1. Parts of Budget
  2. #1: Direct Taxes
    1. Direct taxes under Interim Budget 2014
    2. Income Tax
    3. Shortfall in Direct tax collection = #EPICFAIL
    4. But Why shortfall in Direct tax collection?
  3. #2: Indirect taxes
    1. Indirect Taxes in Interim Budget 2014
      1. #I1: Service Tax
      2. #I2: Excise Duty: Automobiles
      3. #I3: Excise: Mobile handsets
      4. #I4: Custom Duty: soap industry
      5. #I5: Custom Duty: Bank note Mill
      6. #I6: Counter Veiling Duty (CVD): Road machines
    2. Indirect Tax collection = #EPICFAIL shortfall
    3. Why shortfall in indirect tax collection?
  4. MCQ Data for Tax collection: Ascending descending
    1. Table1: Direct vs indirect
    2. Table2: Ranking Among all taxes (2013-14)
    3. Table3: Ranking Among all taxes (2014-15)
    4. Table3: Tax collection highest to Lowest
  5. Gross vs net Tax revenue
  6. Appendix
    1. #1: Direct taxes can be levied on Expenditure also
    2. #2: Canons of taxation: why some taxes get abolished?

Parts of Budget

budget revenue part tax and non tax

Budget two parts.
revenue part (Current) capital part

within that, make two columns each, for incoming money (receipt) and outgoing money (Expenditure).

REVENUE PART CAPITAL PART
Receipt Expenditure Receipt Expenditure

Ya, but what’s the need of this labour? Why can’t we just have a simple income vs expense type of thing? We’ll come to that in third article.

For now, let’s focus on…

Budget => Revenue part

  • Revenue column has two sub-columns: incoming money (Receipt) vs. Outgoing Money (Expenditure).
  • The Incoming money (Revenue receipt) can come from two sources: from tax and non-tax sources.
REVENUE PART CAPITAL PART
Receipt Expenditure Receipt Expenditure
Tax Non Tax
  1. Direct taxes
  2. Indirect Tax

Thus, we’ve come to the main topics of today’s article= direct and indirect taxes and provisions of interim budget 2014 (related to these taxes).

#1: Direct Taxes

Have two subtypes

On Income/ Expenditure on properties/assets/Capital transaction
  1. Income tax
  2. Corporate Tax (and MAT)
  3. Interest tax (on banks)*
  4. Fringe benefits tax *
  5. Hotel receipt Tax*
  1. Wealth Tax
  2. Securities transaction Tax (STT)
  3. Banking cash transaction tax*
  4. Estate duty*
  5. Gift tax*
  • Taxes marked in (*) have been abolished long time ago. I’ve mentioned them here, only in case the nostalgic UPSC professor wants to ask classification type MCQs.

We should also know the direct taxes of state government.

DIRECT TAXES OF UNION DIRECT TAXES STATE
Taxes on Income

  • Income tax
  • Corporation Tax (and MAT)

Taxes on assets

  • Wealth Tax
  • STT
 Taxes on income

  • Agriculture income tax
  • Professional tax

Taxes on properties

  • Land Revenue
  • Stamp duty/registration duty
  • Property tax in urban areas

Now let’s check the provisions of:

Direct taxes under Interim Budget 2014

FM followed the Ethics(GS4) principles while making the interim budget, he did not make any changes in the direct taxes. That means, direct tax system remains the same like Budget 2013. Observe

Income Tax

Taxable Income Income Tax
2 to 5 lakh 10%
5 to 10 20%
>10 30%

Other direct taxes

Corporate tax (desi company) ~34%
Corporate tax (foreign company) ~43%
MAT Minimum alternative tax ~21%
Wealth tax (for wealth >30 lakh rupees) 1%
STT Securities Transactions tax 0.1%-0.001%*

*Depending on nature of securities – future, option, equity etc.

However, FM has done a slight tweaking in the tax deduction for corporates.

until now In interim budget
if company spent money on “in-house” Research development = they can claim tax benefits.
  • Chindu proposed to setup a new organization called “Research Funding Organisation“.
  • This org. will fund fund research projects selected through a competitive process.
  • If company gives cash to this organization, it’ll be deducted from taxable income.

