Economics

• To reduce tariff and non-tariff barriers.
• To eliminate discrimination in trade.
• To facilitate a higher standard of living.
• Stimulate economic growth and employment.
• Contribute to peace and stability.
• Give stronger voice to smaller nations.
• Establish rule-based order as rules reduce arbitrariness and opportunities for corruption.
• Cut the cost of doing business internationally.
• To ensure sustainable development in trade policies.

1. Ministerial Conference

• It is the supreme decision making body of the WTO.
• It (generally) meets once every two years to deliberate on trade agreements.
• The last ministerial conference was held in Geneva in 2021.

2. General Council

• It is the day to day decision making body of the WTO.
• It meets regularly in Geneva and implements the decision of ministerial conferences.
• It has a representative from each member state.
• Below the general council, there are Committees on individual agreements and annexes like anti-dumping, subsidies & countervailing measures (SCM) etc.

3. Director-General

• Present Director-General of WTO is Ngozi Okonjo-Iweala (having dual citizenship of Nigeria and USA) (she is the first female, first African and first US citizen to hold this post).
• Director-General heads the Secretariat at Geneva.

• WTO has Dispute Settlement Body (DSB) that settles trade disputes among nations.
• WTO procedure requires 60 days of consultations among disputants to resolve the dispute, failing which dispute panel is set up.
• DSB’s conclusion can be challenged in the Appellate Body.
• The erring country is directed to change its laws to streamline them within a reasonable time & if the country doesn’t correct them, the complainant country can take retaliatory measures. But there isn’t any punishment for losing a country & practically poor countries cant retaliate against rich nations.

Suppose India is charging a 5% Import Duty on mobiles from South Korea, i.e. in the mobile segment, India is offering the best deal to South Korea by charging just 5% duty. According to the Principle of Most Favoured Nation, India will have to give the same deal to all WTO members, which India is giving to the most favoured nation. It implies that on mobiles coming from China, India will charge 5% duty.

Pakistan Issue

• In 1996, India gave MFN status to Pakistan. But Pakistan didn’t reciprocate to Indian gesture. 
• In Feb 2019, after Pulwama Attack, India withdrew the MFN status given to Pakistan and hiked the customs duty by 200% on goods originating from Pakistan.

Tariff Barrier

• When government imposes very high tariffs/taxes on foreign products to protect their domestic market. 
• It has been opined by various economists that Trade Barriers doesn’t correct trade imbalances of country. It just shifts trade imbalance to other countries. E.g., What the US was importing earlier from China will now be imported from India or Vietnam.

Non-Tariff Barrier

• In Non-Tariff Barriers, although there aren’t any tariff barriers, policies are made to make it hard for foreign players to compete with domestic players.
• E.g. 
  • Government putting tender that only domestic companies can compete.
  • Not giving clearances easily on ports
  • Setting export quality norms so high that other countries can’t export
  • Providing subsidies to domestic producers

Case for free trade

What are the reasons for the government not to interfere with trade?

There are three arguments in favour of free trade. 

1. Free trade & efficiency

• Free trade promotes efficiency & avoids duplication of efforts 

2. Comparative Advantage Theory

According to David Ricardo’s Comparative Advantage Theory

• Produce what you have comparative advantage and import other things.
• This system leads to better efficiency and output.

3. Economies of scale in production

• Develop particular industry in one country & let it trade with the bigger market of the world. This production on a large scale will lead to economies of scale. 

4. Political argument

• A world that trades freely is a world that is at war less often. 

The case against Free Trade

• Beggar thy Neighbour Policies: Countries do this, especially by devaluing their currency.  

• Indian exports boomed due to low barriers. Indian exports have increased from $33.22 billion in 1998-99 to more than $100 billion.
• India won a multilateral dispute against the USA, which was otherwise impossible.
• India adopted international standards in IPR due to TRIPS. As a result, foreign flow increased in R&D.
• Textile boomed because MFA scrapped & ATC adopted under WTO.

Under the Agreement on Agriculture, subsidies are divided into three categories, and member countries have been directed to cut down the Amber Box subsidies.

These three boxes of subsidies are

1. Green Box Subsidies

• Subsidies that don’t disrupt trade balance OR cause minimum damage to the trade balance.
• E.g. agriculture R&D, extension services, insurance money etc.  
• Limits under AoA: Nothing, and Governments can give as much as they want.

2. Blue Box Subsidies

• Blue Box Subsidies aim to limit production.
• These subsidies don’t increase with production. For example, subsidies linked with acreage or number of animals.
• Few countries like Norway, Iceland, Slovenia etc., use the blue box subsidies. 
• Limits under AoA: Nothing.

3. Amber Box Subsidies

• Amber Box Subsidies disturb trade balance like subsidies on fertilizers, seeds, power, irrigation and Minimum Support Price.
• They distort the trade balance because they encourage excessive production. Hence, a given country’s product becomes cheaper than others in the international market.
• Limits under AoA: De Minimus Limits are imposed on them. These are the minimal amounts of Amber box subsidies permitted by WTO, even though they distort trade.

• This system impacts India because these subsidies are calculated with 1986 as a base when India’s production levels were low. Along with that, Inflation is unaccounted in the calculation. As a result, India’s 10% subsidy is much lesser than USA’s 5% subsidy. In 2017, Bali Package was signed, under which developing countries, especially India, were allowed to breach the 10% limit until the solution to this problem was reached. 

Critique of AoA

• The developed countries use the Agreement on Agriculture under the WTO framework as a tool to dismantle the public procurement infrastructure of developing countries. Developed countries such as USA and Canada produce food grains in large quantities, and they want to turn developing countries into a market to dump their surplus grains while converting the developing countries to produce tropical products needed by them at low prices. 
• ‘Reference price’ for calculating support was the 1986-88 average world price of a crop which they converted to rupees at the then-prevailing ₹12.5 per dollar exchange rate.

