In its quest for revenues, will the govt hurt Dalal street?

he government derives as much as 70% of its revenues from taxes, both direct and indirect. Other major revenue sources include dividends from the Reserve Bank of India and various public sector units. Then there are one-off items such as proceeds of disinvestment, spectrum auctions, amnesty schemes, etc.

If the government wants to bring down its borrowings, it must raise revenues.
Revenues raised through higher taxes are not good for the markets, but revenues raised by widening the tax net is a positive for the market.

Similarly, higher disinvestment target is a positive for the market. The government has to consciously widen the tax base as India has one of the lowest tax-to-gross domestic product ratios in the world.

The market will look for tax reforms rather than higher or lower tax rates, though higher tax rates will be taken as highly negative.

This budget is not likely to see tax reforms as goods and services tax and the Direct Taxes Code are slated for introduction in April 2012.

The government had a good revenue year last year. Tax collections in the April 2010-January 2011 period are on track with corporate tax collections up 25% and indirect tax collections up 43% on a year-on-year basis. The growth in indirect tax collection is impressive considering taxes were reduced as a stimulus measure.

There are expectations that some indirect taxes may be raised as part of the stimulus rollback, which is inflationary in nature.

However, the higher revenues projected from raising indirect taxes can bring down the pressure on fiscal deficit. There are also expectations of a higher slab on individual income tax, leading to a lower growth projection for direct taxes. An anti-inflationary budget will ideally have higher tax rates to reduce consumption as income at the hands of consumers comes down. However, given that the consumer class is affected by inflation the most, the government will have to do a fine balancing act.

The government last year budgeted for Rs35,000 crore from auction of spectrum and Rs40,000 crore from disinvestments. It raised over Rs100,000 crore from the auctions, thereby reaping a one-time revenue benefit of over Rs65,000 crore. The disinvestment target, however, faced a shortfall of around Rs8,000 crore. This year, investors cannot expect one-time revenue gains while the disinvestment target will be kept at Rs40,000 crore. Hence, the government will have to find new ways of earning revenues apart from taxes.

Investors must view the revenue sources of the government as critical. The way the government raises revenues impacts the market directly and sentiments can turn very fast if the market perceives the budget as being market-unfriendly. A market-unfriendly budget could mean higher capital market transaction taxes, higher capital gains taxes or higher corporate taxes.

arjun@arjunparthasarathy.com