The only summary of Union Budget 2016-17 you need to read

Finance Minister Arun Jaitley presented the Union Budget for the financial year 2016-17 in the Parliament today. In the run up to the budget, financial experts had dubbed this as a make or break budget. On February 21st, Swaminathan S Anklesaria Aiyar wrote in Times of India:

“Once the Budget was the biggest event in February. Now it is just another event, not even as important as a student rally in Jawaharlal Nehru University. No longer does the Budget spell out radical economic policy changes. It has become more routine and boring.”

This budget achieves precisely this – a dull and boring budget, broadly presenting a believable picture on the numbers and outlining the priority area of government spending without doing anything fancy. Of course, every announcement is pro or anti someone but the headline commentary by Arun Jaitley points to the relative redundancy of the budget, with increased focus on implementation and things which happen outside of the budget.

Upsides of the Budget

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Fiscal Deficit targets stuck to at 3.9% of GDP in 2015-16 and 3.5% of GDP in 2016-17 is the single biggest announcement in the budget. While this math is tough to relate to for the public at large, a deviation from the fiscal consolidation path would have been highly negative for global credit rating agencies, global investors, and for the RBI as well. This opens the door for an immediate rate cut by RBI – which may well come through out of turn in the next couple of days.

Focus on Rural Economy and Growth was expected, given that India is reeling with debilitating effects of two back to back bad monsoons.  Just like the Vajpayee government which focused on increasing agricultural incomes, this government has carved an ambition to double agricultural incomes by 2022. The enabling parameters are – linking MGNREGA spend to productive assets like farm ponds, dug wells, and compost pits with record high allocation of ₹38,000 crore, creation of a Long Term Irrigation Fund under NABARD at ₹20,000 crore allocation and a program with ₹6,000 crore allocation for better ground water management. The government will also fast-track 23 major irrigation projects and bring an additional 28.5 lha land under irrigation (about 20% of the total cultivable land in India). This is in addition to already announced programs on Soil Health Card which promotes optimal use of fertilizers and the Crop Insurance Scheme which broadbases the insurance  benefits to farmers.

Creation of a National Agriculture Market, to be facilitated by states amending their respective APMC acts to let farmers sell their produce anywhere in India has been announced for April 2016. This is a big move, but so far only 12 states are onboard the program, and the Prime Minister needs to push these state law changes the way he is popularizing the Crop Insurance Scheme directly.

Road Infrastructure, which has several trickle down benefits – demand of cement and steel, sale of automobiles, faster movement of goods and perishables and so on – gets a big push. The government has set a target of 2019 for full connectivity of all eligible habitations for getting a road connectivity, marking ₹27,000 crore including state share for village roads. The government will earmark ₹55,000 crore for road construction with National Highways Authority of India (NHAI) adding another ₹15,000 crore via bonds, in total bringing the road spending to ₹97,000 crore. Given that this biggest allocation will reside with Mr Nitin Gadkari, among the top performing ministers in the Modi government, the infrastructure push should yield results in the form of the desired 30 kms per day highway construction this year.

Small Businesses and Professionals have been given a boost by simplification of the tax compliances by them. The scheme where a business could declare 8% of its turnover as Taxable Income and avoid keeping any detailed records has now been extended to businesses with a turnover of upto Rs 2 crores, up from the Rs 1 crore earlier. Similar benefits have also been extended to professionals.

Focus on Job Creation directly has been given a push. The government now proposes to pay the employer contribution of 8.33% to the Provident Fund (PF) for employers creating new job opportunities, encouraging the organized sector taking on rolls its temporary, contract employees. They ahve also proposed specific tax breaks aimed at incentivising hiring. Skill development has been granted additional budgets to set up 1,500 new Multi Skill Training Institutes.

Focus on Enabling Legislation comes out at various places in the budget speech. The government proposes to create a model shops and establishment act which states can adopt voluntarily, letting small businesses remain open longer. There was a mention of Goods and Services Tax (GST) and Insolvency Bills, indicating the government has not given up on them. The FM also talked about amending the Companies Act 2013 to have easier registration for new Start Ups. A Public Utility (Resolution of Disputes) Bill has been proposed to fast track disputes related to PPPs and infrastructure projects. A Code of Resolution for Financial Firms has been proposed which will deal with “orderly unwinding” of financial firms in the event of a bankruptcy. But the biggest announcement was the government will finally legislate Aadhar and institutionalize the Direct Benefit Transfers (DBT), with FM making it clear that Aadhar will not form the basis of either domicile or citizenship – addressing the concerns of the traditional BJP supporters who saw Aadhar as the back door entry for illegal immigrants getting Indian passports.

Social Sector Spending has been given a boost this year. The opposition had picked this area up as a big gap last year. The government proposes to bring in a healthcare insurance for a large cross-section of the population in addition to expanding the program to sell generic drugs at a lower price, at 3,000 new generic medicines stores across the country. The FM also proposed a new scheme to promote expansion of dialysis facility to tackle the renal diseases that presumably have been a cause of much angst and inconvenience for a growing section of the population.