• Under this, the export of farm or animal products can be banned from a particular country to protect humans, plants & animals.
• Under this agreement, each nation can make its own Quality Control Rules given they are scientific.
• E.g., In 2014, European Union (EU) Trade commissioner banned imports of Indian Alphonso, eggplant & other vegetables due to fruit fly contamination in earlier shipments which can impact the health of plants in the EU.

• Under the TBT Agreement, the export of any non-farm product can be banned from a particular country if the product is dangerous to health or the environment.
• E.g., the US can ban entry of Indian Pharma Products under this agreement if they don’t meet health standards. 

If the host nation is giving large subsidies to its domestic industries (non-farm), then importing nation can take the following actions

It has three main pillars

• Intellectual Property Rights (IPRs) include copyright, patents, GI etc.
• The most revolutionary aspect of TRIPS is that it provides product patents instead of a process patents. 
• TRIPS gives protection of 20 years for patents, 50 years for copyrights, 7 years for trademarks and 10 years for layout designs. 

• TRIMs Agreement deals with the investment done by the businesses based in one country in a foreign country. It has the provisions of equal treatment of foreign companies wrt national companies. 

1. India’s Solar procurement under National Solar Mission
   • USA filed a case against India, arguing that India’s National Solar Mission gave public procurement preference & subsidy to India-made solar panels, creating a non-tariff barrier for US solar panels. Subsequently, India lost the case and withdrew these barriers in 2017. But, the USA still alleges that India is still giving preference to local manufacturers.
2. Ban on American Poultry
   • In 2007, India banned the import of US poultry under the provisions of the Indian Livestock Importation Act, 1898 due to the fear of avian influenza/bird flu (H5N1). The USA alleged that these claims had no scientific basis, and the ban was imposed to protect local business interests. In 2016, WTO ruled in favour of the USA. The USA alleges that India is still creating barriers to its poultry imports and hence demanded $450 million compensation from India in subsequent cases filed in 2018.
3. Export Incentive Schemes of India
   • In 2018, the USA filed a complaint against export incentive schemes of the Indian government viz. (1) Merchandise Export from India Scheme (MEIS), (2) Export Oriented Units (EOU), (3) Electronics Hardware Technology Parks (EHTP), (4) Special Economic Zone (SEZ) and (5) Export Promotion Capital Goods. Under this scheme, India gives tax reliefs and subsidies to its exporters. The argument of the Indian government was based on the fact that they will phase out these schemes after 8 years from and these subsidies and tax reliefs were needed as India is a developing country.
   •  But WTO ruled against India in 2019 and ordered India to stop such schemes within the next 90-180 days. But India challenged this in WTO Appellate Body

In WTO, negotiations related to trade are taken up in different rounds. E.g. WTO was formed as a result of the Uruguay Round. In 1986, these countries started to negotiate on a specific determined set of things under the Uruguay Round on which the decision was reached in 1993. After that, countries decided to move ahead to take other subjects in order to make the trade even freer. Hence, Singapore Round started in 1996 in which discussion was to be held on investment, government procurement, labour, environmental laws etc. But Uruguay Round had certain shortfalls which started to impact developing countries, and they started to protest. Hence, Singapore Round was scrapped, and negotiations started under Doha Round in 2001. Presently all the negotiations are going under Doha Round

Doha Development Round (DDA) officially began in November 2001 (4th Ministerial). DDA was set up to deal with many deficiencies of WTO significantly impacting developing countries. These include 

1. Public Stockholding: Developing countries wanted special safeguards & a change of rules relating to public stockholding for food security. 
2. Introduction of measures to blunt the market power of large firms in the pharmaceutical industry  
3. Making trade of goods and services easier across national borders 
4. Freer mobility of labour in global services trade 

Principles of Doha Round

1. Single Undertaking

• ‘Nothing is agreed until everything is agreed‘ i.e. the developed countries can’t cherry-pick which parts to prioritize.
• It is the root cause of why the Doha Round is struck. 

2. Transparency

• The negotiations have to be transparent.

3. Special & Differential Treatment

• The member countries will take the principle of special & differential treatment for developing & least developed countries into account while negotiating. 

India’s stand at Ministerial Conferences

• Export Subsidies: Reduce export subsidies given by developed nations.
• Special Safeguard Measures: USA, Canada, and other developed countries give their farmers 70-80% subsidies. If such produce is exported to developing countries, it can crash the price of agricultural commodities in those countries, negatively impacting local farmers. Hence, India and other developing countries want Special Safeguard Measure (SSM) under which such countries can raise the tariff on agricultural commodities temporarily to deal with the fall in the price of agricultural goods. There is a difference between developed and developing countries over the trigger factor at which SSM can be activated. 
• Stockholding: A permanent solution to public stockholding to ensure the continuation of its food subsidies for public distribution programs.           
• Re-affirming the Doha Development Agenda (DDA) and supporting the argument that new issues like—global value chain, e-commerce, competition laws, labour, environment and investments should be introduced only after settling all the issues to be discussed under DDA.

Why DDA is facing the roadblock?

 The reason is the fight between the developed and developing countries with differing demands

Developed Countries (headed by US , EU, Japan etc) => Bring back the Singapore Issues 

• They want a start to negotiations for new trade agendas, including investment, competition policies, government procurement, labour, environment and climate change.
• Developing Countries are against any conclusion of the Doha Round without a clear decision regarding the solution on key existing issues.

Developing Countries (headed by China, India etc)

• They want Doha Agenda negotiations to be completed before moving on to other items.

