Report to the President of the International Bank for Reconstruction and Development and the International Development Association on India's economic development effort (Vol. 9 of 14) : Problems of public financial policy

 This Volume, No. M y and Volume X deal with Financial Policy. Volume I X was prepared by M r . Stanley Please and Volume X by Mr. Atle, Elsaas. They are based on study i n India i n the period October 1964 t o March 1965. Since t h a t date a few minor e d i t o r i a l changes have been made but there has been no substantive revision o r updating.  . . . OF COnTiEITTS TABLE SUI4lIARY AWD CONCLUSIOlJS ........................................... i A. 'The Groxth of Union Goverrm-ent Tax Revenue .................. i B. Evaluatiori of F i s c a l Performance ............................ i C . Company Taxatlon and t h e Obstacles t o Growth ................ vi D . The Supply of Risk C a p i t a l t o t h e P r i v a t e Sector ............. x E . The Financing of S t a t e Expenditure .......................... fii A . 1ntroduc.tion ............................................ B . Quantita.tive Clutline of Union Tax Revenue Growth ........ C . The Buoyancy of Tax Revenue ............................. a. The Buoyancy of Aggregate Union Taxation ............ b. The Buoyancy of Union Excise Duties ................. c. The Buoyancy of Personal Income Tax ................. d . The 3uogancy of Corporation Tax ..................... A . Revenue Performance i n Vacuo ............................ B . Revenue Performance i n R e l a t i oil t o 3 u d ~te r y Requi ~enlens a t C. F i s c a l Performance i n Relation t o Development Requircnierlts 1 . Introduction ........................................ 2 . The Foreign Fxcllaxge Eottlenec!; ..................... 3 The Food SuppJy Bottleneck .......................... 4. Concluding Remarks .................................. I11 . COWANY T a A T I O N AND THE OESTACLES GROWTH ................ A. Introduction ............................................ B. Rates of Tax on Company P r o f i t s......................... C. Tax Concessions t o Coixpanies ............................ D . The Conplexity of Con?an.y Taxation ...................... E . ..................... The Variabilit:y- of Co~ilpanyT a x a t j on  F . Company Taxation i n t h e Light of Certain i'lajor Obstacles G Growth o .................................... . 1 Increasing Productive Capacity ....................... 2 . 'Fkie u t i l i z a t i o n of Capacity .......................... 3 . b v a i l a b l l i t y of Equity C a p i t a l ....................... I V . TFX SUPPLY O iUSK CAPITAL TO TEE PXVATE SECTDS ............. F A . The Problem .............................................. B . The P a t t e r n of Corn~~any Firlance ........................... C . The Equity iinrket ........................................ D . Nw I s s u e s ............................................... e % . Policj; Neasures .......................................... A . The categories of S t a t e Ikq~enditure ...................... 1 EZevenue Account and C a p i t a l Account &-penditure ...... . 2 . Developnient and Mon-T)cveloginent Expen& t ure .......... 3 . Plan and ilron-Fl-an Expenditure ........................ I3 . Variations i n t h e Total and i n t h e Co:.rposition of S t z t e Financing .........................................a C . The Financing of S t a t e Expendi.ture ....................... 2 . The Taxation of Agriculture ............................... . I r o c e d ~ r r ef o r Determining t h e P a t t e r n of S t a t e Finarlcing . 1 The iXmnce Conu!.nission ................................ . 2 Planning Commission ................................... . 3 Fi~~arlce ;!inistry ...................................... F . ...................................... Determination of Volurae. P a t t e r n and Form of Center Aid t o t h e S t a t e s 1 . Determination of T o t a l Volume of Center Funds ..........DD... ............... Transferred t o S t a t e s .. 3. 2. 4. Determination of S t a t e D i s t r i b u t i o n of Center Funds S p e c i f i c versus Non-Speci2ic Center Assistance Conditional versus U~lconditior~al Cen%er Assistance ....... ...  A. The Grovth o f Union Government Tax Revenue 1. The t a x performance of the Union Goverm~entover t h e l o n g e r p e r i o d o f planned development s i n c e 1951 and more p a r t i c u l a r l y over the p e r i o d of t h e Third P l a n s i n c e 1961 has been impressive : a n average annual i n c r e a s e in revenues s i n c e 1951 of 10 p e r c e n t p e r annum and an average i n c r e a s e of 18 p e r c e n t p e r annurn over t h e p a s t f i v e years. Union e x c i s e d u t i e s and. conpany tax- a t i o n have been t h e most buoyant t a x e s throughout t h e p e r i o d b u t i n rece:it y e a r s customs d u t i e s have a l s o k e n i n c r e a s e d and the revenue frorr. them has r i s e n v e r y a p p r e c i a b l y p a ~ t i c u l a r l ya s compared with i t s behavior i n tine 1 9 5 0 ' s when it had been v i r t u a l l y stagnant. Personal incone t a x h a s keen t h e l e a s t buoyant o f t h e major tax l e v i e s . 2. IJe have attempted to analyze the buoyancy o f Union Taxation i n t e r n s o f t h e b u i l t - i n e l a s t i c i t y of the t a x s t r u c t u r e a s opposed to auto nor lo:^^ i n c r e a s e s i n t a x r a t e s and coverage. Despite the s t a t l s t i s a l d i f f i c u l ' t i ~ s involved and t h e problem of divorcing the e f f e c t on t a x revenues of changes i n r e a l income from changes i n money iiicome, th.: a n a l y s i s tends t o c0nfi.m -r t h e e s t i m a t e of f u t u r e revenue a t unchanged t a x r a t e s a s made 'Dy the ~ n d i a n Working Group on F i n a n c i a l Resources f o r the Fourth Plan. T h i s Group estima- t e d an annual r a t e of i n c r e a s e of 8.5 p e r c e n t ir. t o t a l Union revenues. % i s f i g u r e and o u r o+m c a l c u l a t i o n s a r e based oil p a s t e w e r i e n c e and the-ref o r e e L e y probably e r r on t h e low s i d e . This i s because the changes i n the t a x s t r u c t v - r e which have been i n t r o d u c e d s i n c e 1951 have n o t o n l y ir,c=.eased t h e g e n e r a l l e v e l of t a x a t i o n b u t a l s o its b u i l t - i n r a t e of growth. T'nis Is most c e r t a i n l y %me i n t h e case of Union e x c i s e d u t i e s . It was a l s o t r u e of company t a x a t i o n thotxgh the two 1965 budgets have e f f e c t i v e l y and s i g n i f i c a n t l v reduced marg-kal t a x r a t e s . Personal income t a x a t i o n has been t h e most d i s a p p o i n t i c g t a x i n r e g a r d to i t s b u i l t - i n e l a s t i c i t y . This has a r i s e n o u t of the d i s % i n c t i v e f e a t u r e s o f t h e t a x r a t e s t r u c t u r e which a r e t h a t it imposes very high r a t e s of t a x !~pon the high income groups b u t very low r a t e s f o r those vho comprise the Iridian middle c l a s s . There has been a d e c l i n e i n the nw.Ser o f -incomes s u b j e c t t o t h e high r a t e s o f t a x and in both t h e t o t a l and t h e t a x c o n t r i b u t i o n o f t h e s e incolres. This r e f l e c t s mainly an i n c r e a s e i n t a x evasion and avoidance. Ts'hilst t h e d e c l i n e i n t a x revenue has been o f f s e t by t o t a l t a x p a ~ p e n t sby rr,iddl-e income r e c e i v e r s the o v e r a l l buoyance o f the t a x has been undermined. W be- e l i e v e t h a t a n i n c r e a s e i n t a x r a - t e s on t h e middle income groups i s both possi'ole and d e s i r a b l e . The g r e a t e r s i m p l i c i t y introduced i n t h e 1965 budget ca:1 be welcomed b u t it was accompanied by very s i g n i f i c a n t reductions L i r a t e s r.!h.ich we r e g a r d a s a cause f o r concern. The 1956 budget has lhtroduced a 13 p e r c e n t surcharge which has had the e f f e c t i n conbination with increased. a l l o x a ~ c e sof s l i g h t l y i n c r e a s i n g t a x payments on incomes o f R s . 7,400 and above. B. E v a l u a t i o n of F i s c a l Performance 3. Center t a x revenue has i n c r e a s e d from 5.1 p e r c e n t o f n a t i o n a l incore i n 1951-52 t o 6.2 p e r c e n t i n 1960-61 and 9.4 p e r c e n t i.n 1 9 6 3 4 . This has implied a margiinal r a t e of Union t a x a t i o n o f 23 p e r c e n t over t h e f i r s t t h r e e y e a r s o f t h e Third Plan and o f about 37 F e r c e n t i f allowance i s made f o r t h e i n c r e a s e i n population over t h i s p e r i o d - i.e., i f we r e l a t e the i n c r e a s e in p e r c a p i t a tax payments over t h e period to the i n c r e a s e i n F e r c a p i t a incone.  If S t a t e t a x a t i o n i s i n c l u d e d ( t h i s i s d i s c u s s e d l a t e r in tine Report) the t a x revenue/^^^ r a t i o i s a i ~ u n c l13 p e r c e n t . I n d i a s t i l l ranks, d e s p i t e h e r . e f f o r t s and f o r what, t h e u n q u a l i f i e d w n p a r i s o n i s tmrGi, a s average-to-low i n t h e i n t e r n a t i o n a l comparison of tax l e v e l i n r e l a t i o n t o n a t i o n a l -kcolre. T h i s r e f l e c t s b o t h h e r p o v e r t y and. t h e low l e v e l of t a x a t i o n from which he s t a r t e d h e r program of planned development. i 4 . More s i g n i f i c a n t i s t h e r e l a t i o n s h i p o f t a x performance to budgetargr reauirements. Here t o b e g i n w i t h w e n o t e t h a t %lie Government h a s p e r s i s t e d i n . # I u s i n g i t s conver,tional budget p r e s e n t a t i o n i n a n a l y z i n g Vie f i n a r i c i a l impact of i t s o p e r a t i o n s and t h a t f o r 1965-66, f o r -instance, t h i s pernritut,ed it t o c l a i m t h a t i t s o p e r a t i o n s i n t h e ensuing f i s c a l . y e a r would r e s u l t I n a budget s u r p l u s o f Rs. 4 c r o r e s whereas t h e y would i n f a c t be e x p a n s i o ~ a y yt o t h e e x t e n t o f o v e r Rs. 850 cr3res.V T h i s l a t t e r amount measures simply t h e e x t e n t t o which Government e - q e n d i t u r e , o r payments to t n e p u b l i c and abroad, s x c e e d s - Government r e c e i p t s ( t a x e s and borrowing) from t h e i n t e r n a l p c b l l c . ~ : ~ c l u d e d from t h e r e c e i p t c a t e g o r y a r e borrowings from the Reserve Bank and l o a n s and g r a n t s from abroad. It i s n o t n e c e s s a r i l y t h e c a s e t h a t t h i s misleadjr,!: p r e s e n t a t i c n h a s k f l u e n c e d p o l i c y . However, t h e f a c t t h a t f o r t h e f i r s t time d u r i n g t h e p e r i o d of planned development t h e budget p r o p o s a l s i n t r o d u c e d i n Piarch 1965 were expected t o r e s u l t in a n e t r e d u c t i o n i n t a x revenue, was n o t , w f e e l , u n r e l a t e d to t h e f a c t t h a t t h e c c n v e n t i o n a l b u t m i s l e a d i n g p3senta- e t i o n i n d i c a t e d t h a t t h e budget was more than balanced and t h a t t h e r e f o l ~some r e d u c t i o n i n t a x a t i o n was p o s s i b l e . 