Did not implement

  1. GAAR
  2. Direct tax code (DTC)
  3. Goods and services tax (GST)

Shortfall in Direct tax collection = #EPICFAIL

shortfall direct taxes

Observe

  • Feb 2013: FM proposes taxes for year 2013-14. Along with this, he’d give estimate of tax collection e.g. x crore from income tax, y crore from corporate tax and so on. Let’s label this column as Budget estimate (BE) 2013.
  • 1st April 2013: new tax rates would have become effective, people start paying taxes accordingly….May, june, july, august, September, October, November, December,….January 2014… So now FM gets new data. So, he’d correct (revise) his previous “estimate”. We label this Revised Estimate (RE)2013.
  • And finally for the year 2014-15 (Starting from 1/4/14 to 31/3/15, FM would again make budget estimates for next (interim budget) so let’s label it (BE)2014.

Thus total we’ve three estimates:

Direct tax BE 2013 RE 2013 BE 2014
Wealth Tax 950 950 950
Securities Transaction Tax 6720 5497 5992
Income Tax 240919 236194 300474
Corporation Tax 419520 393677 451005
Total from Direct tax 668109 636318 758421

Absolute numbers are not important but “interpretation” is. Let’s try a clichéd MCQ.

Which of the following direct tax, fetches maximum revenue to government of India

  1. Wealth Tax
  2. Securities Transaction Tax
  3. Income Tax
  4. Corporation Tax

For all three columns, you can see: Corp>>IT>>STT>>Wealth tax.

Anyways, let’s enter into a deeper analysis. Observe the total collection from direct Tax (in above table).

  • In Feb 2013, Chindu estimated ~6.68 lakh crore rupees would come from direct taxes alone! (BE2013)
  • But he revised the data yesterday, we see barely 6.36 lakh crore have come from direct taxes (RE2013).
  • So, what’s the “shortfall” in direct tax collection here? 6.68-6.36= 32,000 cores

But Why shortfall in Direct tax collection?

  1. Because IT officials are lazy and incompetent, hence lot of people managed to evade tax? NOPE.
  2. Because Chindu (Harward Graduate) and his finance Secretary (IAS) are weak in maths and economics, hence they made wrong estimates in the first place? NOPE.

Then who is the main “villain” behind this shortfall? Ans. (1) inflation (2) policy paralysis.

Why high Inflation = Low collection of Direct taxes?

  1. Corporate tax= paid by Tata, Birla, Reliance, Samsung, LG, Motorola, Videocon etc. They’ll pay less tax IF their profit is DOWN. Now, High food/fuel inflation=> people spend less money on consumer durables– mobile, TV, fridge etc.=> sales down=>profit down=> corporate tax goes down.
  2. Less profit=> company cuts jobs, doesn’t give salary raise to existing staff= people pay less income tax.
  3. Less profit = less dividends to shareholders => mutual fund/sharemarket investment declines= security transaction tax also goes down.
  4. High inflation = real interest rates are negative (recall Urjit Patel) = people invest more in gold and less in mutual funds/sharemarket etc.=> security transaction tax collection is lower than expected.

Why Policy paralysis = Low collection of Direct taxes?

Run the same logic and you’ll see the connection. e.g.

  1. Policy paralysis=corporates cannot open new factories=> less profit=>less corporate tax.
  2. Since corporates cannot open new factories=> less new jobs=>less people fall in the income tax bracket (starting from Rs.2 lakh to 5 lakh).

ok enough of direct taxes. let’s move on. otherwise our remaining jawaani will be spent in analyzing the direct tax only.

budget revenue part tax and non tax

REVENUE PART CAPITAL PART
Receipt Expenditure Receipt Expenditure
Tax Non Tax
  1. Direct taxes (DONE)
  2. Indirect Tax (now let’s study this)

#2: Indirect taxes

What are the indirect taxes of Union and States?