Consequences of DDA roadblock

Since WTO is not going anywhere and has stuck since decade, nations have started to look towards Regional Trade Agreements (RTAs). These developments have posed a question regarding the future of the multilateral trading system under the WTO. 

• With this, it is not surprising if the members no longer value the relevance of WTO & become more frustrated with its process. Consequently, members will be more eager to look for alternate routes outside the WTO, notably via Regional Integration. 
• Earlier TPP among the 12 nations (which was scrapped by Trump) and RCEP & TATIP can be understood as a pragmatic response to the DDA roadblock.  
• In all, Bilateral Free Trade agreements have increased from 124 in 1994 to 600 in 2015 

But neither approach with its inherent discriminatory nature is a substitute for WTO and its strong edifice of a multilateral system of rules based on egalitarian principles and effective dispute settlement mechanism.

• It is the amount by which revenue expenditure exceeds revenue deficit.
• It is generally given as a percentage of GDP. 

Budget 2023 Revenue Deficit

• For 2023, the Revenue Deficit target is 2.9% of GDP.
• In absolute terms, the Revenue Deficit of the Indian Budget is ~Rs. 9 Lakh crore.

• Some of the grants given by the Union to the State governments are used to build assets. Hence, those grants should not be counted in the calculation of Revenue Deficit. Using this argument, the UPA government introduced the concept of Effective Revenue Deficit.
• Effective Revenue Deficit = Revenue Deficit MINUS Grants used for asset generation.
• For 2023, the Effective Revenue Deficit target is 1.7% of GDP.

• The budget deficit is the difference between receipts and expenditure (both revenue and capital) (Always Zero)
  • = Total expenditure MINUS total receipts
  • = (Revenue expenditure + Capital Expenditure) MINUS (Revenue receipt + Capital receipt)

• But it is zero because the government is borrowing the money. 

• If we subtract the amount paid as interest payment on old loans from the Fiscal Deficit, we get Primary Deficit.
• Thus, the primary deficit reflects the borrowing requirement of the government exclusive of interest payments.
• Manmohan Singh mentioned it for the first time in the 1993 Budget.
• Budget 2023: 2.3% of GDP.

Introduction

• The act/process of financing a deficit budget by a government 
• In this, the government knows well in advance that total expenditure would be more than total receipts & hence enacts such policies to sustain the burden of deficits. 
• The first to use this was the USA in the 1930s to combat the Great Depression of 1930. In the 1960s, this idea became well known in the world.
• India tried her hand in deficit financing in 1969 & since the 1970s, it has been a common phenomenon. But the levels of fiscal deficit reached unsustainable levels & its composition was also unjustifiable, not based on sound fundamentals of economics.

Means of  Deficit Financing

Means are given below in order of their preference

1. External aids

• These are the best money to fulfil a government’s deficit requirements, even if it comes with soft interest.
• If it is coming without interest, nothing would be better than that.

2. External Borrowings

Although considered as erosion of nations sovereignty but are better than internal borrowings because of two reasons

• External borrowings bring hard currency, which has an extra edge in spending.
• It doesn’t cause a crowd-out effect & other sectors can use saving.

3. Internal borrowings

• Going through this route hampers investment prospects of the public & corporate sector (leads to Financial Repression).
• The economy moves either towards stagnation or slowdown. 
• It happened in India in the 1960s, 70s, 80s.

4. Printing Currency

• It is the last resort. 
• It has significant damaging effects on the economy. 
  • It increases inflation proportionally because of more money in the market without a proportional increase in goods. 
  • It brings steady pressure & obligation on government for an upward revision in wages & salaries of employees. Hence, government expenditure increased, leading to further printing & vicious circle continues.

India & Deficit Financing

• Keynes advocated the idea of the fiscal deficit, but it has catch in it & third world countries overlooked that. The catch is related to why the economy should go for this & what should be the composition of the fiscal deficit.
  1. The best composition is a fiscal deficit with the revenue surplus budget or zero revenue deficit budget.
  2. Deficit requirements of lower revenue expenditure & higher capital expenditure is the second-best option provided revenue deficit is eliminated soon.
  1. The last situation could be a major part of deficit financing is going for revenue expenditure. 
• India & other third world economies had gone for the third option & it proved dangerous for them.

Why Fiscal Deficit is bad for the health of the Economy?

• Sovereign rating downgrade: Credit rating companies can downgrade country ratings in case of higher fiscal deficits. It affects investor confidence. 
• Crowding out / Financial repression: Government forces Public Sector Banks to purchase more Government Securities (G-Secs), reducing the capital available to the private sector. It raises the borrowing cost for private enterprise.
• Intergenerational parity: It hurts the future generations as they will have to pay increased taxes to settle the government debt. 
• Inflation: Too much government debt can lead to inflation and reduce real interest rates.
• Exchange rate risk: Poor credit rating pushes the exchange rate down, increasing foreign borrowing and making imports expensive.

• The key trigger of the default in 1991 was irrational public spending by borrowing money in the late-1980s. FRBM law (2003) was aimed at limiting the government’s borrowing under Article 268 of the Indian Constitution.  
• Targets under the FRBM Act
  • Under the original act, the Fiscal Deficit was to be reduced to 3% of GDP (for Union), and 3% of GSDP (for States) and Revenue Deficit was to be eliminated, i.e. reduced to 0 till 2008.
  • The act was amended in 2012, and the new target was changed to 0% Effective Revenue Deficit and 3% Fiscal Deficit till 2015.
  • The deadlines to achieve the targets were extended further in subsequent Finance Bills.