5 The main f e a t u r e of t h e budget p i c t u r e i s t h a t d e s p i k t h e app- xi- mate d o i ~ b l i n gof Union c u r r e n t income between 1963-61 and 1964-65 iqhich r e p r e - s-?nted, an i n c r e a s e i n income o f o v e r R s . 900 c r o r e s , Cavernment s a v i n g i n c r e a s e d b y a mere Fls. 44 c r o r e s above i t s 1960-51 l e v e l of Rs. 68 c r o r e s . Ele primary cause of t h i s poor response of Govemxent s a v i n g t o i t s t a x e f f o r t i s to be found, of c o u r s e , in t h e i n c r e a s e in c u r r e n t e;:pendi ture which Z z i t s t u r n i s a r e f l e c t i o n predominantly o f a t h r e e - f o l d i n c r e a s e i n d e f e n s e e q n d i t u r e . If defense e x p e n d i t u r e had r i s e n o v e r t h e p e r i o d fm.2 1963-61 o n l y a t tile same r a t e a s non-defense e x p e n d i t u r e , Gove,ment s a v i n g t : ~ u l d have amounted t o w e l l over Rs. 500 c r o r e s i n 1964-65 i z s t e a d o f a mere Rs. 112 c r o r e s . h s such it would have r e p r e s e n t e d a k n o s t 3 p e r c e n t o f n a t i o n a l income i q s t e a d o f t h e 0.6 p e r c e n t of n a t i o n a l income which t h e C e n t e r Gov?mrnent, i n of f a c t c o n t r i S u t e d t o t h e f l o ~ r t o t a l s a h g s . T h i s r a i r e s the quest,ion wllether t h e t a x e f f o r t would have been made b u t f o r t h e Chinese emergency and riore W emphasize t h a t t h e tern lle_xpansionarylli s used h e r e i n a s t r i c t i l y de- e s c r i p t i v e sense. U n f o r t u n a t e l y t h e term i s f r e q u e n t l y t a k e n t o be s7pono- mous p i t h l l i n f l a t i o n a r y " and l i k e t h a t term and i t s antonym Ifdeflation2ry1l i s t a k e n to be a v a l u e judgment. A s t h e subsequent a n a l y s i s irldicat.ns, however, we c e r t a i n l y do - v i s h expansionary to be i g t e r p r e t e d h e r e a s not n implying t h a t t h e p o l i c y i s i p s 0 f a c t o u n d e s i r a b l e . O t h e cont,rary an llexapansionaryl' f i s c a l o p e r a t i o n is, i n many circumstances, a s i s now wide- l y acknowledged a p p r o p r i a t e and -hdeed e s s e n t i a l . The i s s u e i s orlly whether i n the p a r t i c u l a r circumstances t h e degree t o which f i s c a l opera- t i o n s a r e expansionary o r t h e r e v e r s e i s a p p m p r i a + ~ . Judgment on this issue i s obviously f a c i l i t a t e d i f the presentation of the f a c t s c l a r i f i e s r a t h e r t h a n o b s c u r e s t h e measurenent o f t h i s degree. fundamentally r h e t l i e r t h e a l l o c a t i o n of n e a r l y 5 p e r c e n t o f i t s n a t i o n a l income and 45 p e r c e n t of c e n t r a l g o v e m n t c u r r e n t r e c e i p t s to d e f e n s e i s c o n s i s t e n t w i t h t h e achievement o f the development aims which I n d i a has s e t i t s e l f i n the p a s t and f o r t h e f u t u r e . 2 - q e r i e n c e t o d a t e does n o t demonstrate such c o n s i s t e n c y . It i s c e r t a i n t h a t t h e p r e s e n t burden of defense n e c e s s i t a t e s f a r g r e a t e r f i n a n c i a l m o b i l i ~ ~ a t i oen f o r t s b y the S t a t e s and t h e p u b l i c e n t , e r - f p r i s e s i n t h e f u t u r e t h a n i n t h e p a s t and t h e s e i n v o l v e both p o l i t i c a l and economic d i f f i c u l t i e s which c a n n o t be l i g h t l y overlooked. A t t h e moment t h e f i n a n c i a l t r a n s f e r s to t h e S t a t e s and t o t h e autoliomous p u b l i c e n t e r p r i s e s i dominate b o t h t h e t o t a l amount o f c a p i t a l e x p n d i t u ~ n t h e C e n t e r ' s 3udg;et 2nd t h e i n c r e a s e 5rhich has o c c n r r e d o v e r time. They have been r e s p o n s i b l e , along w i t n t h e i n c r e a s e in c u r r e n t government e x p e n d i t u r e , f o r t h e v i r t u a l doubling o f t h e Government's e x p e n d i t u r e s u r p l u s fmm over Rs. 600 c m r e s i n 1960-61 t o about 2s. 1,200 c m r e s in 1964-65. 6. The Gov2rnment h a s succeeded in m o b i l i z i n g a c o n s i d e r a b l e .volume o f domestic s a v i n g s f o r h e l p i n g to finance i t s d e f i c i t . These s a v i n g s a r e v e ~ y l a r g e l y channeled through t h e i n s t i t u t i o n s ( p a r t i c u l a r l y t h e L i f e Insurance C o r p o r a t i o n and t h e P r o v i d e n t F'unds) x h i c h a r e o b l i g e d t o i n v e s t a p a r t o r (i:l t h e c a s e o f t h e P r o v i d e n t S o c i e t i e s and o t l e r t m s t f u n d s ) Yne whole of t n e i r funds i n Government s e c u r i t i e s . T h e i r volume has v z r i e d c o n s i d e r a b l y from y e a r t o y e a r and l i k e w i s e t h e p r o p o r t i o n o f t o t a l Center c a p i t a l exper1d.i- t u r e r,dnich t h e s e funds have covered has v a r i e d fmrn l i t t l e more t h a n 20 to 25 p e r c e n t t o a s high a s 33 p e r c e n t i n 1963-64. 7. It i s a p p a r e n t + h a t tlie Governnentls f i s c a l p o l i c y i s 5 0 t h marked- l y expansionary and, t h a t i t s expansionary e f f e c t h a s i n c r e z s e d considera3l.y i n t h e l a s t h a l f of t h e T h i r d P l a n p e r i o d a s compared w i t h t h e f i r s t h a l f . The c r u c i a l q u e s t i o n , however, i s whether t h e growth perfcmance o f t h e Indian economy could have been improved by a markedly d i f f e r e n t f i n a n c i a l p o l i c ~ . This g e n e r a l q u e s t i o n c a n be broken down i n t o a s e r i e s of f u r t h e r q u a s t - h n s ; e . g., would f u r t h e r t a x a t i o n o r f i n a n c i a l m o b i l i z a t i o n g e n e r a l l y have peY.-n!itctd an i l l c r e a s e i n investment: Could investmerlt have been f z c r e a s e d ~ r i t h o v - tany f u r t h e r i n c r e a s e s i n t a x a t i o n ? :;hat e f f e c t rnrould a more e x p a n s i o ~ a q rp o l i c y have had on t h e g e n e r a l l e v e l o f p r i c e s ? Has the i n f l a t i o n o f t 5 e p a s t 18 months been t h e outcome o f a n over-expansionary o r insv.fficien+,ly restl-'.ct,ive p f i ~ a n c i a l o l i c y ? Was there, and i s t h e r s s t i l l , u l t i m a t e l y a choice tc I= made between s t a b l e p r i c e s and growth o r a r e t h e y c o n s i s t e n t w i t h each o t k r and under what circumstances w i l l +&is consistency a r i s e ? 8 . I n a n a l y z i n g t h e s e q u e s t i o n s we r e j e c t t h e a g g r e g a t i v e concep-5s f r e a u e n t l y used f o r t h i s purpose w i t h t h e i r i m p l i c i t assumption o f a t e q 7 h i g h degree o f f l e x i b i l i t y i n t h e patt::rns and use af a v a i l a b l e o u t p u t . In f a c t i n I n d i a two b o t t l e n e c k s e c t o r s i n t h e p a t t e r n o f s x p p l y s t a n d o u t oinove a l l o t h e r s . These a r e t h e f o r e i g n exchange b o t t l e n e c k and t h e a g r i c u l t l l r a l bottlenec!;. V h i l s t c o n c e p t u a l l y t h e s e two can be t r e a t e d a s r a j - s i n g t h e same g e n e r a l problems i n r e l a t i o n t o t h e expansion of d o n e s t i c monetary demand, t'ney r a i s e markedly d i f f e r e n t i s s u e s from t h e p o i n t o f view of f i n a n c i a l policy. 9o The f o r e i g n exchange problem i s p r i m a r i l y a problem i n r e l a t i o n to the l e v e l o f investment expenditure rrrhich siiould be aimed a t . Has the l e v e l of investment been too high i n t h i s regard and thus l e d to an undue s t r c i n on the economy? The argument t h a t i t s l e v e l has n e c e s s i t a t e d administrative c o n t r o l s over f o r e i g n exchange i s i r r e l e v a n t given t h e f i x e d r a t e of es:change. With a higher exchange r a t e tbe n e c e s s i t y f o r t'nese c o n t r o l s cou1.d b obviatkd.e Furthermore, t h e a v a i l a b i l i t y of f o r e i g n exchange f o r financing the d i r e c t import requirements f o r investment p r o j e c h has n o t been a major problem, f o r public and p r i v a t e funds from overseas could in t ? i main be found f o r p r ~ j e c t s brought to the stage of planning a t whlch t h e i r financing could t;e cc~sl;."e-red. The c r u c i a l a s p e c t of the problem i s t h e r e f o r e wkietker inves.Lment derr.and. upon t h e output of domestic c a p i t a l goods s u p p l i e r s and o f the ccnstruciion, t r a n s p o r t and o t h e r s e r v i c e s required f o r i n ~ e s ~ e has been tor-, high ;:i~rzri nt t h e r e s t r i c t i o n on t h e output of these s u p p l i e r s imposed by the shortage of f o r e i g n exchange f o r so-called maintenance imports. Such an exsess2.ve l e v e l of demand would be r e f l e c t e d in a general 1engtilenir.g o f p r o j e c t const,r~:ction periods due t o delays i n domestic procurement, i n r i s e s i n the p r i c e s of domestically produced c a p i t a l goods and i n the need f o r i n c r e a s i s g l y severe c o n t r o l s on the a l l o c a t i o n o f domestic i n p u t s t o meet investment demand, Un- doubtedly, a s the Mission1s i n d u s t r i a l team has emphaslzed., p r o j e c t cocstruct- ion periods i n I n d i a ' s public s e c t o r have been i n o r d i n a t ~ l ylong and ;:.rites of the domestic goods end sei;srices required have riseri. I n i t s a n a l y s i s of these delays and c o s t i.ncreases major e m ~ h a s i si s giTren t o problems r 2 l a % i : i ~ O t o p r o j e c t planning, changes i n p r o j e c t s during t h e i r er,ecu%ian, changes in f i n a n c i a l arrangeiwnts, manage r i a l problems, e t c . IGbiere delay due to domestic pro-urement i s discussed, problerns o t n c r than those arisir,g direct;-y o u t cf t h e s h o r t ~ g eof maintenance imports f o r suppli9x-s a r e zmph2sized. However i t i.s made c l e a r t h a t p a r t o f the d i f f i c u l t y has stemmed fron; thl.s l a t t e r cause; t h a t supplies of c a p i t a l goods and o t h e r dornes-tic i q u t s required to meet investment demand have been held up and have r i s e n i n p r i c z dce to i n a b i l i t y t o meet a l l demands imposed upon them xhich i n iCJs -tu.i"n has r.c.,sul+~d, i n t e r a l i a , from an i n a d e q u a t ~supply of f o r e i g n exchange f o r s-,a=s, e s s e n t i a l imported components, e t c , F u r t h s r m o ~ ,bot,h the pressure on %he i r i f e r n a l m a t e r i a l s c o n t r o l system and much of the r i s e i n the p r i c e s of dornes.t;,callg supplied i n p u t s , i s evidence o f market imbalance i n these sectors. It does not, ho%rever, appear to us t h a t investment demand was g r o s s l y excessive. Some reduction would have permitted a s l i g h t l y increased r a t e of p r o j e c t implement<ation and would have r e l i e v e d sorne of the pressure on the c o n t m l system and on p r i c e s - However, the main errrphasis o f our argument i s t h a t the d i f f i c u l t i e s were mainly on the supply s i d e of the problem and were .;lot i n e v i t a b l e . It i s our view that, the l e v e l of i n v e s t i m t demand which the l government promo +kd t ~ o ud c e r t a i n l y have been more within the bounds of t h e foreign exchange c o n s t r a i n t on domestic procurement i f the t o t a l foreign 2x- change resources had been b e t t e r a l l o c a t e d - s p e c i f i c a l l y if Inore of the t o t a l had been a l l o c a t e d to the provision of so-called mainterlance imports and i f the a l l o c a t i o n had been more e f f i c i e n t . ::Je c i t e the inadequacy of maintenance b p o r t s simultaneously with the existence of l a r g e unused o r slow- l y used a i d commitrr;ents and p o t e n t i a l commitments. In p a r t t h i s i s a question of the t y i n g o f foreign exchange by l e n d e r s and aid-givers t o p a r - t i c u l a r purposes and comnodities. In f a c t it i s a matter o f the whole system of i q o r t c o n t r o l s which has been the s u b j e c t of a separate s k d y by the mission.