Indirect taxes (Union) Indirect Taxes (States)
  1. Custom Duty (Import, Export)
  2. Excise Duty (CENVAT system)
  3. Service Tax
  4. Central sales tax (CST)*
  1. Sales Tax/ VAT
  2. Excise duty on DESI liquor and Narcotics
  3. Motor vehicle tax, Taxes on boats and animals.
  4. Toll tax (opposed by MNS/Shiv Sena)
  5. Electricity tax.
  6. Luxury tax (on restaurant, spa etc.)
  7. Taxes on Betting and gambling (on whether Modi will become PM or not)
  8. Advertisement tax (other than TV, Radio, Newspaper)

*Note: CST-Central sales tax- it belongs to Union but ca$h entirely given to States. So in budget estimates, it’s collection is listed as “–” or “00”. But for MCQ purpose, know that it is the “Indirect tax of the Union.”

Indirect Taxes in Interim Budget 2014

We saw that FM has not changed direct taxes. BUT for indirect taxes, he has made slight reductions/tweaking for certain items, to boost the economy. Let’s check them one by one

#I1: Service Tax

The “Rate” of Service tax is not changed. It is same as last year (2013-14)

Service tax 12.00%
2% educational cess. Meaning tax on tax = 2% of 12% +0.24
1% Senior & Higher Education Cess= 1% of 12% +0.12
Effective service tax =12.36%

Then what is new in interim budget?

Following items have been exempted from service tax payment

  1. Rice: services related to loading, unloading, packing, storage and warehousing (Because)
    1. Tamilandu CM Jayalalitha has wrote letter to Mohan, demanding the same.
    2. putting service tax on rice related services=raises the cost of implementing Food security act.
  2. Cord Blood bank (they store umbilical cord for future stemcell therapy)

Make no mistake: they’re exempted, but not put in “negative list”.

Service tax “negative list” Exempted list
Govt. cannot levy Service tax on the names included in this list (total 17 items.) Theoretically, these services are taxable under service tax, BUT for the time being, FM gave them exemption.
To modify this list, FM needs parliament approval (because he needs to amend the Finance Act.). FM can modify this list by a simple notification. He doesn’t need parliament’s approval.
Examples

  1. Services by the Reserve bank of India;
  2. Betting and gambling. (because they fall under State list.)
  3. Funeral, burial
 Examples

  1. Rice loading-unloading
  2. Cord blood bank

#I2: Excise Duty: Automobiles

For past few months, Automobile sector was facing slowdown because

  1. High inflation =people postpone purchase of high value items
  2. High interest rates (because to combat inflation, RBI did not reduce monetary policy rate i.e. repo rate)
  3. High Fuel prices.

Therefore, to go a boost to automobile sector, FM has reduced the excise duty on

  • Automobile: SUV, Small cars, motor cycles, scooters and commercial vehicle (rickshaw, bus etc)
  • This will be applicable only upto 30 June 2014.
  • Result: cheaper vehicles, (hopefully) more people will buy more, and automobile sector will see boost in sales.

#I3: Excise: Mobile handsets

To decrease the imports of mobile phones, FM has reduced the excise duty on mobile handsets as well. How does it help?

Foreign mobile Subjected to custom duty. (But FM did not reduce it)
Desi mobile Subjected to excise duty (FM reduced it)

Result? Price wise: Desi mobile cheaper than Foreign mobile. = more sales. Import of foreign mobiles declined=> less CAD. (just like the gold logic.)

By the way, why did not FM raise the custom duty of Foreign mobiles instead -afterall, that’d also make desi phones cheaper!

Reasons:

  1. US/China may drag us to WTO
  2. Higher custom duty doesn’t decrease consumption. It only increases smuggling. (lesson learned from gold!)

So it is better to reduce excise on desi phones, than raise custom on foreign phones.

#I4: Custom Duty: soap industry

  • Rationalized the import duty on non-edible oils, fatty acids, fatty alcohols.
  • This will reduce the cost of (imported) raw material used in soap industry and oleo-chemicals industry (e.g. glycerin)
  • Results? Soaps will become cheap. (because that was the matter of life and death!)