2018 Amendment to FRBM Act

• These amendments are based on NK Singh Committee Report.  
• New Targets to be achieved till 2024-25 budget  under FRBM Act are 
  • Public debt has been made the main anchor, and the Centre’s Debt to GDP ratio should be brought down to 40%, and the overall (Centre+ States) ratio should be brought down to 60%.
  • Fiscal Deficit should be brought down to 3%.
  • Primary Deficit should be brought down to 0%
  • Revenue Deficit and Effective Revenue Deficit will not be used as main anchors in the FRBM Act.
• Escape Clause has been introduced, i.e. during the war, national calamity, collapse of agricultural output, fall in GDP growth rate or structural reforms in the economy, the government can cross fiscal deficit target by 0.5% of GDP. 

• Revenue Budget contains the revenue receipts and the revenue expenditure.
• Further, the revenue receipts can be divided into tax revenue and non-tax revenue.
• Revenue expenditure can be further categorised into components like Interest paid by the government on loans taken, Grants given by the Union to States, Subsidies, Grants etc. 

• Receipts that don’t lead to a claim on the government. They are also termed as non-redeemable. 
• In simple words, this is such cash received by the government which doesn’t need to be paid back by the government in future. Take the example of tax in which money received by the government in the form of tax is not to be paid back by the government.
• They are further divided into tax revenues and non-tax revenues.

What is Tax?

• Tax is a compulsory payment by the person or legal entity (like a company) to the government in return for which the payer can’t claim any specific benefit from the government.
• Tax is a legal obligation that taxpayers can’t refuse to pay.

Methods of taxation

Proportional taxation is typically used in combination with either progressive or regressive taxation. Proportional with progressive taxation is used in India.

Canons of Taxation

Canons of taxation are the characteristics of a sound taxation system.

Adam Smith has enumerated four canons of taxation. These include

If a tax doesn’t follow these canons, it is scrapped. E.g., the Gift Tax was abolished in India because it didn’t follow the Canon of the Economy (hardly Rs. 10 crores were used to be collected, and the government had to maintain a large workforce for its collection).

Importance of Taxation

• Revenue generation: The government uses taxation to generate revenue for its operations, infrastructure development, welfare programmes, education, defence, etc. 
• Resource Redistribution: Tax can be used to transfer resources from the affluent to the weaker section of society. The government uses the cash received through tax to run welfare schemes for weaker sections. 
• Behaviour Discouragement: Also referred to as social engineering, taxes can be used to discourage people from antisocial behaviour. It is often done by heavily taxing the commodity, increasing its price. 
• Protecting local Industry: The government usually protects local industries through heavy import tariffs, making imported goods more expensive than local goods, thereby encouraging local production. 
• Improving Accountability: Taxes help build up a country’s economy and make the government accountable to its taxpayers. Taxpayers demand accountability from the government of the day.

• It is levied on a person’s income or wealth and is paid directly to the government.
• Direct Tax has incidence & impact both at the same point
• It depends on the paying capacity of a person, i.e. rich pay more than the poor.

Pros & Cons of Direct Tax

Pros of Direct Tax

• Direct tax is progressive in nature. Hence, the richer pays higher.
• Inequality in income can be reduced using this as direct tax helps in income redistribution.
• Direct taxes can ensure the canon of certainty as the income taxpayer knows when and at what rate he has to pay income tax.
• It increases the accountability of the government. When a person pays directly to the state, he becomes more conscious about the efficacy of the government’s spending. 
• It encourages savings and investments. E.g. to avail deductions, people invest in Provident Fund, Insurance etc. 
• It is elastic, i.e. quick results are shown when raised or lowered. 

Demerits of Direct Tax

• Expensive collection: Government has to maintain salaried employees to collect direct taxes. Hence, the base is kept narrow (mainly to reduce staff expenses, a lot of poor are kept out).
• Inconvenient: The taxpayers find it problematic to maintain accounts & submit returns.
• The externality is not counted (e.g., if a particular company is producing tobacco & another company is making medicine, both will be subjected to the same corporate tax, although the tobacco producer is damaging public health).
• Hardship is not counted (e.g. carpenter & landlord have to pay the same direct tax (income tax)).
• If direct taxes are raised above a certain point, it leads to less tendency to do work as the citizens are not willing to earn more as they have to pay more taxes.
• They are prone to loopholes, litigations and tax evasion. 

Question: Why is it important to take more people into the direct tax ambit when the government can raise tax indirectly?

• It is the direct tax levied on a company’s net profit.
• Earlier, Corporate Tax was in the range of 30% of net profit. But to provide a boost to the economy, the government has been continuously decreasing the rate so that more surplus can be reinvested in the economy. The present rate of Corporate Tax is as follows:-

Side Topic: Equalisation Levy (Google Tax) and Concept of Significant Economic Presence

• Issue: Foreign Companies have to pay 40% Corporate Tax on profits in India. But Indian Taxation System is designed to tax companies that are based in India. However, most Internet giants, such as Google, Facebook etc., are headquartered outside India. Along with that, almost all the digital companies, like Apple, Google, Amazon, Uber etc., have shifted to countries like Luxembourg (Amazon) and Ireland (Google), which have almost zero tax rates. They channel their profits from operations in the host country to zero-tax economies and pay zero tax to the host country. 
• To deal with this, the Government of India imposed an equalization levy and introduced the concept of ‘Significant Economic Presence’ (SEP). It implies that if a foreign company is making money from Indians through digital services, it has ‘SEP’ in India, and the Indian government can tax it. In 2016, an Equalisation Levy or Google Tax of 6% was imposed on digital advertisers. Countries like France have also implemented a tax on large technology companies called GAFA Tax (Google-Amazon-Facebook-Apple) in 2019. 
• In Budget 2020, the Government imposed an Equalisation Levy of 2% on the revenues generated through the online sale of digital goods and services by non-resident e-commerce companies, streaming companies (like Netflix, Amazon Prime etc.) and online travel aggregators (like Trivago), provided that their revenue exceeds Rs 2 crore. 
• The US government has raised an issue against it by arguing that this levy is a burdensome restrictive measure, has costly compliance requirements and subjects US companies to double taxation. But India has claimed that it is not discriminatory against US companies as it is charged equally to all the foreign companies operating in India. Along with that, it is also in line with OECD-G20 suggestions to tackle tax challenges. 