&/ Had t h e d i s p o s i t i o n of f o r e i g n exchange been improved by l a r g e r a n d more e f r i c i e n t a l l o c a t i o n t o s o - c a l l e d malhtp,nance imports, it i s s t i l l p o s s i b l e t h a t investmerit aemmd ~ r o u l dhave Seen e x c e s s i v e w i t h o u t a n a b s o l u t e i n c r e a s e in t h e t o t a l volume o f f o r e i g n exchange. Our u l t i m a t e judgment, t h e r e f o r e , on t h i s m a t t e r depends on what we t a k e a s given. I f no change in t h e f a c t o r s b e a r i n g on t h e su?ply o f domestic c a p i t a l goods and. r e l a t e d s e r o i c e s i s assumed t o have been p o s s i b l e t n e n sone r e d u c t i o r , i n i n v e s t m e n t demand would have been d e s i r a b l e . On t h e o t h e r hand: i f t h e a l t e r n a t i v e p g l i c y measures to i n c r e a s e t h e s u p p l y and improve t h e u t i l i z a t i o n o f ;Icrej.gn exchange f o r maintenance i m p o r t s were a t a l l f e a s i b l e by d e c i s i 0 r . s o f bot,h t h e a i d - g i v e r s and t h e Govsrnment o f I n d i a , t h e n we would s t r o n g l y argue t h a t any r e d u c t i o n i n i n v e s t m e n t demand should be t r e a t e d a s t h e l e a s t desirable alterna ttve. 10. An i n c r e a s e i f o r e i g n exchange f o r meeting -investment demand l r d c c u l d c o n c e i v a b l y be achieved by r e d u c i n g ~ e r s o n a l i s p o s a b l e incone and t h u s t h e irnport r e q ~ i r e m e n t sf o r producing consumer s u p p l i e s . 3oriev2r t h e import c c n t e n t of consumer demand i s low - a b o u t J! . p e r c e n t on average t,l?ougrh p m b a b l y h i g h e r a t t h e ma-gin. n A u n s e l e c t i v e p o l i c y ~ r c ~ u l dt,h e r e f o r e , have t o aim a t r e d u c i n g consumer incomes veyy n a r k e d l y in o r d e r to e f f e c t a g i v e 2 s a v i n g i n f o r e i g n exchange and we wculd e x p r e s s doubts a s t o how f a r it i s ie d e s i r a b l e t o push sucli a p o l i c y . Tl ~ ~ o u however urge c o n t i n u i n y d 9 s c i y l i n e ld t o e n s u r e t h a t s e l e c t i v e measures a r e taken t o d i s c o u r a ~ ecor,sumpt!.on ?avi=lg a high i n d i r e c t a s w e l l a s d i r e c t i m p o r t c o n t e n t . This a l s o a p p l i e s v l t h e q u a l f o r c e to s e l e c t i v e measures aimed a t r e l e a s i n g s u p p l i e s f o r e,-?o?ts i n those c a s e s where t h e o b s t a c l e to e x p o r t i n g i s p n y s i c a l avail-ability and n c t p r i c e , ove-rseas demand, e t c . (e.g., v e g e t a b l e 0 5 1 s ) . 1 . 1 'The second b o t t l e n s c k to t h e expansion o f domestic demand -i s % h a t o f food supply. bihat needs t o be judged i n t h i s r e g a r d i s bethe her i.ndia~i p o l i c y h a s been t o o e x p a n s i o n a ~ yi n r e l a t i o n t o t h i s s u p p l y c o c s t r a i n t . W h i l s t t h s r i s e i n f o o d g r a i n p r i c e s i n 1963 t o alrproximately 25 p e r c e n t above t h e l e v e l o f t h e p r e v i o u s decade and t h e i r subseouent r i s e t o a p ~ r o s i - m a t e l y 5 0 p e r c e n t above t h i s l e v e l , s u g ~ e s ti n s u y f i c i e n t r e d ~ z c t i o ni n p e r s ~ n a ld i s p o s a b l e incone, t h i s prima f a c i e evidence i s n o t c o r v i n c l n y . To b e g i n w i t h t h e short-m.n e l e m e n t i n t h i s p r i c e r'ise can effectivel-J be d e a l t w i t h o n l y , a s t h e N i s s i o n ' s A g r i c u l t u r e R e p o r t makes c l e a r , b y b i l f f e r s t o c k o p e r a t i o n s . PIore i m p o r t a n t l y , however, it i s t h e y~iewo f t h e a g r t c u l t u - p a l team t h a t t h e n e c e s s a r y r i s e i n t h e t r e n d r a t e o f growth i n a g r i c u l t u r e firm around 3 p e r c e n t t o b.5 o r 5 p e r c e n t p e r y e a r can o n l v be induced i f , --3al lt uar a l t P e cterms r o f inproved.f t h e a g r i c u l t u r a l s e c t o r ysis-a-ris the non- inter agricu i se tor a e trade o Wfiilst t h e c r i s i s p r i c e s f c r food may perhaps have been t o o high t h e team's view i s c e r t a i n l y t h a t a l e v e l c o ~ s i d e r - a b l y h i g h e r t h a n t h a t e x i s t i n g from t h e mid-1950's t o 1902-63 i s r e q u i r e d if adequate i n c e n t i v e s t o i n c r e a s e d o u t p u t a r e t o be g i ~ r e n . \<hi:-st a c h a r ? ~ e i n t h e t e r m s o f t r a d e could i n p r i n c i p l e be brough'c a b o u t by a r e d l l c t i o ? in non-a - r i c u l t u r a l p r i c e s , t h i y i s n o t c o n s i d e r e d - n g e n e r a l e i t h e r r e a l i s t i c i o r desirable. &/ See Report by J e a n Baneth: " P h y s i c a l C o n t r o l s on Resource A l l o c a t i m s and Investment". 12. The danger is, on t h e c o n t r a r y , t k a t t h e impro-red terms o f t r a d e o f a g r i c u l t u r e s i n c e 1962-63 k r i l l n o t be maintained Secause of a r i s e i n non- a g r i c u l t u r a l p r i c e s and t h a t t h e y w i l l be p e r m i t t e d 4 1 o c c a s i o n a c ~ n t ? ~ u o u s x upward s p i r a l o f c o s t s and p r i c e s . This r e s u l t s p a r t i c u l a r l y from the per- v a s i v e n e s s of t h e dearness allowance system i n wage agreements i n both t h e p u b l i c and p r i v a t e s e c t o r s o f t h e I n d i a n economy. A f t e r f o u r y e a r s of reasonable p r i c e s t a b i l i t y up t o 1963-6L, t h e p r i c e i n d e x f o r manufactwed goods has gone up 7 p e r c e n t o v e r t h e p a s t y e a r aad it i s uncerttain what f u r t h e r adjustments f o r h i g h e r wage c o s t s a r e s t 2 1 in t h e p i p e l i n e . It f c l l o w s t h a t i f a change in r e l a t i v e p r i c e s to a s s i s t in b r - h g i n g abovt t 5 e s t r u c t u r a l changes i n t'ne economy, i s n o t t o r e s u l t in a n infla+,iol;ar: s x i r a l , t h e I n d i a n a u t h o r i t i e s must pay f a r more a t t e n t i o n to t h e acceptance and i m p l e m n t a t i o n of a r e s t r a i n e d incomes p o l i c y . 13. In t h e l i g h t of t h i s a n a l y s i s it appears to u s t h a t it ~ o u l d have se,wed l i t t l e co n s t r u c t i v e purpose t o have implemented a more financial.',^ r e s t r i c t i v e p o l l c y . F o r tkie above a n a l y s i s makes economic groxth dependent q o n a change i n r e l a t i v e p r i c e s i n o r d e r t h a t t h e changes i n a g r i c u l t u r ~ s u p p l i n s t h a t growth has denanded should have been e f f e c t e d . T?!?lilst -is it h i g h l y d e s i r a b l e t h a t t h i s change i n r e l a t i - v e p r i c e s should have ta!cen p l a c e in a c o t t e x t o f r e a s o n a b l e g e n e r a l p r i c e s t a b i l i t y , it has t o be emphasized p t h a t a r e s t r i c t i o n i s t f i n a ~ c i a l o l i c y would have done v i r t u . a l l y n o t h i n g whatsoever to e f r ' e c t t h e r e q u i r e d change in r e l a t i v e p r i c e s and c o l ~ l dn o t t h e r e f o r e have done otherwise than undem-iiie t h e r a t e o f growth, a l b e i t t h a t it might have prevented a g e n e r a l i n c r e a s e i n p r i c e s . To t h e e x t e n t t'r:at something approaching t h e l e v e l of food p r i c e s which h a s e::isted in t h e l a s t two y e a r s i s Zudged a p p r o p r i a t e t o induce t h e changes in fcod s u p p l y t l i ~ t , a r e deemed d e s i r a b l e , t h e n it i s i n a r p r o p r i a t e t o argue t h a t f i n a n c i a l pol.icy has been t o o expansionary in r e l a t i o n t o t h e food supply b o t t i e ~ e c kand t h a t t h e I n d i a n a u t h o r i t i e s have been g u i l t y of p u r s u i n g u n d i s c i p l i n e d monetary e and f i s c a l p o l i c i e s . On t h e c o n t r a r y , w would argue t h a t t.he bottlenecic of food supply which has, and is, r e s t r a i n i n g t h e development o f tile eCOi13Tii'j', has r e s u l t e d in p a r t from t h e f a i l u r e i n t h e previous decade t o a c c e p t tile i m p l i c a t i o i i s f o r r e l a t i v e p r i c e s o f t h e need t o i n c r e a s e food suy:plies. F a l l i n g and low p r i c e s f o r food s i n c e t h e e a r l y 1 9 5 0 ' s have indeed give.: Inc?.ia u n t i l r e c e n t l y i t s e n v i a b l e r e c o r d in t h e i n t e r n a t i o n a l l e a g u e t a b l e o f movements i n g e n e r a l p r i c e s , b u t a t t h e e x p n s e o f t h e development o f t h e a g r i c u l t u r a l marketable s u r p l u s upon which economic growth must in a c o u ~ t r y a s poor and a s underfed a s I n d i a , be based. It collld, of course, be argued t h a t an e a s y Yay t o improve t h e terms o f t r a d e o f a g r i c u l t u r e r.rculd have been to reduce PL 480 s u p p l i e s . Ple would p r e f e r to t r e a t PL 480 sll>iplies a s given and t o ask what l e v e l of consumer demand and t h e r e f o r e of t o t a l dnmestic denland was econon?i,cally d e s i r a b l e given the aggregate supyly of foodstvLff This i s n o t t o deny t h e v a l i d i t y o f t h e argument t h a t more PL 480 suppl.ies . s should have been used f o r b u f f e r s t o c k o p e r a t i o n s i n o r d e r to o f f s e t y e a r to y e a r f l u c t u a t i o n s i n p r i c e s , and a s m a l l e r volume i n merely augmenthg annual s u p p l i e s d i r e c t l y i - r r e s p e c t i v e of t h e i m m e d i a t e marke-t s i t u a t i o n . C. Company Taxation and t h e O b s t a c l e s t o Growth 14. Consider-able