From Business World of 15 May 2005.
A Year of Chidambaram
Long ago I watched P Chidambaram from close by; what I saw
filled me with enormous respect for him. I found him highly intelligent; in a
government full of nondescript characters, he was a breath of fresh air. I
found him wanting to learn; amongst politicians who either did not know they
needed to learn or were too afraid to ask, he surprised me. He put in an
enormous amount of work; although he had already arrived, he had no inclination
to rest on his oars. And he went into detail; in our system of government that
was most unusual for a minister and deeply unsettling for many of his
bureaucrats. These were my impressions; they were not the impressions of
everyone. In particular, he was reputed to have a short fuse, and was known to
lose his temper with civil servants. I myself consider losing one’s temper as a
form of defeat; but as I waded through the quagmire of futility that is our
government, I had some sympathy with him.
Given this extraordinarily high
opinion that I have of him, I was bound to be disappointed by his performance,
and so I have been from time to time – including in the past year. For
Chidambaram has collected a bright team of economists in the finance ministry.
Rakesh Mohan is a bit impatient with macro, which I think is the heart of the
finance ministry; but his heart is in the right place. Parthasarathy Shome
built up a towering reputation helping other countries reform their fiscal
systems before he ended up in the finance ministry; so it is not wrong to
expect miracles from him. Ajay Shah is, in my view, unduly sold on modern
neoclassical economics and has no sense of structural factors. But he is bright
– he is so much brighter than I as Vijay Kelkar once said – and on things he
cares about, such as pension systems, he is more than right. Of Ashok Lahiri I
have a less clear picture as an economist; but he is not known to make
mistakes. If used in the right fashion, economists working together keep one
another from going astray. So if only Chidambaram could use his team, if he
would make them argue things out before him, if he would make them reach a
consensus and if not, explain wherein they disagree, he would have an
unbeatable team.
As it happened, the team was
beaten hands down. The introduction of the value added tax could not have been
more messy. Major states did not join. Traders went on strike after strike. So
as not to provoke them, state governments kept sales tax officials from
checking traders’ accounts. Despite three years of preparation, VAT rates
differ across states, giving obvious opportunities for arbitrage and causing
large shifts in economic activity. Above all, VAT cannot work without a
seamlessly interconnected electronic accounting system. The system was not
introduced; worse still, sales tax officials in many states do not even know
what such a system would be. So the VAT will not fail; people will just not
know whether it failed or succeeded, and how much better it could work. It will
not be demonstrably better than what preceded it.
I would not be surprised with the
finance ministry shook off the blame for this. For introduction of VAT was
state governments’ responsibility; if it fails, it is their failure. This
argument is not entirely valid. They will bear the consequences of failure. But
the finance ministry had almost 20 years’ experience of its own VAT; the
simplest thing for it would have been to impart its own experience, and stop
the states from making elementary mistakes. What alarms me is the unwillingness
to be proactive, to be responsible, to take pride in a job well done. It was
the comfort in mediocrity that used to depress me most in the government;
seeing the VAT imbroglio, I feel nothing has changed.
Chidambaram has presented two
budgets as UPA finance minister. The first was nothing to write home about, for
obvious reasons. The previous NDA government had already presented a budget
four months before without calling it one, and only eight months were left
before the next one. So apart from finding some money for UPA’s hobbyhorses –
notably the employment creation programme – Chidambaram did not do much in the
first budget.
The trouble he got into over the
second budget is still fresh in public memory. It was not a bad budget; in
particular, what he did to simplify tax treatment of savings was admirable. So,
in my view, was his reduction of corporation tax – although it would have made
better economic sense to equalize the corporation tax rate and the peak income
tax rate instead of leaving the former slightly higher. But what good he did
was completely lost in the noise over two new taxes he introduced. One was a
tax on cash withdrawals from banks over a certain limit. The other – called the
fringe benefits tax – was taxation of company expenditure on personnel which
could not be attributed to individual employees. The first drew ire from the
entire urban middle class, and was so reviled that Chidambaram changed it into
something utterly different. He shifted the tax from savings accounts, which
most middle class individuals keep their money in, to current accounts, which
only businesses use; and he raised the limit over which the tax would have to
be paid. The reason he gave for the tax – that it would enable the ministry to
track black money transactions (that is, transactions on which tax is evaded) –
was specious. Cash is not essential to black money; I am not even sure that it
is a major component. Most tax evasion is done with bogus accounting entries
and bribery of tax officials. And the tax actually gives all concerned notice
that their transactions will be watched, and gives them ample chance to cover
their tracks. This move is so stupid that I cannot understand how a man of
Chidambaram’s intelligence could ever countenance it.
The fringe benefits tax is somewhat
more defensible. The basic point is that pay and perquisites must be taxed
somewhere; actually, they are deducted from corporate revenue and therefore
exempt in companies’ hands, but are taxed as personal income in employees’
hands. A company may spend money on employees which cannot be seen to benefit
them individually – for instance, on a club for them, or on a corporate tour.
Should such expenditure be taxed? If one wants to be consistent, yes; but if
one wants to keep the system simple and to minimize discretion amongst tax
officials which increases their power to harass and mulct, the answer would be
no. Wilting under corporate pressure, the finance ministry made the fringe
benefits tax even more complex than it need have been – it introduced a long list
of taxable benefits, some of which are going to be quite difficult to estimate;
and for each it had an arbitrarily fixed proportion of expenditure that would
be taxed. Not to mention that the tax itself is not the corporate tax rate but
a new, invented one. It is so complex that perhaps only Chidambaram could have
invented it – or could think that it is practicable.
So naturally I am disappointed
with Chidambaram’s performance in the first year – and I do not believe
explanations that would shift responsibility to others. But that does not
diminish my respect for his intelligence or my hope in his ability. I shall
continue to hope for quite some time longer that he will do reforms that no
other finance minister could.