But there are issues with Equalisation Levy

• MNCs can’t get the input tax credit. Hence, they increase their subscription price, which the Indian consumer ultimately bears. 
• These MNCs, especially American companies like Google, Microsoft, Adobe, Netflix etc., lobby the US Senate to retaliate by imposing more taxes on Indian products. 

• When the company pays a dividend to their Shareholders, shareholders had to pay the Dividend Distribution Tax to the government. 
• The government has abolished this tax in Budget 2020.

• When an owner makes a profit by selling his capital assets, such as non-agricultural land, property, jewellery, patents, trademarks, shares, bonds etc., he must pay the Capital Gains Tax (CGT) on the profit earned.
• It is of two types i.e. 
  1. Long Capital Gains Tax (LCGT): if the asset is kept for a long (the period varies according to the type of asset, like 1 year for Shares, 2 years for property etc.) before selling and sold at a profit, LCGT is to be paid on the profit earned.
  2. Short Capital Gains Tax (SGCT): if the asset is kept for a short time before selling and sold at a profit, SCGT is to be paid on the profit earned.  
•  It follows the principle of Tax Deduction at Source (TDS), i.e. buyer will deduct CGT from the amount to be paid to the seller and deposit it to the government. 
• Budget 2022 has placed a 30% tax on virtual digital assets (like bitcoins, NFT etc.).

• STT is charged at a rate ranging from .001% to .125%, depending on Security.
• It is applicable to Shares, Mutual Funds etc. 
• Capital Gains Tax is charged when there is profit, but STT is charged for trading the Securities and will be charged immaterial of profit or loss.

The general rule is,  

• The surcharge is applied on the Tax  
• Cess is applied on (Tax+ Surcharge)  

Surcharge vs. Cess

Cess and Surcharge in previous years

• Health and Education Cess levied at the rate of 4% on direct taxes such as Income Tax and Corporation Tax.

• Social Welfare Surcharge on imported goods (10% of the Customs Duty).
• Health Cess on imported medical devices (5% of Custom Duty) for building infrastructure for Ayushman Bharat.
• Agriculture Infrastructure and Development Cess on imported goods such as gold, alcohol, urea, apple etc.

Side Note: Why (Union) Government Loves Cess?

• While the Centre has to share the revenue from other taxes with the States mandatorily based on the recommendations of the Finance Commission (under Article 270), it retains the entire kitty with a cess.
• Governments often resort to cesses to generate tax revenue, as they offer a relatively simple and straightforward way to do so. Cesses can be introduced, altered or repealed with relative ease through the issuance of a notification, making them a flexible tool for policymakers to raise funds.

There are many issues with the Direct Taxes of India. As a result, just 4% of voters pay income tax; corporates suffer from high Corporate Taxes, and foreign companies don’t invest in India due to high Corporate Taxes on foreign companies. To overhaul the Direct Tax System of India, the government set up a task force under Arbind Modi. It suggested the following in its report submitted in August 2019

1. Replace the complex Income Tax Act of 1961 with a simple Direct Tax Code.
2. Further reduction in Corporation Tax.
3. The same taxation system should apply to foreign and domestic companies.
4. Provide additional tax relief to the Startups. 
5. More tax slabs should be introduced.
6. Set up Litigation Management Unit to look after tax-related court cases efficiently.

• Indirect Tax is levied on the purchase of goods and services and paid indirectly to the government. 
• Unlike direct taxes, it is charged from all people at the same rate (irrespective of their economic status).
• In this, tax incidence and tax impact are at different points.

Pros and Cons of Indirect Taxes

Pros

• Wider Coverage Base: All consumers, whether rich or poor, have to pay indirect taxes
• Economical to collect: As producers and retailers collect tax and submit payments to the government, the cost of collection is reduced. The merchants serve as honorary tax collectors.
• Checks harmful consumption: The Government can impose indirect taxes on commodities detrimental to health, e.g. tobacco, liquor etc. They are known as sin taxes.
• Convenient to pay: Consumers can pay indirect taxes easily when they purchase a good or service. 

Cons

• Regressive nature: Indirect taxes are regressive since both rich and poor persons have to pay the taxes equally, irrespective of their income level.
• Uncertainty: The implementation of indirect taxes results in an increase in prices and subsequently leads to a reduction in the demand for goods. It, in turn, creates uncertainty for the government regarding the anticipated revenue collection.
• No Civic Consciousness: As the indirect tax hides in the price, the consumers are unaware of paying the tax.
• Cascading Effect: If the input tax credit is not given, Indirect taxes can lead to a cascading effect, i.e. Final consumer will have to pay tax on taxes. 

Theory: Ways to impose Indirect Tax

Indirect Tax can be imposed in two types 

1. Specific Tax per Unit
2. Ad Valorem

1. Specific Tax per Unit

• In this, tax is charged per unit (immaterial of the unit’s price).  
• E.g., In the example below, the tax on bikes is fixed at Rs 3000 per unit (irrespective of cost).

 Problem

• The government’s tax revenue doesn’t rise automatically with the rise in the prices of goods. Hence, the government must frequently increase the tax rates in this system.
• It also leads to inspector raj as traders can find loopholes – first to make bigger units and then ask retailers to cut into smaller pieces.