#I5: Custom Duty: Bank note Mill

  • Bank Note Paper Mill India ltd. (Bangalore)
  • They make the special paper for producing currency notes
  • FM allowed them to import capital good (machines) @a very low duty (5%)

#I6: Counter Veiling Duty (CVD): Road machines

First, What is CVD and how does it affect sales?

Vehicle manufactured by Subjected to
Desi player Excise duty
Foreign company (and imported in India) Custom duty
  • It may happen that, desi vehicle is expensive because high excise duty on its input (chassis, engine, wiring, glass etc.)
  • Result: Foreign vehicle cheaper, juntaa more attracted to buying foreign vehicle than Desi.
  • Consequence: domestic industry gets less sales. IIP declined, job loss, industrial sickness.

Possible- Solutions:

  1. Give subsidy to desi vehicle makers
  2. Reduce excise duty on desi vehicle (and its inputs)
  3. Increase custom duty on foreign vehicle.
  4. Put additional custom duty on foreign vehicle to such a level that, [taxes on foreign vehicle] become of same level like [taxes on desi vehicle].. This solution is called counter veiling duty (CVD).

Interim budget & CVD

Import of Road construction machinery will be subjected to CVD. (= it’ll help desi manufactures, because now foreign machines will no longer be very cheap compared to desi. So road contractors/companies are more likely to be buy desi items.)

Indirect Tax collection = #EPICFAIL shortfall

Just like Direct tax collection, here also, Chindu failed to meet targets

Indirect Tax BE 2013 RE 2013 BE 2014
Excise Duties 196804 178787 199831
Customs 187308 175056 201314
Service Tax 180141 164927 215478
Total from Indirect Tax 5.65 lakh cr. 5.19 lakh cr. 616623

Observe the columns of (original) budget estimate BE2013 VS Revised estimate RE2013. Every duty collection is less than original target.

What is the shortfall in the collection of indirect taxes?

5.65 MINUS 5.19 =~45000 Crore rupees.

Why shortfall in indirect tax collection?

#1: Excise duty down

In the recent months, IIP has been going down for Consumer durables

  • Example of consumer durables: TVs, mobiles, cars, bikes, fans, ACs, refrigerators, ceramic tiles and carpets. (all these subjected to excise duty)
  • High level of inflation =>people spend less on consumer durables. (because they’ve to spend more on food and fuel.)

#2: Custom duty down

  • Duty on gold increased => smuggling => tax is evaded.
  • Policy paralysis => Big projects file pending => businessman won’t need to import any raw material/ machines/construction-vehicles etc. (Even if he wants to!) therefore custom duty declined.

#3: Service tax

  • Inflation responsible. High level of food-fuel inflation => people spend less on luxuries – hotels, spa, gym etc.
  • In fact, government knew in advance that service tax collection would be lower than target, hence they had been running ads of “Voluntary Compliance Encouragement Scheme (VCES) for service tax.” From July 2013 onwards. But still, barely ~6000 crore recovered from people who had been evading service tax payment so far.

MCQ Data for Tax collection: Ascending descending

enough of shortfalls in tax collection, we need to worry more about MCQs than about economy. So let’s update tables

Table1: Direct vs indirect

Tax BE 2013 RE 2013 shortfall BE 2014
Direct 6.68 6.36 32k 7.58
Indirect 5.65 5.19 45k 6.2
Total (lakh cr.) 12.35 11.58 77k 13.78

ya but What’s the wisdom here for MCQs? =that DIRECT tax brings MORE revenue to government that INDIRECT tax.

So far, we’ve data for Direct taxes and indirect taxes. Now for MCQs, we need the overall ranking (of which tax brings highest/lowest revenue.) Since we’ve revised estimates (RE 2013), so we can now ignore the ORIGINAL estimates of BE 2013.