c r i t i c i s m o f t h e ve i g h t o f t a x a t i o n on companies i s made i n I n d i a and t h e formal r a t e s c e r t a i n l y g i v e s u p p o r t t o this cri+Yicism. The b a s i c r a t e i s 50 p e r c e n t b u t t h L s can r i s e t o 70 p e r c e n t a t t!le margin even before the furtiner imposition of a 7.5 pel. c e n t t a on d i v i d e n t d i s t r i - butions and a 12.5 p e r cerit t a x on bonus share i s s u e s d Ho>rever, these formal r a t e s exaggerate t h e weight of t.axation a c t u a l l y f a l l i n g on companies. A study of company accounts shoris t h a t the provision f o r t a x a t i o n (and t h i s i s i n g e n e r a l in excess of tax has increased from 38 p e r c e n t i n 1960-61 and 43 p e r cent in 1961-62 t o 51 p e r c e n t in 1962-63. Perhaps even more important i s t h e range of t a x e w r i , e n c e of companies. For the t5ro y e a r s f o r which it has been possi'ole to 05taii-1 a r e l e v a n t classification (1961-62 and 1962-63), over LO p e r c e n t of conpanies al.located l e s s than 30 7 p e r c e n t of t h e i r p r o f i t s a g a i ~ s t a x 7ayments w h i l s t a t the o t h e r e x t ~ a ~ e p e r cent o f companies in 1961-62 and 25 p e r c e n t i n 1962-43 a l l o c a t e d r:r;re than 60 p e r c e n t of t h e i r p r o f i t s f o r this purpose. For c e r t a i n i ? d u s t r i s s t h e rpread is even wider. For i n s t a n c e i n the f e r r o u s and non-fer:-s.us z e t a 1 products group, eleven of the 25 companies i n 1962-63 were providing mc?e ttlan 60 p e r c e n t of t h e i r p r o f i t s f o r t a x l i a b i l i t i e s and nine were ?rovi(ii.ng l e s s than 30 p e r cent which means t h a t only f i v e of them were providj-ng between 30 p r c e n t and 60 p e r cent. N docrmented evtdence i s imnefLat.el:r o a v a i l a b l e t o enable t h i s p a t t e r n of compaqy t a x exper-ience i n India fx ke compared w i t h t h a t i n o t h e r c o u n t r i e s b u t o u r guess would be t h a t t h e q m a d i n India i s much ~ i d e r than in most o t h e r c o u n t r i e s o f both the developed and l e s s developed world. 15 T l i i s wid+,h of t a x experience stems p r i m a r i l y from the n;ari;r t a x concessions which a r e granted t o companies. The most important o f t h e s e , p a r t i c u l a r l y i~ coverage of conpanies, i s the development rebate givt31 i n r e s p e c t of expenditure on new p l a n t and machinery, but in a d d i t i 5 ~ the:- a r s o t h e r concessions which t o a narrotrer group of companies a r e of s i g i f 5 c a n c e . These concessions a r e tliose t o new companies ( p a r t i a l tax holiday), t o companies in high p r j - o r i t y i n d u s t r i e s , t o conpanies vrorlting a s tiif t sys ';err., t o small companies and t o companies engaging i n exports. The 1965 bl'd+;et introduced f u r t h e r concessions t h e most important of ?;~rhich were aimec! a t expanding companies; expansion f o r t h i s purpose i s d e f i ~ l e di n bm!s of i c c ~ e a s e dpro f i t s tax l i a b i l i t y and increased e x c i s e duty pajmen5s pnya;~le n on increased production over a base year. A important innovz tior, -h-tro2ucsd with these two concessions i s t h a t of the encashable t a x c r e d i t which i n f a c t means t h a t the range of t a x experience o f companies can be even f u r t k s r broadened by havlng some companies enjoying a "negativeTft a x burder,. 16. The Indian company t a x system is undov.btedly corri-ple~: and t h i s has been a f o c a l p o i n t of c r i t i c i s m . IVevertieless w have n o t been persu3,led e that, such comple,dty i s undesirable. C e r t a i n l y we would i g e ~ e r a lf a v o r rl more use of f i s c a l measures f o r the a c h i e v e m e ~ tof t h e Government's o b j e c t i v e s and l e s s use of a d m i n i s t r a t i v e c o n t r o l s f o r t h i s purpose and i n e v t t a 5 l y t h i s implies a degree of complexity in t h e t a x s y s t ~ m . F i s c a l inceiltives xiL3.ch Prork through t h e company t a x s y s t e m might n o t d i r e c t l y provide much encourage- ment o r discouragement to development i n p a r t i c u l a r s e c t o r s of t h e ecGnomy; The 1966 budget has increased the b a s i c r a t e of corripany t a x a t i o n t o 55 p e r cent. A t t h e same time t h e t a x on bonus share i s s u e s has Seen abolished arid the t a x on divfdend d i s t r i b u t i o i l s l i m i t e d to d l s t r i b ~ l t i o n s in excess o f 10 p e r c e n t of t h e paid-up e q u i t y c a p i t a l . i n d i r e c t l y t h e y do so by v a r y i n g t h e a v a i l a b i l i t y of t h e f i n a n c i a l means n e c e s s a r y f o r expansion t o t a k e p l a c e . I n e f f e c t t h e Government provides r i s k c a p i t a l in t h e form of -increased p o s t - t a x p r o f i t s tc, those companies which s a t i s f y t h e c o n d i t i o n s which each concession s t i p u l a t e s . It attelnpts to e n s u r e t h a t some a t l e a s t of t h e i n c r e a s e d p o s t - t a x p m f i t s a r e r e t a i n e d by companies, i n s i s t i n g t'nat 75 p e r c e n t of t h e development r e b a t e i s p u t t o d a s p e c i a l r e s e r v e a ~ t h a t the new t a x c r e d i t s based on i n c r e m n t a l e x c i s e d u t y and p r o f i t s t a x payments a r e used f o r t h e r e p a ~ p e n tof debt. 17. There has been c o n s i d e r a b l e i n s t a b i l i t y in I n d i a n corcpan:~ tax l e g i s l a t i o n and the Government i t s e l f h a s recognized the need t o givf? rric)re s t a b i l i t y t o b u s i n e s s in t h i s r e g a r d , a r e c o g n i t i o n which has been r e f l e c t e d in both i t s g e n e r a l pronouncenents and i n i t s r e c e n t changes i n t h e develop- nlent r e b a t e concessi-on. It i s c e r t a i n l y t r u e t h a t t h e r e has been a good d e a l o f experimenting w i t h t a x measures over t h e l a s t decade and we ha-.re been dismayed by t h e a p p a r e n t complete f a i l u r e to stud.^ t h e impact of p a r t i c x l a r company t a x measures o r even to c a l c u l a t e :TIOW much each t a x c c ~ c e s s i o n" c o s t s " t h e Government in terms of revenue foregone. Nevertheless, much o f the c r i t i c i s m o f company t a x p r o v i s i o n s from t h e p o l h t o f view of t h e i r u n p r e d i c t a - b i l i t y , f a i l s t o recognize t h e changes i n t a x a t i o n which a r e c a l l e d f o r t h by e x t e r n a l p o l i t i c a l e v e n t s such a s t h e Chinese i n v z s i o n o r by e v e n t s i n t h e p r i v a t e s e c t o r of t h e ecor,omy i t s e l f such a s the d e c l i n e i n r e a l investment a f t e r tile boom of 1957-58 and t h e c u r r e n t e q u i t y mal-ke+, depression. F u r t h e r - more, t h e c r i t i c i s m o f t e n seems to imply t h a t t h e r e i s a s e t body o f t 2 x p r i n c i p l z s f o r f o s t e r i n g development which can be i n s t a n t l y a p p l i e d by 3 Government whereas t h e p r o c e s s o f evolving such a tax system t s i l l ine-Ji",zbly involve a good d e a l o f t r i a l and e r r o r . 16. There a r e t h r e e key i s s u e s i n t h e growth o f t h e p r i v a t e s e c t o r a g a l n s t which t h e weight and s t r u c t u r e o f t a x a t i o n has t o be considered; f i r s t l y t h e growth o f p r o d u c t i v e c a p a c i t y , secondl:,~ t h e u t i l i z a t i o n of Fro- d c c t i v e c a p a c i t y and t h i r d l y t h e a v a i l a b i l i t y of r i s k c a p i t a l . The gro11th of productive c a p a c i t y i s v e r y s t r o n g l y encouraged by l i b e r a l d e p r e c i a 5 i o n p r o v i s i o n s and more p a r t i c u l a r l y by t h e development r e b a t e which i s i n e f f z c t a non-repayable silbsidy e q u i v a l e n t to t h e marginal r a t e of t a x to :rhish a f;-rm i s s u b j e c t m u l t i p l i e d by t h e p e r c e n t a s e of i t s ex2enditur-e on p l a n t and machinery which i s d e c l a r e d r e l e v ~ n ff o r t h e computation of t h e r e b a t e . U n t i l piarch 1965 t h i s percentage was v i r t u a l l y uniform a t 20% f o r a l l c a p i t a l e x p e n d i t u r e . In March (65 a h i g h e r r a t e o f 25 p e r c e n t was i n t r o d u c e d f o r companies i n c e r t a i n p r i o r i t y i n d u s t r i e s and a lower r a t e of 15 p e r c e n t f o r a l l o t h e r companies a s from 1967. I n t h e supp7zmentar-y budget measures i n t r o d u c e d i n August 19-55 t h i s s e l e c t i v i t y was f u r t h e r i n c r e a s e d by a p r o v i s i o n t h a t g r a n t e d a 35 p e r c e n t r e b a t e t o t h e p r i o r i t y i . n d u s t r i e s on investment undertaken between A p r i l 1965 and Perch 1970 a t which d a t e t h e 25 p e r c e n t r e b a t e proposed in t h e March 1965 budget would becone OF, n r a t i v e . Furthermore, f o r the mon-priority s e c t o r the i n t r o d u c t i o n of t h e 15 p r c e n t r a t e was postponed from ?!arch 1967 t o March 1970. FThilst t h e r e b a t e c s r t a i n - l y p r o v i d e s f i l m s w i t h funds f o r development, it can be q u e s t i o n e d x h e t h c r t h e s t r o n g inducement which it g i v e s to c a p i t a l i n t e n s i v e development i n an economy which i s s o r e l y s h o r t of c a p i t a l , may n o t be e x c e s s i v e . This q u e s t i o n i s p a r t i c u l a r l y s i g n i f i c a n t i n r e l a t i o n t o t h e second of tbe growth i s s u e s above, namely t h e u t i l i z a t i o n o f c a p a c i t y . The concern we f e e l i n $ h i s connection i s t h a t t h e high marginal r a t e o f t a x a t i o n r e p r e s e n t e d by t h e 40 p e r c e n t s u r t a g which can Secone o p e r a t i v e f o r sorce h i g h w e f f i c i e n t c o ~ p a n i e s ,a c t s a s a p o s i t i v e discouragement t:, t h e acliievement of development through b e t t e r u t i l i z a t i o n of c a p i t a l . Whilst t h e s u r t a x was conceived a s an emergency measure, t h e r e a r e s i g n s t h a t it has become acce?ted a s a d e s i r a b l e p a r t o f t h e b a s i c t a x s t r u c t u r e . Its impact on e f f i c i e n t f i r m s i s relieved t o some e x t e n t by t h e e x t r a s h i f t d e p r e c i a t i o n concessiofi and by t h e r e c e n t con- c e s s i o n s based on i n c r e m n t a l e x c i s e d u t y and p r o f i t s t a x payments. These two measures e f T e c t i v e l y reduce t h e m a r g i n a l r a t e of t a x on companies : k k h a r e expanding t h e i r o u t p u t q u i t e s i g n i f i c a n u y . The incremental. prof i t s tax c c n c e s s i o n , f o r i n s t a n c e , r e d u c e s t h e marginal r a t e of t a x on some c c n p ? i e s from 70 p e r c e n t t o 56 p e r c e n t and on o5hers from 5 0 p e r c e n t to LO p e r cell%. D. The Supply of R i s k C a p i t a l t o t h e P r i v a t e S e c t o r - 19. The v s r y h i g h r a t e s of p r s o n a l iiicome and ~ t 3 ~ a t i c r.rl. ' c h a r e inposed on t h e high 5ncorae in I n d i a from >horn t h e s u p p l y of rk:: c a p i t a l c o u l d be e x ~ e c + & dto be forthcoming, a r e w i d e l y b e l i e v e d t o lit-ie l e d t o a s i t u a t i o n i n which p r i v a t e s e c t o r development i s impeded becanse : : 1 a s h o r t a g e of such funds. Thus, e v e n i f t h e g e n e r a l p o i n t v e r e t o be Zccepted t h a t o n l y t h r o u g h t a x p o l i c y can t h e aggregate l e v e l of i n t e r n a l s a v i n g s f o r development be adeqv.atel:r i n c r e a s e d , t h e r e i s s t i l l t h e danger, because of a p r e d i l e c t i o n o f p u b l i c f h a n c i a l i n s t i t u t i o n s f o r t . r m l e n d i n g , t h a f :.ritiiln a l a r g e r t o t a l of savings, t h e supply o f r i s k c a p i t a l t o t h e p r i v a t e s e c t o r declines . 