But in some cases, we prefer the Specific Tax per Unit. These include cigarettes and other demerit goods.

2. Ad Valorem

• In this, tax is charged per unit price.
• E.g., say tax for the bike is 3% of the price.

This system is beneficial as the government’s tax revenue increases naturally with a price increase. Along with that, tax dodging is not possible in this. Hence, we prefer Ad Valorem System in most cases.

Excise Duty

• Excise Duty is the indirect tax levied when a product made in India is sold in India. 
• After GST, Excise Duty on all except Petroleum Products has been removed. 

Custom Duty

• It is the indirect tax levied when some other country’s product is imported to India or Indian product is exported abroad. 
• Customs duty on imported and exported goods is still intact after GST.
• If the government wants to protect the domestic industry, it can increase the customs duty on those goods. E.g., the government increased the customs duty on imported raw materials, capital goods and project imports in the Budget (2023) to increase their domestic production.

Side Topic: Anti-Dumping Duty

• Anti-Dumping Duty is a protectionist tariff a domestic government imposes on foreign imports if it believes it is priced below fair market value.
• Suppose it costs Rs 100 to produce 100 ml of Coconut Oil in India. The producer will sell this in the market at a rate of Rs 100 plus excise duty (or GST). 
• Suppose that producers in China are also producing the same coconut oil at Rs 100 and selling it at 100 plus excise duty in the Chinese market. But when they export the same thing to India, they charge just Rs 60 (due to various Export Subsidies given by the Chinese government). 
• In such a case, since Chinese products are being dumped in India, India can impose a Dumping Duty on that along with Custom Duty such that it costs the same in India as Indian Products. 

• GST is the major tax reform of the government that has subsumed all the indirect taxes in itself.
• Dealt in a separate article (CLICK HERE).

• Pigouvian tax is imposed on bodies having negative externalities. 
• The effect of one person’s action on the well-being of a third party is known as an externality.  

Clean Environment Energy Cess

• It is imposed on the imported Coal, peat & lignite and desi coal at the rate of ₹ 400 / ton.
• Money goes to Clean Energy Fund & is used to fund clean energy projects.
• The government has decided to use the proceeds of this cess for Compensation of Losses of States due to GST implementation. 

• A windfall tax is levied on unexpected or unplanned profits, often resulting from a significant event such as a natural resource discovery or unexpected price increase of any good. The purpose of a windfall tax is to capture some of the unexpected profits and redirect them towards public benefit.  
• It happened in the case of petroleum.
  • In June-July 2022, Fuel prices witnessed an exponential increase in the global markets. Indian refineries, which export a large amount of petroleum and diesel, started to make huge profits. Hence, the government imposed Special Additional Excise Duty (SAED) on the export at the rate of ₹6/litre for Petrol and ₹12/litre for diesel.
  • But towards the end of August 2022, as fuel prices started to decline in the global market, the Indian government started to eliminate or reduce the duty.

All the money collected by the Union government through direct and indirect taxes is shared with the states on the formula suggested by the Finance Commission (under Article 280 of the Constitution).

Such an arrangement has been made because

• The taxation powers of State governments are low. 
• The Union government collects all the important direct taxes like Income and corporate tax.

Presently, the 15th Finance Commission has recommended that Union should share 41% of divisible taxes with the states.

• The Tax: GDP ratio of India is 11.1%.  

• Considering India’s development levels, the Tax: GDP ratio should be around 20%. But India has a low Tax: GDP ratio due to various reasons like
  1. Tax Evasions
  2. Black Money

The revenue obtained by the government of India from sources other than tax is called Non-Tax Revenue. These include

1. Revenue from selling goods and services like post-office services, selling telecom spectrum etc.
2. Dividends and profits received from Public Sector Enterprises, RBI etc.
3. Interest received on loans given to states, foreign countries etc.
4. Grants received by the Union government from foreign countries or organisations (these grants are not to be paid back)
5. Escheat: When a person dies without leaving a will or legal heirs, the state is entitled to their property.

Non-tax revenues are significantly lower than tax revenues. E.g. for 2023, Net Tax Revenue is projected to be Rs 23 lakh crore, and Non-tax revenue is projected to be Rs 3 lakh crore.

Revenue Expenditure is that component of government expenditure that is not used to produce any productive asset. Instead, the government incurs these expenditures for its operational needs like salaries, interest on loans, etc. 

Different Revenue Expenditures

a. Interest paid on loans

• Union Government takes a considerable amount of loans. Interest paid on loans taken in the past is counted in the revenue expenditure. 
• It is the biggest component of expenditure. In 2023, Union Government paid Rs 10 lakh crores as interest on its previous loans.

b. Grants given

• Union Government gives a large number of grants as well. These include  
  1. Grants given to states on the recommendation of the Finance Commission.
  2. Grants given to foreign countries as part of soft-power diplomacy.
• The recipient of the grant doesn’t pay it back (it is not a loan but a grant)
• It consumes the second most significant chunk of revenue expenditure. In 2023, the Union government will give ~Rs 6.6 lakh crores in grants. 

c. Subsidies

• Subsidies are the benefits given to individuals or firms by the government to reduce the financial burden of a specific section of society.
• Union Government gives various types of subsidies like 
  1. Food Subsidy: The government buys wheat and rice from farmers at MSP and then distributes the food to the poor at low prices under the provisions of the Food Security Act.
  2. Fertilizer Subsidy: It is used to provide urea to farmers at a low price.
  3. Fuel Subsidy: LPG cylinders are given to households at a price lower than the market price.
  4. Subsidies on loans are given to various sections like farmers, MSMEs etc.
• In 2023, the Indian government gave Rs 4 lakh crore in subsidies.