No big talk on divestment and strategic sale this year came through in the budget, though the target for revenue collection via this route is retained at about ₹36,000 crore. There are two interesting parts to this process after the government has missed this target every year successively. Firstly the Central Public Sector Enterprises (CPSEs) will be allowed to sell or use their assets for productive use. These assets can include land or other physical assets like machinery. Secondly the NITI Aayog will now shortlist the CPSEs fit for sale or divestment. Once the recommendations are taken to the Department of Investment and Public Asset Management (new name for Department of Divestment), a group of secretaries will approve the proposals followed by a CCEA nod. This 3 tier structure shifts the focus away from the Finance Ministry in coming years to achieve the revenue line item goals. The FM even had a sentence around the government being fine with its stake in public sector banks sliding under 50%!

Black money reduction and repatriation has been a big topic for the Modi government. This budget allows a new scheme – which is a penalty cum surcharge scheme as opposed to an amnesty scheme – for anyone holding undeclared income or assets to come out, pay a 30% tax with 7.5% penalty and 7.5% surcharge for agriculture and regularize the accounts. The government has done a good job of not calling it an amnesty scheme or it would have been challenged right away in the Supreme Court, given the prior commitments made by Union governments on not opening new Voluntary Income Disclosure Schemes (VDIS). The provisions also establish that the government considers holding black money in India “less bad” than holding black money abroad – a similar scheme floated last year for overseas unaccounted money had higher penalties.

Focus on Direct Benefit Transfers (DBT) will continue, with the government announcing a part of the fertilizer subsidy payment moving to the DBT platform. This is however a pilot to be floated this year.

Moving away from the Plan / Non Plan Legacy has been established starting next budget with this year being the last of the 12th Plan. If we are not going to be governed by Planning Cycles, why not have a Plan / Non Plan distinction of spending? The government can now move to the Capital and Revenue expenditure model – similar to any corporate and easier to understand and follow. This is a good move for better public finance management.

Big boost for the gram panchayats and the local bodies is in store, which will get a grant of ₹2.87L crore from the budget. This translates to about ₹80L per gram panchayat and ₹21 crore per urban local body. These numbers are good enough to have some of the central programs see the light of the day. Unfortunately, no direct link has been built by the FM on how these funds will be used, when there was an opportunity to do so with respect to Swachh Bharat.

There is a boost for low cost housing, with 100% tax exemption (MAT applicable) for companies which invest in 30 sq mt (metros) / 60 sq mt (other areas) housing schemes for the next three years. The first time home buyers will get an additional ₹50,000 deduction on interest payments for property values under ₹50L. This will be a boost for many cities (except maybe Mumbai, Delhi, and Bangalore!) and rurban clusters. Additionally, those employed professionals who do not get a House Rent Allowance (HRA) from their employers, will have an increased tax deduction from ₹24,000 to ₹60,000 per annum for the rent paid. This will put ₹3,000 additional income per month in the hands of beneficiaries mostly from lower middle class segment.

Dispute Resolution for Taxation issues has been given a push by the FM. Those firms battling retrospective taxes (like Vodafone and Cairn) can pay the tax due without any penalties or surcharges and settle the disputes rather than going the international arbitration way. The rules to apply retrospective provisions have been further tightened with more scrutiny. The assessment scrutiny process will continue to become digital with the top 7 cities to be made completely digital with no face to face interaction with the assessing officer. These are good small steps, but of course the real need is to curb bureaucratic exuberance on the ground.

Downsides of the Budget

The Picketty Budget syndrome did kick in after all, with the government making moves towards taxing the rich and bringing in new cess for retail investors. The surcharge paid by those with more than 1 cr in income will go up from 12% to 15%. There will be a Krishi Kalyan Cess at 0.5% on all taxable services going forward. It would have been easier for the FM to just raise the Service Tax rate rather than bringing in a new cess. Any cess is tough to take away and the market was anyway aligned towards a Service Tax hike in the direction of a potential consensus GST rate of 18%. This presents bad optics and additional overhead of managing a new line item. The government can always repurpose any tax collection anywhere – so the need to call a cess Krishi or Swacch Bharat is not very important if the government can demonstrate those were the real end uses.

Bank recapitalization at ₹25,000 crore is not a great statement to make. The government had already provided for ₹70,000 crore over the next three years for this purpose and shifting the needle on yearly allocation by a small amount does not help. The government will kick the can down the road waiting for the Bank Board Bureau to make its recapitalization recommendations. But overall this is a number which is neither here nor there. Sure, the government will claim that it demonstrated intent, but the situation warrants rapid and deep response, not band aids.

The Dividend Distribution Tax for the super rich has been introduced this year. Anyone who gets more than ₹10 lakhs in dividend income in a given year, will pay 10% tax on it in addition to the tax already paid by the companies distributing the dividend. Assuming a dividend yield of 5-6% on a corporate profit base of ₹1.5 trillion, the dividend base will be around ₹75 billion. Half of it may already be going to the government so any tax will be a right pocket – left pocket arrangement. Of the balance ₹40 billion, if the promoters and those with more than ₹10 lakhs in dividends corner half, we are talking about a dividend base of ₹20 billion. On this a 10% tax will yield nothing much – ₹2 billion – for the government. While the argument can also be that if there isn’t much financial impact, what’s wrong with the tax in the first place, this brings in additional procedural complications and hassles.