20. I n q u a n t i t a t i v e terms t h e e x t e r n a l (i.e., e x t e r n a l t each ~ o r % ~ a n y ) c supply of r i s k c a p i t a l a cortipany i n f a c t i s n o t - h > o r t a n t r e p r e ~ e n ~-c z~ ~ r o u n d1 0 w r c e n t o r l e s s of the p r i v a t e s e c t o r ' s f i n a n c i a l r e q u i r e n e n t s and 1 6 p e r c e n t o f i t s supply o f e q u i t y F m d s . T h i s r e l a t i v e unimportar,ce .?ri.ses from t h e f a c t t h a t l i k e r a l d e p r e c i a t i o n p r o v i s i o n s p n - r i d e a b o u t 3'3 p e r c e n t o f company f i n a n c e and to t h i s i s ad.ded t h e d e t ~ l o p ~ ~ reen t t e concesslo;?ba and o t h e r a l l o c a t i o n s t o r e s e r v e s which i n t o t a l mean t h a t arolmd 5 0 p:.r c e n t of a l l t h e i r r e q u i r e d f u n d s a r e p r o v i d e d i n t e r n a l l y by co~r:pa-;?ies and t h a t about 90 p e r c e n t o f t h e i r f i x e C i n v e s t n e n t requirements a r e covered f r z n t h i s source. T h i s h i g h l e v e l of s e l f - f i n a n c i n g a r i s e s n o b 5 t h s tarir3l.n~ t i s , by i n t e r n a t i o n a l s t a n d a r d s , a v e r y h i g h r a t i o o f d i s t r i b u t e d t~ u n d . i s t r i b u - t e d p o s t - t a x p r o f i t s (annual average r a t i o o f 2 : l ) . 21. The remaining f i n a n c i a l requirements o f t h e c o r p o r a t e s e c t . r !law beer, net bj borrowing rerilich h a s accounted f o r a b u t 140 p e r c e n t of i t s re- j q u i r e m n t s . C e s p i t e a p a r t i c u l a r l y heavy r e l i a r l c e on borroraing i n r e c e n t :,Tears 1 t h e d e b t - e q u i t y r a t i o h a s in a g g r e g a t e remained w e l l below t h e 2 : l e v d r ~ k i c h i s accepted a s t h e norm by t h e c a p i t a l i s s u e s c o n t r o l a u t h o r i t i e s and c a n i.il g e n e r a l be r e g a r d e d a s prudent. The p r i n c i p a l s t a t u t o r y long-term f i n a n c l a l i ~ i . s t i t u t i o n shave been i n c r e a s i n g t h e i r l e n d i n g a c 3 i v i t i e s p a r t i c u l a r l y s i x e 1962-63 and t h e y now p r o v i d e a b o u t a t h i r d of a l l term f i n a n c e a s comrai-ed w i t h a n e g l i g i b l e p m p o r t i o n i n p r e v i o u s y e a r s . T h e i r a c t i v i t i e s a r e in f l . t u r e - 1/ Reduced t o 35' p e r c e n t i n March 1966 when a s n o t e d above ( f o o t n o t e on page v i i ) t h e b a s i c r a t e o f company t a x a t i o n was r a i s e d from 50 p e r c e n t to 55 p e r cent. t o be c o o r d i n a t e d and extended by t h e I n d u s t r i a l Development Bank o f I n d i a established Last year. 22. The e q u i t y market h a s experienced a marked d e p r e s s i o n s i n c e 1762 w i t h t h e s e c u r i t y p r i c e i n d e x f a l l i n g by about 20 p e r c e n t . T h i s has been a source o f c o n s i d e r a b l e concern in I n d i a . I n l a r g e p a r t it must be t r e a t e d a s a response t o t h e g e n e r a l p o l i c y of r a i s i n g t h e i n t e r e s t r a t e s t r u c t u r e r e f l e c t e d i n a r i s e in bank r a t e by 50 p e r c e n t s i n c e 1962 ( f r o n 4 p e r c e n t t o 6 p e r c e n t ) . T h i s h a s been r e i n f o r c e d by t h e widely a c c e p t e d n e c e s s i t y f o r a c o r r e c t i v e t o t h e e x c e s s e s of t h e 1959 t o 1962 s t o c k e x c l ~ a r g eboom sixl t h e n o t o r i o u s s e n s i t i v i t y of s t o c k markets t o p o l i t i c a l e v e n t s such a s t h e C h k e s e emergency and Nehrul s clea th. 23 The e f f e c t of t h e d e c l i n e i n e q u i t y p r i c e s on t h e volume of new i s s u e s h a s been c o n s i d e r a b l e though o n l y i n r e l a t i o n t o t h e boom p a r s of 1 9 6 1 and 1962 and n o t in r e l a t i o n t o t h e t r e n d o f issv-es o v e r t h e p a s t n i g h t y e a r s . Furthermore, t h e d e c l i n e in new i s s u e s can be a t t r i b u t e d t o a d e c l j x e i n i s s u e s , e s p e c i a l l y r i g h t s i s s u e s , by e s t a b l i s h e d conpanies tchich. have been a b l e to t i d e themselves o v e r t h e p e r i o d of d e p r e s s i o n i n t h e f i n a n c i a l r n a r k e t b y r e c o u r s e to Sorrowing. Newly e s t a b l i s h e d companies have no such f l e x i b i l i t y e x c e p t t o d e l a y their e s t a b l i s h m e n t . F i g u r e s of o v e r - and - s u b s c r i p t i o n and of u n d e ~ w r iitn g commitments and disbursements i n d i c a t e t h e poor response of t h e n a r k e t t o new i s s u e s . F h i l s t t h i s has keen part,:.ci~.larly t r u e i n t h e l a s t two y e a r s , both t h e p r o p o r t i o n o f s h a r e i s s n e s u n d e r w r i t t e n and t h e p e r c e n t a g e taken up by u n d e r w r i t e r s has i n c r e a s e d c o n t i n u o u s l y even d u r i n g t h e s t o c k exchange boom. This s u g g e s t s t h a t t n e problem o f t h e s i x p ~ l y c o f ~ i s k a p i t a l t o t h e p r i v a t e c o r p o r a t e s e c i a r i s in ? a r t a short-,run proSlem i n t h e p r e s e n t depressed s t a t e o f t h e market b u t a l s o in p a r t a l o ~ g r~ n ur problem a r i s i n g o u t o f t h e p e r s o n a l t a x a t i o n and o t h e r p o l i c i e s being p~lrsuecl by t h e I n d i a n Government. 24 Fhilst t h e s h o r t - r u n problem can be d e a l t w i t h by a d e m a t e uni=zr- v r i t i n g f a c i l i t i e s , t h e l o n g e r r u n problem r e q u i r e s t h a t more r l s k - s a v i n g s be made a v a i l a b l e f o r p o r t f o l i o inveeiment purposes. I n I n d i a n c i r c ~ m s t a 3 c e swe judge t h a t t h i s would have t o be a c h i e v e d l a r g e l y through an i n c r e a s e i n i n s t i t u t i o n a l ec,uity investment. Already t h e i n s t i t u t i o n s a t b o t h the Se:?+sr and S t a t e l e v e l s a r e h e a ~ i n v e s t o r s in s q u i t i e s both on an u n d e r w r i t i n g and j a p o r t f o l i o b a s i s . The L-ife Insuraiice Corporation, in p a r t i c u l a r , %as i n r e c e n t y e a r s been i n v e s t i n g aSout R s . 15 c r o r e s a n n u a l l y i n e q u i t i e s (~3:cclud- i n g u n d e r w r i t i n g o b l i g a t i o n s ) and 18 p e r c e n t o f i t s investment p o r t f o l i o i s r e p r e s e n t e d by i n d u s t r i a l s h a r e s (mainlv p r e f e r e n c e and e q u i t y s h a r e s ) . Furthermore, t i e U n i t T r u s t which was e s t a b l i s h e d l a s t y e a r i n v e s t e d a7r)roxi- m a t e l y 3s. 9 c r o r e s in i n d u s t r i a l e q u i t i e s o u t cf i t s t o t a l a v a i l a b l e funds f o r i n v e s t r e n t of R s . 23 c r o r e s . 25 However, i n g e n e r a l t h e Government has p l a c e d s e v e r e r e s t r i c t i o n s on t h e investment o f i n s t i t u t i o n a l funds i n o r d e r to e n s a r e t h a t t h e y a r e used f o r p r i o r i t y purposes. Of p a r t i c u l a r importance i n t k i i s r e g a r d i s Kfie i n s i s t e n c e t h a t a l l funds m o b i l i z e d under t h e v a r i o u s P r o v i d e n t Fund S c h e ~ s be i n v e s t e d in Government and o t h e r approved f i x e d i n t e r e s t s e c u r i t i e s . The n e t annual i n c r e a s e i n t h e s e funds i s now around Rs. 50 c r o r e s and can be expected t o i n c r e a s e s i g n i f i c a n t l y i n t h e futu-re. Furthermore, i n a s i t u a t i o n of p o t e n t i a l i n c r e a s e s i n t h e g e n e r a l l e v e l o f p r i c e s t h e r e i s much t o be h s a i d f o r p e r m i t t i n g some a t l e a s t o f t h s s e funds t o be i n v e s t e d - more i n - f l a tion-proof s e c i l r i t i e s t h a n Government bonds. Thus, t h e r e i s b o t h a narrower and wider j u s t i f i c a t i o n f o r r e l a x i n g t h e r e s t r i c t i o n s on tileso, p r o v i d e n t funds i n o d e r t o p e r m i t a t l e a s t a p r o p o r t i o n of t h e i r p o r 5 f o l i o s t o be in e q u i t y shares. 26, A s a f u r t h e r i n s t i t u t i o n a l development to augment t h e s u p p l ~ ~ of r i s k c a p i t a l t h e r e i s scope - in p a r t recognized b y t h e I n d i a n authorities themselves - f o r widening t h e a c t L v i t i e s of the Unit T r u s t by offeri.r,g a ra:ige -- ~f mits c a r r y i n g a v a r i e t y of terms, b y reducing t h e - f a c t o m - h i ~ u mpurchase de from Rs. 100 to t h e s t a t u b minim~un of Rs. 1 0 and b.j i n v e s t i n g t h e Trl:stl s ~ funds a w i d e r s e l e c t i o n of companies. The achieveTnent o f t h e s e advazces might be dependent upon t h e c r e a t i o n o f competing t r u s t s e a c h r e c e i v i q g t h e t a x advantages a t p r e s e n t enjoyed s o l e l y by t h e U n i t T r u s t o f I n d i a i t s e l f , 27. I n c r e a s i n g t h e t o t a l f l o v of r i s k c a p i t a l i n t h e s e ways w-ill i 5 s e l f e a s e the problem of e n s u r i n g t h a t t h e f l o t a t i o n o f nev corcpanies i s c o t i m - peded by inadequate r e s p n s e t o p u b l i c e q u i t y i s s u e s . %ot-rever, because of t h e importance o f t'nis a s p e c t of t h e problem, we a>rould s u p p o r t d i s c r i m i n a t o ~ j p o l i c i e s ?rhich f a v o r the purchase of i n i t i a l e q u i t y s h a r e i s s u e s of new cor?panies. F c r t h i s reason ve s u g p o r t t h e trio measures which ha::e receliTIy been i n t r o d u c e d by t h e I n d i a n Government which provide t h i s d i s ~ r ~ i r i a t j - o n . The f i r s t of t h e s e exempts from wealth t a x f o r f i v e y e a r s the value of ec!;ity s h a r e s i n new i f i d u s t r i a l com.panies where t h e s n a r e s form p a r t of an i n i . ' l a l i s s u e of e q u i t y s h a r e c a p i t a l made by a company a f t e r F e b r u a q ~25, 1965. ' h e value of t h i s concession w i l l v a r y according t o t h e t o t a l t a x a i d e w2altl.1 of t h e i n v e s t o r . It % , r i l l r i s e from z e r o f o r t h e ;Investor t ~ h 0 s eT o t a l t a x a i ~ l e r-realth i s l e s s than r u p e e s one l a k h t o a maxihum of 2.5 p e r c e n t on n e t vrealth r o ~ 2 rupees t e n l a k h s . A t t h i s top r a t e of wealth t a x , t h e r e f o r e , the c o ~ i c e s s i o ni s t h e e q u i v a l e n t of a f i x e d 2% p e r c e n t r e t u r n o n -!,he e q u i t y i n - vestment f o r f i v e y e a r s . 