Side Note: Impact of Subsidies

Subsidies can have both positive as well as negative impacts.

• Subsidies given on merit goods like healthcare, education etc., show a positive impact as it leads to better health and educational outcomes.
• But in some cases, like subsidies given on urea can encourage farmers to use excessive amounts of urea, impacting the farm’s fertility and leading to environmental degradation.
• Along with that, subsidies increase the fiscal deficit of the government.

Issues with Subsidies in India

• Subsidies in India are regressive in nature due to their universal nature. Hence, richer households get more subsidies in comparison to poor households. E.g., Electricity subsidy benefits the richer as they consume maximum electricity.
• Inclusion and Exclusion errors in subsidies: Ideally, only the poor should receive a government subsidy. But it has been observed that most of the subsidy leaks are due to exclusion and inclusion errors.
  1. Exclusion Errors: Poors who should receive subsidies don’t benefit from subsidies.
  2. Inclusion Errors: Rich and ghost beneficiaries who shouldn’t get any subsidy enjoy the benefit of subsidies.
• It hurts the government finances as well without yielding the required benefits. Indian government gives Rs. 3 to 4 lake crore on subsidies.

Side Note:  Steps taken by the government wrt Subsidies

• Targeted beneficiaries: To identify people who should receive a subsidy, the government is using Socio-Economic Caste Census (SECC).
• Direct Benefit Transfer: Subsidies are directly transferred to the bank account of the beneficiary using the JAM platform. 
• Ghost beneficiaries have been removed by linking subsidies with Aadhar.
• Subsidies on things like petrol and diesel have been removed.

Economic Survey Topic: Using Behavioural Economics to reduce subsidy expenditure

Government should use behavioural economics to encourage people above the poverty line to give up subsidies voluntarily in the following ways.

1. Generally, people go with the status quo. So, the ‘Default ticked option’ in LPG registration forms should be ‘I wish to give up the subsidy’. Hence, the person will be ‘forced’ to untick the option to avail of the subsidy benefit.
2. Advertisements to highlight that “people are helping in poverty removal by giving up subsidies. “
3. The online ‘subsidy giving up process’ should be quick and hassle-free.
4. Disseminate the name of people who have given up subsidies in the neighbourhood using SMS or other online forums so that others can follow in their footsteps.

d. Defence Expenditure

• Defence revenue expenditure is the expenditure to give salaries to the armed personnel and buy ammunition for the defence forces. But it doesn’t include expenditure to purchase new weapons.
• In 2023, the Indian government spent Rs 2.79 lakh crore in defence expenditure.

It consists of capital receipts and capital expenditure.

2.1 Capital Receipt

• Unlike Revenue Receipts, Capital Receipts are those receipts that lead to a claim on the government.  
• In simple words, this is such cash received by the government that needs to be paid back by the government in the future.

It can be further divided into debt and non-debt. 

a. Debt Receipt

Debt is the government borrowings. Government can borrow money either internally or externally.

a.1 Internal Debt

• Internal debt is a loan taken by the government from the citizens or different institutions within the country.
• Primary sources of Internal Borrowings include 
  1. Individuals who buy the bonds issued by governments.
  2. Banks purchasing government bonds and securities.
  3. Institutions like LIC, GIC etc., can also buy government bonds.
  4. Provident fund
  5. Small saving schemes 
• For 2023, the target of internal debt is Rs 17 lakh crore.

a.2 External Debt

• The external loan is the loan taken from the government of other countries or an international organization (like the World Bank, IMF, BRICS Bank etc.). 
• The government will borrow Rs 22,000 crore from external sources in 2023.

b. Non-Debt

It has two components

b.1 Loans Recovered

• It consists of the principle of loan given back by states or other countries to which India has lent.
• Union will recover Rs 23,000 crore in 2023.

b.2 Disinvestment

• Cash received by the government by selling the shares of Public Sector Enterprises.
• In 2023, Government will raise Rs 61,000 crore via disinvestment.

2.2 Capital Expenditure

 It consists of 

1. Paying back the principles of loans earlier taken.
2. Expenditure on making of the capital assets like roads, buildings etc
3. Giving debt/equity finance to PSUs & foreign institutes, providing loans to State Government & Foreign Government.

In Budget 2023, Capital Expenditure is pegged at Rs 10 lakh crores.

Side Topic: State CAPEX Loans / Special Assistance to States for Capital Expenditure

• To deal with the Covid pandemic, the Union government has decided to give interest-free 50-year loans to states for capital expenditure. States can spend this on building infrastructure in health, rural development, water supply, irrigation, power, transport, education and urban development. 
• In Budget 2022, the government has decided to give CAPEX loans of Rs 1 lakh crores to the states.
• In Budget-2023, the government announced that a proportion of State Capex loans will be linked to
  1. Reforms in the Finances of the Urban Local Bodies
  2. Scrapping old vehicles
  3. Construction of Unity Malls etc.

• The term ‘fiscal‘ is derived from a Greek word that means ‘basket‘ and symbolizes the public purse.
• Fiscal Policy is a set of government decisions concerned with raising revenue through taxation & with deciding on the amount & purposes of its spending. 
• It involves the use of taxation & government spending to influence the economy. 
• The budget is the primary tool used by the Government to implement its fiscal Policy.