Tax collection ranking revised 2013-14

Table2: Ranking Among all taxes (2013-14)

Type Taxes RE 2013
direct Wealth Tax 950
direct Securities Transaction Tax 5497
indirect Service Tax 164927
indirect Customs 175056
indirect Excise 178787
direct Income Tax 236194
direct Corporation Tax 393677

Table3: Ranking Among all taxes (2014-15)

Type Taxes BE 2014
direct Wealth Tax 950
direct Securities Transaction Tax 5992
indirect Excise 199831
indirect Customs 201314
indirect Service Tax 215478
direct Income Tax 300474
direct Corporation Tax 451005

lets make one final table

Table3: Tax collection highest to Lowest

Rank 2013 (Revised Estimate) 2014 (projected)
1 Corporation Tax Corporation Tax
2 Income Tax Income Tax
3 Excise Service Tax
4 Customs Customs
5 Service Tax Excise
6 STT STT
7 Wealth Tax Wealth Tax

Observe the rank of top two (Corpo, IT) and bottom two (STT, wealth) are same for each year.

only difference is in the rank 3-4-5 because Chindu hopes Service tax will bring highest collection among all indirect taxes in the year 2014-15. (will it? well, that remains to be seen!)

From exam point of view,

  • At the moment, Tax Ranking of 2013 is more important. (Because it is near to reality – based on actual data gathered from April 2013 to almost upto Feb 2014. this ranking is unlikely to change.)
  • While tax ranking of 2014 is just projected revenue from interim budget. It’ll change when new government makes new (full) budget (=tax rates changed= collection ranking will be changed).
  • Then you’ll have to mugup the new updated ranking accordingly. (we’ll see when full budget comes after election).

Gross vs net Tax revenue

Before going into gross vs net, let’s take two quick bites:

#1: Tax sharing

80th amendment 2000: 29% of total taxes of the Union need to be shared with states
13th FC (Kelkar)= Union to share 32% with states.
14th FC (YV Reddy): yet to give recommendation.

#2: NCCF

National Calamity Contingency Fund (NCCF)

  • Under Home ministry
  • Part of Public account (hence parliament approval not necessary.)

Now coming to the main point:

Gross Tax revenue

It includes

  1. Total direct taxes of union (we already saw)
  2. Total indirect taxes of union (we already saw)
  1. +Union territories without legislature (Diu, Daman etc.)=> their direct & indirect taxes are also counted here.

Net Tax revenue

This equals, Gross tax revenue MINUS [revenue shared with states + money sent to National calamity contingency fund]

Let’s observe the data (numbers not important.)

crores RE 2013 BE 2014
A.(Gross) Tax Revenue [=direct + indirect + UT w/o legislature] 1158906 1379199
B.MINUS tax revenue shared with States/UT 318230 387732
C.MINUS money transferred to calamity fund (NCCF) 4650 5050
NET Tax revenue=A-(B+C) 836026 986417

Ok, but why do we need to find Net tax revenue?

Because, from gross tax revenue, union has to give some money to States/UT and calamity fund=> remaining money is the “actual” money left in the hands of Union government (that they can spend as per their own wishes).

Let’s try a very cheap MCQ

Which of the following statements is/are correct

  1. In union budget, gross tax revenue is always lower than net tax revenue
  2. In the union budget, net tax revenue is calculated as the sum of [Gross tax revenue + taxes shared by States + money unspent in calamity fund]
  3. Both A and B
  4. Neither A nor B

Approach: When in doubt about gross vs. net, just count the number of alphabets in their spelling. Gross (5) and Net (3). So any formula that seems to go the other way = wrong. (e.g. observe statement B, if it were true, then NET would be higher than GROSS. Because everyhing is +…+) hence, B is definitely wrong. Same way, statement A is wrong because 5 > 3.

Side note:

Net GDP = Gross GDP MINUS depreciation.

Here also, Net (3 letters) is lower than Gross (5 letters).

So far,

REVENUE PART CAPITAL PART
Receipt Expenditure Receipt Expenditure
Tax Non Tax
  1. Direct taxes (DONE)
  2. Indirect Tax (DONE)

budget revenue part tax and non tax

Remaining columns and topics, in next articles, one by one.