28. The second and more important measure was i n t r o d u c e d i n Decer;:'uer 1964 and p r o v i d e s f o r the g r a n t o f t a x c r e d i t f o r f o u r y e a r s to p ~ r c l - ~ a s e r s of the s h a r e s o f new companies e i t h e r d i r e c t l y o r from u n d e r w r i t e r s up t a a maximum purchase of Rs. 35,000 i n any one year. The a s s i s t a r l c e i s a t a de- c l i n i n g r a t e . On average f o r t h e maximum investment o f R s . 35,090 it r e p r e - s e n t s a 3 s p e r c e n t t a x - f r e e r e t u r n on i n v e s t r e n t i n t h e r e l e v a n t s e c l ~ r l t i e s f o r f o u r y e a r s . The s i g n i f i c a n c e of i t s t a x - f r e e q u a l i t y % s i l l of course r e a n mom i n g r o s s terms t o t h e high income i n v e s t o r than to the i o ~ r incorr.5 i n - v e s t o r . I t s a t t r a c t i o n t o t h e low/middle income i n v e s t o r i s t h a t t h e r1orri2i p e r i o d o f w a i t i n g b e f o r e new e q u i t i e s pay dividends i s bridged by, i n ef+'?ct, a Sovcrnment subsidy. E. The Financing o f S t a t e S x p e n d i t u r e 29. T o t a l e x p e n d i t u r e by t h e S t a t e s a s a p r o p o r t i o n of t o t a l S o v e m e n t e x p e n d i t u r e f e l l from o v e r 60 p e r c e n t i n t h e mid-1950's t o 55 p r c e n t i n 1961-62 i h e d i a t e l g b e f o r e t h e Chinese emergency. D e s p l t e the f a c t t h a t ex- ~ e n d i t u r e sby tlie S t a t e s have continued t o i n c r e a s e s i n c e the eraergency a t x h a t a p p e a r s t o be an unreduced r a t e , t h e i r r e l a t i v e importance has d e c l i n e d  - xii - due to t h e t r e b l i n g of defense e x p n d i t u r e by t h e Union Government so t h a t it now r e p r e s e n t s l e s s t f i a ; ~h31f of t h e t o t a l (46.5 F e r c e n t i n 1963-64). b T i t h i n t h e t o t a l d e b t s e r v i c i n g h a s i-ncreased from an z ~ m u a laverage o f Rs. 1 3 c r o r e s d u r i n g t h e F i r s t P l a n t o an e s t i m a t e d Rs. 210 c r o E s i n 1964-65 a t which l e v e l it r e p r e s e n t s almost a t h i r d of a l l non-development e x p e n d i t u r e . Other non- development e x p e n d i t u r e (covering p o l i c e , j a i l s , t a x c o l l e c t i c n ) h a s approxi- m a t e l y doubled s i n c e the F i r s t P l a n and d s v e l o p ~ e n te x p e n d i t u r e h a s i n z r s z s e d almost fourfold. 30. The most s t r i k i n g f e a t u r e ~ i h i c hemerges from an a n a l y s i s o f t h o p a t t e r n of S t a t e f i n a n c i n g i s t h e slow but, p e r s i s t e n t iizcrcase (19611-65' n!i&t x p o s s i b l y be a n e x c e p t i o n ) i t h e p r o p o r t i o n of t o t a l f i n a n c i a l r e s o u r c z s ~ ~ ~ ht h e S t a t e s have d e r i v e d from t h e Center. This has c r e p t upvards :'rum h i c j u s t above 40 p e r c e n t a t t h e b e g i n n i n g of t h e F i r s t P l a n t o v i . r t u a l l g 50 p e r c e n t i n 1963-64. The growing dependence h a s been p a r t i c u l a r l y rar!ted i n r e l a - t i o n t o t h e r e c e i p t s of t a x revenue and o f g r a n t s b y t h e S t a t e s . 1dhils-L s i r c e 195'1 a littl3 under t w o - t h i r d s of a l l revenuz a c c o u n t r e c e i p t s have See:, i n t h e f o r n of t a x revenue r e c e i p t s , within t h i s t o t a l t h e s h a r e o f central-l:: c o l l e c t e d t a x e s has i.i..~creased e l a t i v e l y t o t h a t o f l o c a l S t a t e t a x e s . This r change o c c u r r e d p a r t i c u l a r l y d u r i n g t h e Second P l a n a s c o ~ p a r s dw i t h t h e l l r s t P l a n though t h e f i g u r e s Tor 1962-63 and 1963-6L! s u g g e s t t h a t i t might Se con- t i n u i n g a t a reduced r a t e . A s i n i l a r change i n p a t t e r n can be observed x i t h r e s p e c t t o non-tax revenue which, w h i l s t it h a s i n t o t a l rerriained virtua!.lg s t a t i o n a r y i n terms o f i t s r e l a t i v e jmportance, c o n c e a l s t h e marked growth i n C e n t e r g r a n t s p a r t i c u l a r l y between the F i r s t snd Second P l a n p e r i o d s b u t a l s o i n t o t h e T h i r d P l a n p e r i o d a s well. 31. EIot,~ever, w h i l s t t h e growing f i n a n c i a l d.epend.ence o f t h e Stat,es i n r e l a t i v e t e r m s is c e r t a i n l y one cause f o r concern, >:hat i s o f e q u a l i x p o r t a n c e i s the growbh i n t h e a b s o l u t e anount of C e n t e r f i n a n c i a l a s s i s t a n c e which t h i s i n f a c t r e f l e c t s . O ~ r e rone-half o f t h e i n c r g a se sir.ce 1960-61 in. tlie S e . n t e r l s r e s p o n s i b i l i t y f o r f i n a n c i n g 30th i t s own i n v e s t n e n t e x p e n d i t u r e s and feat o f t h e S t a t e s , p u b l i c e n t e r p r i s e s , e t c . , fias r e s u l t e d from i t s i n c r e a s e d f i l i a n c i a l r e s p o n s i b i l i t y t o t h e S t a t e s . T h i s p r o p o r t i o n i s even h i g h e r if t h e a n a l ~ r s i s i s c a r r i e d back f u r t h e r . It i s f o r t h i s reason t h a t we have argued th::t i f r e a c c e p t a s a f i x e d component i n t h e s i t u a t i o n t h e C e n t e r ' s high l e v e l of ex- p e n d i t u r e on defense which h a s e r o d e d away t h e s a v i n g s which could. otke:wise have been e x p e c t e d from i t s i m p r e s s i v e t a x performance, t h e n i.t becories even more i m p e r a t i v e f o r t h e S t a t e s t o i n c r e a s e t h e i r own f i n a n c i a l mobil.ization effort. 32 Within t h e t a x str11ctul-e o f t h e S t a t e s t b e most dynamic eleme:lt h a s been k d i r e c t t a x a t i o n :except e x c i s e d u t i e s which tjre a f f e c t e d by p r o h L b i t i o n p o l i c y ) . The rise i n s a l e s t a x revenue has been p a r t i c u l a r l y s t r i k i n g h s v i a g r i s e n t o f o u r times i t s averaFe F i r s t P l a n l e v e l and double i t s average Seccnd. P l a n l e v e l . It now a c c o u n t s f o r 40 p e r c e n t o f a l l S t a t e t a x revenue a s com- p a r e d w i t h 25 p e r c e n t d u r i n g t h e F i r s t P l a n period. l * % i l s t revenue fmm o t h e r i n d i r e c t t a x l e v i e s h a s i n c r e a s e d l e s s i n a b s o l u t e terms, t h e r a t e s o f ,nro:rrth have been comparable w i t h t h a t o f s a l e s t a x revenue. Revenue from e l e c t r i c i t y d u t i e s , i n p a r t i c u l a r , h a s r i s e n very s t e e p l y . 3y c o n t r a s t d i r e c t t a x e s have b2en e x t r e m e l y i n e l a s t i c i n t'ceir revenue y i e l d s . A g r i c u l t u r a l income t a x i s n o t o n l y unimportant i t o t a l b u t h a s been virtu.al1.y s t a g n a n t i n t h e p a s t t e n n  - xiii - years. Land tax revenue has a l s o increased a t a v e q low r a t e and now provides only about a s i x t h cf t o t a l S t a t e t a x relanue a s compared w i t n i t s 25 p e r cent c o n t r i b u t i o n during the F i r s t Plan period. 33. Under any conceivable economic circumstances ' India b u t more n L p a r t i c u l a r l y in t h z p r e s e n t circumstances i n which a major mobilization of re- sources f o r defense purposes i s being attempted concurrently with a major mobilization of resources f o r development purposes, i t I s e s s e n t i a l t h a t a sustained and s i g n i f i c a n t e f f o r t to increase t h e contribution r:l.lich i s m d e by t h e a g r i c u l t u r e s e c t o r i s required. This i s made a l l the moxe ir-porfaiit 5y the recommendation elsewhere i n the 14ission's Report Ynat t h e stirnula=?-~n of a g r i c u l t u r a l production r e q u i r e s an improvement i n i t s terms of t r a d e vis- a-vis the noii-agricultural s e c t o r a s compared ~ L t h the s i t i ~ a t i o nwi-ich e x i s t e d u n t i l 1963. \ a i l s t a g r i c d t u r a l income +,axation can be, aild i s , used 2.n .h :e t a x a t i o n of t h e organized p l a n t a t i o n s e c t o r , this r a i s e s very d i f f i c ~ r l t administrative o b s t a c l e s i n the remaining p a r t of the agric311tural sec to r. -7 rurthermore, the i n c e n t i v e s + increased output a r e negated t o the exten5 a t h a t the e f f e c t i v e marginal n r i c e received by c u l t i v a t o r s i s reduced by an a g r i c u l t u r a l income t a x . 3h. Given these a&.inistra t i v e and economic considerations, emphasis n e c e s s a r i l y focuses on the extension and/or i ~ t e n s iica t i o n of land ta::a ?Lo:?. f Providing cnanges in land, values a r e n o t too c l o s e l y c o r r e l a t e d with c'ranges i n output (and they a r e most u n l i k e l y t c be), t h i s form of t a x a t i o n induces favorable income e f f e c t s on production without the unfavorable disincentLve e f f e c t s which s t e m from forms of t a x a t i o n which a r e c l o s e l y r e l a t e d t o i n - crements of output. Furthermore, a s with a l l d i r e c t +,axes, it induces c u l t i - va t o r s t o increase t h e i r marketed s u p p l i e s i n o r d e r t;r, lneet t h e i r t a x b i l l s . L lllore important s t i l l , i n the eyes of most o f f i c i a l s , ' t i s a form of t a x a t i o n which i s r e l a t i v e l v simple to administer. I n t h i s l a t t e r regard, CIS s i m p l e s t s o l u t i o n t o thz problem of i n c r e a s i n g the reveaue fmm land t a x a t i o n i s a sL1.r- c h ~ r g e c u r r e n t r a t e s of tax. Such a s o l u t i o n i s !>robably the only one on possible i n the short-run, b u t it must be recognized t h a t valua5ions of property a r e now so o u t of date (some d a t i n g back a century o r nore) t h a t con- s i d e r a b l e i n e q u i t y i s l i k e l y t o r e s u l t . Moreover, a revaluation o f pro;j2rQ would become e s s e n t i a l i f the t a x s t r u c t u r e wzre to be made more com~;.lex by, f o r instance, making i t progressive. This would both enable t h . e burdell on tile small c u l t i v a t o r ( e e g . , hcldings up t o 5 a c r e s o r 1 0 a c r e s ) to be abolished o r reduced, and a t t.he same time give an induceinent t o l a r g e land- owners to d i v e s t themselves o f some of t h e i r hold.ings i n accordance v ~ t i ?t h e aim of inposing a c e i l i : ~ gon land holdings. The increase i n a ~ n u a lt a x revenue ~irhichcould be derived from land t a x a t i o n has been estimated a t between R s . 