• The word ‘Budget’ is derived from the French word ‘baguette’ means a leather bag as Finance Minister keeps the leather budget bag and presents them in Parliament. 
• The Budget 2023 has mentioned 7 priorities, i.e. ‘Saptarishi‘ for Amritkaal, which include
  1. Inclusive Development
  2. Infrastructure and Investment
  3. Reaching the Last Mile
  4. Financial Sector
  5. Green Growth
  6. Unleashing the Potential
  7. Youth Power
• The term ‘Budget’ is not mentioned anywhere in the constitution. But the following provisions of the constitution are related to the budget.
  1. Annual Financial Statement (Article 112) 
  2. Finance Bill for collecting taxes (Article 265)
  3. Appropriation Bill for spending money (Article 114

To comply with these provisions, Finance Minister presents three things in the Parliament every year, collectively known as the budget.

1. Finance bill

• Constitutional Provision under Article 265 says that ‘Without Parliament’s permission, Government can’t collect taxes.’ Hence, Finance Bill is introduced in the Parliament to get permission to collect taxes. 
• All the money collected through taxes goes to the Consolidated Fund of India.

2. Appropriation Bill

• Constitutional Provision under Article 114 says that ‘to take out the cash from the Consolidated Fund of India, Government needs the Parliament’s approval.’  Hence, Appropriation Bill is introduced in Parliament to get that permission. 
• Appropriation Bill has two types of Demands for expenditure.
  1. Demands on Grant: They are to be discussed and voted on. E.g., cash required for various schemes
  1. Expenditures ‘charged’ upon the Consolidated Fund of India. These expenditures can be discussed but are non-votable & get approved automatically. E.g., Salary of Supreme Court Judges, Pension of Supreme Court and High Court Judges etc.

3. Annual Financial Statement

• Article 112 states that President should lay the Annual Financial Statement in Parliament each Financial Year.  
• The Annual Financial Statement is introduced in the Parliament to show data about incoming and outgoing money. 
• There isn’t any specific format mentioned in the constitution except that Annual Financial Statement should show Revenue Expenditure separately from other Expenditure. 

Budget speech +  Economic Survey of India

• Finance Minister also releases Economic Survey and gives a Budgetary speech in Parliament. But there isn’t any constitutional obligation to present these things.

Note: Finance Bill and Appropriation Bill are Money Bills under Article 110 of the Constitution. Rajya Sabha has very little power wrt Money Bill, and they can delay it for 14 days. Rajya Sabha can only suggest an amendment to Money Bill, which Lok Sabha may or may not accept.

• Traditionally, Finance Ministers kept budget papers in a leather suitcase.
• In 2019, FM Nirmala Sitaraman changed the tradition and kept the documents in red coloured cloth called ‘Bahi Khata‘.
• In 2022, the finance minister used red velvet cloth over the “digital tablet” to present the digital budget. 

The financial year in India begins on 1st April and ends on 31st March.

Timeline

So, should it be changed?

It is a debatable issue, and arguments are present on both ends of the spectrum.

Government should change it due to following reasons:-

• Many committees and Commissions have recommended that Financial Year starting from 1st April is not appropriate for India. These include 
  • Chamberlin Commission of 1913
  • Sir Dinshaw Wacha Committee, 1921
  • 1st ARC, 1966
  • C Rangarajan Committee, 2011 (Planning Commission) 
  • Shankar Acharya Committee (formed in 2016 by Modi Government)
• Agricultural Economy demands this change: In India, rain happens in June-July-August, and the economy depends upon the quantity of rain (since 49% population depends on agriculture). In case of insufficient rainfall, the government’s revenue can decrease, and expenditure can increase (because MNREGA demand will increase). But the government can’t change budgetary allocations because the Budget is made just before the monsoon. 
• Other Countries such as Austria, Brazil, China, Germany, Netherlands, Russia, and most MNCs start their financial year on 1st January. Hence, it will help in ease of doing business.  
• It is a Colonial Legacy and doesn’t have any cultural and psychological connection with India. 

Government shouldn’t change it due to the following arguments:-

• All laws will need to be amended, which will divert the workforce’s attention. When the global and Indian economy is passing through tumultuous times, this adventurism is uncalled for.
• The system is working fine. As the famous adage goes, ‘don’t fix what isn’t broken’; the government should refrain from interfering with this. 

Conclusion: Changing Financial Year is worth consideration, but it should be accomplished gradually.

 Three types of data are mentioned in the Budget, i.e. Actual Data, Provisional Data and Budgetary Data.

Actual Data

Of the preceding year, i.e. one year before the year in which the budget is presented

• Budget for the year: 2023-24
• Actual Data: 2021-22

Because actual data comes after a lag of one year.

Provisional Data (PD)

Of passed year

• Budget for the year: 2023-24
• Provisional Data: 2022-23

Budgetary Estimates (BE)

For the following year of which the budget is presented

• Budget for the year: 2023-24
• Budgetary Estimate: 2023-24

• It is an ‘unwritten convention’ that the ruling government shouldn’t initiate any significant policy change or scheme when a general election is nearby. It can unduly influence voters’ voting behaviour favouring the party in power. 
• Hence, the government introduces a very slim version of the budget in an election year, and such a budget is known as the Interim Budget. 
• Interim budgets were introduced in 2004, 2009, 2014 and 2019, i.e. election years. 

The primary ministry involved with the work of preparing and introducing the Budget is the Ministry of Finance. Hence, we should have a look at the structure and main functions of each department.

1. Department of Economic Affairs  (DEA)

• It looks after the preparation of the budget & economic survey. 

2. Department of Expenditure

• It prepares an estimate of how much amount is to be spent by different departments. 

3. Department of Revenue

• It looks after the collection of revenue, like direct and indirect taxes.

4. Department of Financial Services

• It looks after Public Sector Banks and their recapitalisation, Regional Rural Banks, etc., and financial sector regulators like IRDA, PFRDA etc.

5. Department of Investment & Public Asset Management (DIPAM)

• It looks after the disinvestment of Public Sector Enterprises as well as the management of their assets.