Appendix

some allied topics that’d have broken the flow of the article, hence putting @bottom appendix.

#1: Direct taxes can be levied on Expenditure also

Observe the case of Service tax vs FBT:

SERVICE TAX FBT
service sector= self-explanatory- doctor, spa, hotel etc. Fringe benefit=when boss gives some facility to worker, Apart from his usual salary.
Salman himself joins a posh Gymnasium, Annual fees Rs.1 lakh (+12% service tax) Salman buys membership to a posh gym, for his bodyguard “Shera”. = 1 Lakh + 12% service tax + 30% FBT on.
paid 1,12,000 to Gym Owner. Gym owner pays 12k to government as service tax.
  • Pay Rs. 1,12,000 to Gym owner (fees + service tax)
  • Pay Rs. 30000 to government (FBT)
Hence it’s called “indirect” tax, because Salman paid the tax but government did not took it from his hand. But from that Gym owner. Called direct tax, because Salman directly had to pay FBT to government (and not to the Gym owner, not to bodyguard Shera.)
this is a tax on “expenditure” (on services) this is also a tax on “expenditure” (on fringe benefits)
still levied as of 2014 discontinued from 2009

let’s try a very cheap MCQ:

  1. A Direct tax can be levied only on the income OR property of a person
  2. Fringe Benefit tax is an example of Indirect tax.
  3. Both A & B
  4. Neither A nor B

#2: Canons of taxation: why some taxes get abolished?

Mind the spelling: “canon” (rules/principles) and not “cannon” (used for bombing).
Adam Smith gave four canons of good taxation system.

  1. Canon of Equality: taxes should be Proportionate to income.
  2. Canon of Certainty: about deadline and rates.
  3. Canon of Convenience: to the tax payer.
  4. Canon of Economy: tax collection cost should be minimum. (i.e. staff salary, Database Management)

+ Misc. principles: – transparency, simplicity, elasticity (to economic fluctuation) etc.
ya but where is it relevant? Recall that government abolished certain direct taxes (estate duty, gift tax etc.) in past. Why? Because, they were not following some of these canons. for example

Gift tax (abolished)

Most people managed to evade. Hence Gift tax used to fetch barely ~10 crores in revenue. Thus, fourth canon missed. (Collection cost very high- staff salary and database Management.)
Finally, in the late 90s, government dropped this tax. Although it doesn’t mean there is no tax on expensive gifts- they’re counted under Taxable income (of the person who receives the gift)

Estate duty (abolished)

  • Estate duty was charged during the “inheritance” of estate. (although this was a Union tax- entirely cash was given to states.)
  • Problem: most people evaded, Estate duty Barely fetched ~15 crores = Again 4th canon missed.

Hotel Receipt Tax (abolished)

  • In the late 80s, we did not have service tax. But government imposed tax if you spent money on luxury hotels. (direct tax- because you had to pay this tax to government and not via hotel owner)
  • problem: same as above. barely fetched a few crores.

Banking cash transaction tax (Abolished)

  • introduced in 2005:
  • 0.1% on cash withdrawals of more than Rs 50,000 (individuals) and Rs 1 lakh for others in a single day from non-savings bank account.
  • Why? to track unaccounted money and trace its source and destination.
  • Abolished in 2009, when Chindu felt he had fetched enough information.
  • Although indirectly the canons were also responsible: #1, #3 and #4.

Fringe Benefit tax (Abolished)

2005 Chindu started FBT
2009 Pranab abolished FBT
  • Compliance cost was very high (Because company would need to keep record and acount of every little fringe benefit they gave to employees)
  • in other words, inconvenience to tax payer (company)=> it was even called “nuisance tax”. Therefore, 3rd canon missed.
  • Besides, revenue collection was ~8k crore. and company would pay less salary to employees in pretext of giving those fringe benefits= employee’s pay less income tax. so indirectly, government was axing its own leg. (Recall our MCQ tables: income tax is the second largest source of revenue for union government!)

Mock Questions
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