120-Rs. 150 c r o r e s and more o p t i m i s t i c a l l y a t Rs. 250 crores. 3 - ~ e s e e s t i m a t e s compare with c u r r e n t revenue c o l l e c t i o n s a t Rs. 123 crores. 35. Central a s s i s t a n c e to the S t a t e s i s i n the f o m of shared t a x 20 revenues ( a p p r o x i m a t ~ l y p e r c e n t ) , g ~ a n t s(approximately 25 per c e n t ) 3nd loans (approximately 55 per c e n t ) . Trro administrative bodies - the Finance Commission and the Planning Commission - a r e p r i m a r i l y responsible f o r determining t h e p a t t e r n and volume of Center financing o f the States. The Finance Commission makes recommendattons i n r e l a t i o n t o the d i s t r l b t l t i o n of rsvenue derived from assigned t a x e s ( e s t a t e e q u i t y ) , and from those taxes p a r t of t h e revenue from rlrhlc!l e i t h e r n:ust be a l l o c a t e d to the S t a t e s (income t a x ) or. can be a l l o c a t e d t o t h S t a t e s ( ~ e ~ t e;:cise duties!. ~ e r It regardi,?g t h e s i z e and d i s t r i b u t i o n of Center a l s o makes r e ~ o n ~ l z n d a t i o n s o g r a n t s which a r e nade t supplement the general revenues o f the S t a t e s under S e c t i o n 275 of t h e C o n s t i t u t i o n . Wkilst t h e Finance Commiss Lon only reco-mends p o l i c y t o t h e P r e s i d e n t and to t h e Government, only in one case has a recormendation from t h e Conmission been r e j e c t e d on a c u e s t i o n o f p r i n c i p l e . The Planning Connission i s concerned with t h e cletemiination o f the rect-;irer.1entr . - fcr fina~cing Plan expenditure. T h i s e x e r c i s e i s ~m-1erta:cenSo t k cuilii uezi?-r-- l y i n connection w i t h t h e Flve-Year Plan and a n n u a l l y when ~ l a n inylArr, :-lt,st8<of- i s b e i ~ g i s c u s s e d v i t h each S t a t e . d 36- The c r i t e r i a by which t k e Finance CornmissLon a d t h e P l a n n l k ~ Commission d e t e r ~ i n e.tke p a t t e r n and volume of Center financing o f S%at,e a c t i v i t y , a r e f a r from c l e a r e x c e p t i n t h e most generalized. -terms. FwL!ler- i.,ore, t h e r e i s evidence t h a t tile p m c e d u r e s both discourage S t a t e ,:ove1.rrrients from r a i s i n g i n c r e a s e d r e s o u r c e s l o c a l l y and a t the same time encourage them t o exaggerate t h e i r p o t e n t i a l f o r undertaking k c r e a s i n g l e v ~ l s f p l a n e:Ten- o d i t u r e . It i s OLU- view t h a t the use o f an e x p l i c i t formula f o r the a l l o c a t i o n of Center funds f o r P l a n f i n a n c k g , t~oisldbe p r e f e ~ a b l et the p r e s e n t q s t e r n o of time-consuming annual cliscussions. Such a formula would focus a t t e n t i o n on the r e l a t i v e weight t o Sc given t o poverty, t a x performance, admL~istrat~5.ve . e f f i c i e n c y , e t c i n all-oca ti:.lg Center P l a n funds and on ame-r,i.ing C,?E s e ~??e.i$lts a s e x p rience scgkests . n I . a d d i t i o n , S t a t e s ~ r o c l dicrlo~ae x a c t l y w l . re tlrey ~ stood i n t e n s o f Center f i n a n c i a l ~ s s i s t z n c e51, relat-ion t t h e i r ?-TI z f f c r t s . o C e r t a i n l y judged by the most obvioiis c r i t e r i a t h a t It cot~lclbe ex?.>cted vould f i g u r e prominently i n any formula which was devised f o r t1ii.s pur:.ose, ti:e p r e s e n t a l l o c a t i o n of g r a n t s arid l o a n s appears t o maice l i t t l e seiice. 37. Though e x c e p t i o n s t o t h e r u l e sxist, Center assis+x-.ce i s g i w n tc t h e S t a t e s primaril-1 on an u n t l e d and uncoridLtiona1 b a s i s . Certai.r_ly t h e e x t e n t o f t h e d i s c i p l i n e t!hj.ch t h 5 Union gavel-rment h a s keen a b l e o r w i l l i n g t o e n f o r c e through i t s c o n t r o l o f t h e p u r s e - s t r i n g s , has been s u f f i c i e n t l y l i g h t a s to have permitted t h e S t a t e s t o evade i n Yarge :)art t h e i r re s p o n s i S i l i t i e s f o r rais-ing more resources locall-y through t h e t,ax system (especial.ly on a g r i c u l t u r e ) and through p u b l i c e n t e r p r i s e I>rlci:lg/?rofit p o l i c y ( e s p e c i a l l y s t a t e e l e c t r i c i t y undertakings). More r a p i d sdvance 5.n t h i s a7ea o f s t a t e fLrancial resources could be achieved i f t h e s a n c t i o n wkich. Center f i n a n c i a l a s s i s t a n c e g i v e s t o t h e Union government were more e f fect!.ve- 1:~ by being, a t l e a s t i n p a r t , more c1earl.y focused on s t a t e perfo~mance. used  I. TIE GRGJTH O UNION GOVERTJi,ENT T X REVENUE F A I A. Introduction 1 . I n any economy i n which economic decision-taking i s divided between government and individual economic u n i t s (persons, firms, etc.) - t h e r e a r e two - =d t h i s means any economy outside of a t h e o r e t i c a l construct general aspects of f i s c a l policy which have t o be examined. The f i r s t of these i s t h e d i r e c t e f f e c t which government spending, taxing, borrowing, lending, e t c . has in r e l a t i o n t o t h e ultimate objective of policy; t h e second i s t h e i n d i r e c t e f f e c t s which these government f i n a n c i a l a c t i v i t i e s have on decisions taken a t the micro l e v e l by those responsible f o r decisions t o invest, t o save, t o export, t o import, etc., etc. These i n d i r e c t e f f e c t s r e s u l t from modifying t h e complex environment of f a c t o r s which in combillation determine decisions a t t h e micro level. 2. It follows t h a t any study which attempts t o appraise the r e l a t 109- ' s h i p of f i s c a l policy i n a country t o t h e attainment of i t s development objectives, must itself proceed along two l i n e s . This i s t r u e whether f i s c a l policy i s i n t e r p r e t e d i n i t s widest sense t o embrace both the spending as well a s the revenue-raising operations of the government o r whether, more t r a d i t i o n a l l y , government spending i s taken a s given and a t t e n t i o n focussed exclusively upoii revenue-raising operatcons. Furthermore, t h i s i s t r u e how- ever widely, f o r reasons of convention o r of convenience, one decides t o define t h e a r e a of f i s c a l policy - e.g., t o include or t o exclude public enterprises. The need t o recognize these two aspects of the problem a r i s e s from the f a c t t h a t t h e d i r e c t and the i n d i r e c t e f f e c t s of a particular f i s c 3 l ineasure might not be,and often a r e not, i n the same d i r e c t i o n , It thus becomes v e r j simple e i t h e r t o approve o r t o disapprove a f i s c a l measure merely by l h i i c - in&ones a p p r a i s a l of it e i t h e r t o i t s d i r e c t o r t o i t s i n d i r e c t e f f e c t s . I n f a c t ultimately tine a p p r a i s a l of a f i s c a l measure o r of f i . s c a l policy i n general, if it i s t o be a balanced appraisal, must consider both the d i ~ e c t and t h e i n d i r e c t e f f e c t s of such a measure o r c o l l e c t i o n of measures. 3. Lest t h i s appear t r i t e , the danger of f a i l i n g t o recognize t h e need f o r a balancing of t h e d i r e c t and of the i n d i r e c t e f f e c t s of f i s c a l measures i s i m p l i c i t , f o r instance, i n the Bank's own documents. O the n one hand the country performance exercises put considerable emphasis on t a x revenue in r e l a t i o n t o G P a s a c r i t e r i o n of domestic economic per- N formance i r r e s p e c t i v e of any d i f f e r e n t i a l adverse e f f e c t s which might accrue from the p a r t i c u l a r t a x s t r u c t u r e i n a country. O the other hand n i n the Bank's study of t h e ffPlarket f d r Indian I r o n Ore1!, t h e adverse i n d i r e c t e f f e c t s of f i v e f i s c a l measures upon the costs of producing and exporting i r o n ore, a r e s e t f o r t h with v i r t u a l l y no reference t o t h e wider context within which these measures were introduced. Examples of t h i s schizophrenic a t t i t u d e can be multiplied t d t h people arguing on the one hand f o r more f i s c a l (including t a x ) d i s c i p l i n e and on the other ich arguing against p a r t i c u l a r t a x measures ~ ~ ~ h might r e f l e c t such d i s c i p l i n e on t h e grounds t h a t they adversely a f f e c t incentives t o work, t o save, t o invest, t o take r i s k s , etc., e t c . !A- It must, therefore, be recognised i n i t i a l l y that t o the extent t h a t the Bank supports a strategy of developnent which places s i g n i f i c a n t emphasis upon f i s c a l measures f o r d i r e c t l y mobilizing an increasing volume of resources f o r development purposes, t h i s ? r i l l r e s u l t in c e r t a i n undesirable i n d i r e c t effects. IJhat one needs t o assess i n a country pursuing such a strategy i s whether, f i r s t l y , these undesirable r e s u l t s a r e reduced t o a minimum by i n t e l l i g e n t f i s c a l policy and secondly whether corrective action i s rapidly taken i n those instances there the undesirable e f f e c t i s regarded as of considerab1.e significance f o r devel- opnent polj-cy. Analogies a r e dangerous but, a s i n war, however well con- ceived a s t r a t e m might be i t w i l l inevitably produce casualties and one must simply expect of wise generals t h a t these casualties a r e reduced t o a minimun and t h a t they a r e not so great in one or more important sectors 'that the whole s t r a t e g y i s undermined by a flank being turned or a supply haze over-run. ,-' L. It must not be thought from the above, however, t h a t a l l the i n d i r e c t e f f e c t s of f i s c a l measures need be undesirable. I n f a c t some of these measures which a r e taken t o modify the efivironment i n which nucro- decisions are made, (e.g., t o stimulate private saving, investment, export a c t i v i t y , etc.) w i l l have been taken deliberately t o bring about decisions which a r e judged t o be nore i n l i n e with the development needs of the country. I n these cases although the government i s acting i n d i r e c t l y upon decisions a t the micro level, the d i r e c t motive f o r i t s actiocs i s t o influence these decisions and thus they become the products and not just the fortunate by-products of such actiono 0. It i s within the broad framework of reference presented above t h a t the study of Indian f i s c a l policy has been undertaken. To 3egin with, appraisal of the revenue performance i s undertaken. This i s made i n quantitative terms i n t h i s chapter, In the next chapter t h i s revenug per- formance i s evaluated i n terms of budgetary requirements a,d of the rJ;,der requirements of development. The coverage of t h i s survey i s lilnited t o the Union Government sector. The reasons f o r t h i s a r e f i r s t l y t h a t the f i n a n c i a l problems of the s t a t e s and the public enterprises are discussed as separate problems elsevhere i n the 14ission's Report and secofidly t h a t they a r e both dependent upon the Center f o r most of t h e i r residual firiancial requiremenix. This i s not e n t i r e l y true, especially i n the case of tile S5ates which have from time t o time borrowed t o finance t h e i r budgetary d e f i c i t s from she Reserve Bank of India. Nevertheless the Center's budget r e f l e c ~ s i n the main the f i n a n c i a l impact of public sector operations a s a rhole. 