There isn’t much to cheer about from the Individual Tax payer point of view. Taxpayers who fall inside the sub-Rs 5 lakh income zone will get an additional  tax rebate of around Rs 3,000, as slabs remain unchanged. There weren’t any  major change in any exemptions or deductions except for those staying in rented houses, who will now get a deduction of upto Rs 60,000.

The National Pension Scheme (NPS) and the EPFO (Employee Provident Fund Organization) have now been equalized. This is a good thing in the long run as the NPS is a defined contribution scheme while the EPFO is modeled as a defined benefits organization.  For all EPFO contributions starting next year, 60% of the withdrawal at maturity will attract taxes. The budget fine print is not clear on the tax slabs applicable and the corpus taxed (employee / employer part, gains made in the scheme). Once this is made clear, the government will have a task at its hand explaining this to the middle class – this is a tough reform measure pushed through, but it will come down hard on the young people starting their careers. This is a perception game to be won or lost and hence safe to assume is not a strong point for the government!

The Tax Code continues to be complex without any roadmap for improvement. For example – fathoming the duty structure on cigarettes which is based on the length of the cigarette and the presence or absence of a filter, maybe nothing short of rocket science. This was reflected in the ITC stock price today during the budget speech. The stock went down sharply at first and then recovered after it was clear that the cigarettes which they sell may not attract a lot of extra tax! Creating slabs for corporate taxes based on the type, size and the date of incorporation of new firms makes that segment complex too. The myriad customs and excise duty changes will take time to trickle down and do not seem to be based on any great logic except the need to balance numbers.

Tinkering of duties for branded garments and additional cess on cars is exactly the kind of negative perception the FM could have avoided to retain the trust with the middle class. The organized retail has grown significantly over the last few years and has been one of the bright spots in the economy. These duties and cess will not yield much revenue, but will needlessly become the talking points for the opposition and the disgruntled supporters alike. The gains from these kinds of adjustments could have been easily made elsewhere! Increasing cost of electronics and digital items including those manufactured in India due to duty structure changes is another area of concern – on one hand the government wants to promote Digital India and on the other, the cost of almost all retail digital equipment will go up.

Protecting firms like Hindalco and others via duty increases on imports is not a great idea. The government cannot be priming “Make In India” as an import substitution program – something that has been tried and tested and has failed. The budget goes into excruciating details for duty changes on several commodities, which really cannot be linked to a yearly budget and does not outline the underlying reasons behind such arbitrary changes.

The Fertilizer Subsidy needed an urgent revamp and restructuring. While the FM will move part of it on DBT, this really should have been an area of focus, especially so with the oil bounty ending for India in the coming year. This subsidy head is the biggest source of leakage apart from MGNREGS and was an ideal candidate for greater action and push for a fundamental redesign.

The phasing of tax exemptions for the corporate has not kept pace with the tax slab change for large firms. While the professionals and smaller firms with up to ₹2 crore in revenue will have an easier tax regime via a presumed tax, the large firms will continue to pay top tax bracket with some exemptions being phased out. While no large firm actually pays 30% corporate tax – effective rates being 23-24% – some of them may actually have a higher tax incidence going forward! The FM had announced a corporate tax rationalization proposal last year and this year it was implemented only for firms with ₹5 crore in revenues. The MSMEs can rejoice but the tax rationalization roadmap gets postponed.

The government missed an opportunity to link support for states and local bodies to actual performance outcomes. While the amount given to states and the local bodies will be at an all time high this year, the government has yet again – like last year – failed to impose conditions on the states to actually make use of the extra allocations. For example, the FM talked about automation for PDS systems. This area could easily have been transformed by asking the shops to model themselves on the Rajasthan model for better stocks, limited stock outs, and DBT for those availing food subsidies. The government will rely on the states to tweak their APMC acts for a national agriculture market. This could have been incentivized through grants for setting up cold storage and supply chains for carrying farm produce across cities and states. Without some of these enabling areas, the central schemes tend to languish at state level without much accountability. The credit for the good goes to the states, with the central government tends to get the flak!

On The Balance

The headlines may not make for attractive reading, but the details are good.

This budget may well be remembered for what it did not do rather than for what it did. The former was uncertain, while the latter was more or less a given. FM Jaitley did not take away the long term capital gains exemption or move it from 1 to 3 years for listed securities. A move on this count would have definitely spooked the stock markets. In fact, the government has reduced the long term capital gains window on unlisted securities from 3 years to 2 years, which may provide an unintended boost to private equity and venture capital transactions!

The budget presents a great case for macroeconomic responsibility, but risks losing the microeconomic battle – the attention of the core BJP support base. This is the same as last year, where the big changes will not be appreciated because the meal for two got half a percent costly and the computer monitor price went up by 200 bucks!

The budget has done the best thing possible – move focus back on executive action, legislative reform and the RBI – which may be compelled to cut interest rates in the near future based on the government prudence. Finally, it will all boil down to ensure that this (rather difficult) math on the revenue side is achieved.

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