. Optimism about the future generates growth. Expectations have a way of getting fulfilled.

Sanjaya Baru is Honorary Senior Fellow, Centre for Policy Research, New Delhi

Modi Has Managed the Optics, Now Comes the Task of Implementation

With the budget, the government is trying to compensate for its neglect of the agriculture sector. Whether global headwinds will allow the government to implement it is yet another question.

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Can the Budget’s political messaging be backed up by sound economics? Credit: PTI

Prime Minister Narendra Modi likened the 2016-17 budget to an important examination he is hoping to pass. Why is Modi according so much importance to this budget? Possibly because both the PM and finance minister realise that the NDA government had lost about two years already and the economy has not shown any significant uptick even as most parameters – rural incomes, agriculture output, average sales turnover of top 500 companies, exports – are in negative growth mode. It is against this difficult backdrop that the finance minister presented the 2016-17 budget.

Politically, Modi wanted to send another crucial message – that he would like to be remembered as a PM who did something for the distressed farmers and the rural poor. And he would not want to be remembered as one concerned only with big business-driven growth.  One could argue that he has passed the preliminary test because the budget succeeds in creating the optics that the NDA cares for Bharat. He does this through a slew of schemes for the rural poor, such as cooking gas for several crore households below the poverty line, more allocation for farm infrastructure, an institutional ecosystem for Dalit entrepreneurs, subsidised health schemes, including medicines and so on.

So the budget is full of good intent.  However, one would like to add a big caveat. Creating optics can be  risky as many PMs in the past have failed to follow up on promises. Also, a pro-poor economic vision cannot be implemented in a vacuum. For instance, an institutionalised ecosystem for Dalit entrepreneurs cannot ignore how bright Dalit students are treated in universities, as we have witnessed in Hyderabad recently.The political economy of the budget therefore can only be located in the kind of larger politics the BJP and its ideological mentors spawn in the country.

Political messaging aside, the overall budget presented by Arun Jaitley looks like a reasonable holding operation as the FM himself warns that the global economic conditions are very uncertain with experts forecasting a possible world recession. This is against the backdrop of China slowing down even further and choosing to devalue the yuan at some point of time.

Exogenous shocks

So however much the NDA attempts to shore up the economy by heavy public investment in infrastructure, the risk of exogenous shocks will always be there. Again, it is partially to shore up the economy against externally induced shocks that the FM resorted to the optics of pursuing an aggressive fiscal deficit target of 3.5% of GDP. However, later in his press conference, Jaitley’s explanation sounded a bit tentative about the necessity of adhering strictly to 3.5 % of GDP as fiscal deficit. He indicated that an expert committee will give a fresh road map and we may “look at a range” to observe fiscal discipline.

There are other hidden factors which suggest that the fiscal target for 2016-17 may be a bit difficult to achieve in a year of tepid growth. The growth forecast remains at last fiscal year’s level – 7 to 7.5 %.  Also 2016-17 will see a much higher funding commitment towards the Seventh Pay Commission award and OROP-related expenditure which is not fully provided for. To that extent, the fiscal deficit may be understated.

The other challenge for Jaitley will be that he has no room to slip up on revenue collections in 2016-17. In fiscal 2015-16, the FM was lucky that he could raise an additional Rs.1 lakh crore through higher petrol taxes which became possible because global oil prices collapsed by over 70%. He will not get this additional windfall next fiscal. On the contrary, he will feel somewhat trapped if oil prices move up 40 to 50%, which is not outside the realm of possibility. In that event, he will be forced to cut oil taxes, rather than raise retail prices of oil from the present levels. Of course, the finance minister has hinted that he could get a bonanza from the new voluntary disclosure scheme in which black money will be converted to white on payment of 45% tax. But many doubt whether this will be a big success. There is also doubt whether Rs. 5 lakh crore of money locked in tax disputes can be partially unlocked through mutual settlement. So there is a question mark over these sources of additional revenue during the year.

The budget has also angered the salaried class by proposing to tax 60% of all PF, EPF withdrawals  for contributions made in future. Earlier these withdrawals were not taxed at all. Overall, the middle class hasn’t gotten  much from the budget. It is also possible that Modi wants to politically signal a pro-rural bias and therefore there isn’t much for the urban middle class.The promise of doubling farmers’ income in fove years is quite ambitious. One only hopes it doesn’t go the way of the PM’s original promise of delivering  farmers a support price which is 50% over their cost of production. It will take a lot for the farm sector to recover from its present lows. Agricultural income growth has been close to zero in the two years of the NDA. The government is now trying to compensate for the neglect of the agriculture sector.

One also expected a more comprehensive road map for the recapitalisation of PSU banks, which remains the most serious hurdle to reviving private investment. Experts say PSU banks need over Rs. 4 lakh crore of capital in three to four years. The allocation of Rs.25,000 crore for recapitalisation of banks is totally inadequate. There is some talk that the RBI will be asked by the finance minister to provide a substantial share of bank recapitalisation just as the US federal reserve did for American banks in 2009. One doesn’t know how Raghuram Rajan will respond to this suggestion.

Finally, only time will tell whether the ambitious proposals set out in the budget will succeed. The optics of politics is one thing, the details of implementation will really hold the key. Especially with regard to the revival of agriculture growth and rural demand – the biggest challenge facing the NDA.