7. I n suSs,?ounnt chapters the ,;roblerr, of State f i n a n c i n g zbllur.!cd t o i n t h e previous psrazraph i s exarrined. Folloving t h i s a s t u d y i s of the ~ a s n i t u d eand structure of company taxat,ion i n India and t h i s taices u s ini:c the 1:~ider f i o l d o f the flo?.r o f c a p i t a l i n t o the priva-ke sectur. It i s and the Goverment's reaction i_?.h i s s t u d y t h z t i n d i r e c t efl'ects o f + ~ x a . t i o n t t 3 them corn up f o r exmination.  B. ..- -- Q u a n t i t a t i v e Outline of Uxion Tax Revenue Grorrth 8. It i s n o t the purpose of t h i s study t o describe i n any comprehensive manner the t a x s t r u c t u r e of the Indian economy and i t s changes over some relevant past . A d e t a i l e d survey of t h i s type was undertaken by t:?e Bank i n 1962. griod However, a review of the general developments which have taken place i s necessary before proceeding with the more s p e c i f i c problems wit11 which t h i s study has been concerned. Table 1 presents the broad s t a t i s t i c a l material of i n r e s ~ e c t the t a x revenue of the Center. 9. It w i l l be seen t h a t over the period of planned develop~~ierit +,he end o f the Third Plan, t a x revenue increased approximately fourfold ( m o ~ to p r e c i s e l y to 396% of i t s 1951-52 l e v e l ) ' ~ h i l s t during the Third Plan p r i o d i t has more than doubled the l e v e l a t which it stood a t ti.&end of the Second Plan Period (228% of the 1960-61 l e v e l ) . These increases represent average annual r a t e s of growth of over 1 0 p r c e n t (10.3%) i n the period since 19%-52 and of 18 percent over the l a s t f i v e years. Table 1: TAX TIEVENUE OF UNIOIIJ G9V!I,Ri\PIEIJT of ( ~ r o r e s Rupees) 1 9 9 - 2 1956-7 1960-1 1961-2 1 9 6 c 3 1963-4 1964-5 1965-6z -966-7 Actual Actual Actual Actual Actual Actual Actual Iieviseci Fst. A. Direct Taxes Corporation Tax b0.8 50.) 1 11 156.5 1. 221.5 274.6 314 33C 376 Income Tax 1b6.7 151.2 167.4 165.4 185.0 258.6 267 250 29b E s t a t e Duty 2.1 3.1 4.2 3.9 4.7 5 7 8 IJealth Tax 8.2 8.3 9.5 10.2 11 1b 14 Expenditure Tax 0.9 0.8 0.2 0.1 - 1 - G i f t Tax 0.9 1.0 1,O 11 . 2 3 1 B. I n d i r e c t Taxes 318.6 363.6 586,4 701.6 4 . 8 106.4 - -- - 12GO 1392 1576 -ms 232.9 173.2 170.0 212.3 246.0 334.8 398 531 565 Union Excise Duties 85.7 190.b 416.b 489.3 598.8 729.6 802 861 0 1 1 1 - - Total c e n t e r 506.1 567.3 878.0 1037.8 1265,9 1613.7 1799 2007 2269 Tax Revenue -1_ y IBRD Current Economic Position and Prospects of India, Re o r t of Bank Mission: Comments on Indian Tax System ( ~ m e x t o AS-91 A P. 10. The general forces c o n t r i b u t i n g t o t h i s development of public revenue were e l u c i d a t e d i n t h e detai'led study made by t'rie Sankt s missioll i n 1962 and they i n general provide t h e explanation of the more r e c e n t c h a ~ g e s t h a t have occurred. I n p a r t i c u l a r , the buoyancy of union e x c i s e d u t i e s has continued with an average annual r a t e of growth of 16 percent during the Third Plan Period. O t h e d i r e c t t a x e s , revenue from the Center1s corporation tax f has continued t o i n c r e a s e r a p i d l y going up by 1965-1965 t o three times i t s 1960-61 l e v e l . This increase, furthermore, has been a steady and cor,tL?uous increase and in t h i s r e s p e c t c o n t r a s t s markedly with t h e change i n revenue derived from personal income t a x a t i o n xJl?j.ch has k e n pe r s i s f s n t l y s l u g ~ l s h r i g h t through t h e 19501s and i n t o t h e 19601s but which e x p r i e n c e d a .Jeqr sharp r i s e of 40 percent from 1962-63 to 1963-6b. I n 1964-65, hornaever, t h e r a t e of growth f e l l t o a mere 4 percent and the rev5sed estimate i n d i c a t e s a f a l l of revenue i n 1965-66. 1.1 The only major change i n emphasis in the broad p a t t e r n of ti-ye Center's t a x s t r u c t u r e which has o c c u r ~ e dsince the previous Eank surt-e;r i s in regard to customs d u t i e s . Due to f o r e i g n exchange l i n i t a t i o ~ s and t h e , r e l a t e d enphasis given t o import saving within development ~ o l i c ; ~reveme frrnrr customs remained v i r t u a l l y s t a g n a n t throughout t h e 19501 s.l During the course of the Third Flan, hoirever, with both t h e volume of impor5s and t h e r a t e s or" duty increasing, revenue from t h i s source has k e n r i s i n g at, an average r a t e of over 25 percent per annum. C. The Buovancv of Tax Revenue 1 2, Variations over time i n t h e revenue derived fron; any t a x o r s t m c t u r e of taxes (i.e., t h e buoyancy of the t a x o r tax s t r u c t u r e ) a r e the o~ztconiegf the combi3ed e f f e c t of t h r e e independent f o r c e s : 1. Changes i n t h e s i z e of the t a x y i e l d which a r i s e "auto- matical.ly1I a s a r e s u l t o f , f o r instance, i n c r e a s e s i n consumption of taxed commodities, lncrea s e s in money income earned i n p a r t i c u l a r tax categories, e t c . These changes r e f l e c t the b u i l t - i n e l a s t i c i t y o f t h e t a x system, 2. Changes i n the r a t e of tax l e v i e d on a given t a x base. 3. Changes i n tiie s i z e of the t a x base which result from legislative,' executive decisions to include ( o r t o exclude ) 'income, e4vendi- t u r e , e tc., which was previously excluded ( o r included ) . U. The d i f f e r e n c e s in t h e way these three f a c t o r s operate a r e of considerable significance. T begin w i t h it r r s i l l i n gerieral be tnxe t h a t o - 1/ The 1951-52 f i g u r e i n Table 1, however, suggests an a c t u a l decline over the period of the 1950ts b u t t h i s i s misleading; revenue i n t h i s y e a r was i n f l a t e d by the s p e c i a l export d u t i e s imposed during the Korean boom. s I n f a c t revenue from import d u t i e s was 9 . 142.2 c r c r e s i n 1951-52 and had only r i s e n t o Rs. 144.5 c r o r e s i n 1956-57. t h e more a goverrmnt has t o r e l y on r a t e increases t o e f f e c t iccreases i n t tax revenue, t h e more s i g n i f i c a n t a r e l Y ~ e l y o become t h e i n d i r e c t e f f e c t s on taxation. This i s another r:ay of saying t h a t it i s Ln general undesir- able t o construct a t a x system on too narrow a base, f o r t h e burden on t h a t base and t h e d i s t o r t i n g e f f e c t s on economic decision-making a r e l i k e l y t o be considerable, 1, 1. This argues f o r constact a t t e n t i o n by t h e Goverrment Lo see!: means f o r \ridening t h e t a x base. P a r t of t h i s widening process :.;ill occu-r automatically i n a developing ecocomy a s incomes, expendi+,ure, e t c . r i s e and thus become embraced a t t h e margin within a previously e x i s t i n g %a;c s t r u c t u r e . It i s highly d e s i r a b l e t h a t a t a x system designed f o r mobiliziz; increas-ing development funds through the f i s c a l system should i f a c t have n t h i s dynamic element b u i l t i n t o i t s structure. I.Io:rever, p a r t of t h e ~:ider?Lr; process must take place by e x p l i c i t a c t i o n a t t h e legislative/executive Level. n This a c t i o n ~9.11 e c e s s a r i l y be constrained by both c o n s t i t u t i o n a l and administrative considerations r5*ich r.d.11 e i t h e r pose insuperable obstacles, o r obstacles rrhich trill Lake time t o overcome, These obstacles r . ~ i l l be a s i d e from t h e pure1.y p o l i t j - c a l considerations r,~hich, a s i n the case of decisions t o increase r a t e s of taxation, w i l l be dependent upon considerations of p o l i t i c a l policy and eqendiency. 1+L; . Given these considerations, what one i..~o111d wish t o see i n tihe broad p a t t e r n of development of a t a x s t r u c t u r e i s f i r s t l y t h a t i t i s s i g n i f i c a n t l y e l a s t i c with r e s p e c t t o changes i n aggregate n a t i o n a l income o r i n n a t i o c a l irxone per capita. Secondly, one would wish t o see an a b i l i t y and will:'.;;:<- ness on the p a r t of governine~tt o take a c t i o n t o viden the tax base bx autonomous action. And t h i r d l y , and l a s t l y , one would 3.sish t o s e e an a b i l i t y and r,illingness t o r a i s e r a t e s of -taxation. It must be re-eiil~hasized t h a t ar, a p p r k i s a l along these l i n e s i s l i m i t e d t o t h e resourcrc mobilizatlori ~ p o t e n t i a l of t h e t & system. The a p p r a i s a l ir, terms of t h e system's abl!.i'~~r t o induce favorable i n d i r e c t e f f e c t s o r t o avoid i ~ d u c i n gunfavorable 1;l- d i r e c t e f f e c t s , i s not included. I( . . Horr i n general does the Indian t a x system ernerde from such an appraisal-? I n the a n a l y s i s which follows t h i s i s looked a t f i r s t l y i n aggregate terms and secoadly a more d e t a i l e d a n a l y s i s of t h e t h r e e maJor c e n t r a l taxes (excise duties, personal income t a x and corpora ti or^ tax) i s undertaken, These t h r e e taxes accowlt f o r 00 percent of Union tw. revcr~xe, a. The Buoyancy of Aggregate Union Taxation i'I. I d e a l l y f o r t h e purpose of t h i s a n a l y s i s i t rrould be d e s i r a b l e t o have an ex-post s t a t i s t i c a l breakdown of t h e a c t u a l change in t a x rev?enue from one year t o t h e next (column (v) i n t h e followins t a b l e ) accordin2 t o t h e e;:tent t o which t h e change was the r e s u l t of a change i n t a x r a t e s or t a x coverase introduced in t h a t year o r was the r e s u l t of t h e ;ro~rth Li revenue a t previously e x i s t i n g t a x r a t e s o r t a x coverage introduced i n t h a t year o r was t h e r e s u l t of t h e growth in revexile a t previously e x i s t i n g t a x r a t e s ar,d coverage. Unfortunately no sclch ex-post breakdown of t h e aggregate i s a v a i l a b l e i n t h i s form and t h e aEalysis must perforce be undertaken on a l e s s s a t i s f a c t o r y basis.  OEN ET Table 2 : REVENTIE FROW UNIO?! G V R M N TAXEG' (Ps. Crores) Gross Tax Revenue T o t a l I n c r e a s e in Tax Revenue Est-Led Annual I n c r e a s e in Tax Revenue Actual Annual I n c r e a s e in Tax Year Revised 9/ (a) (b) Revenue Less Estimated I n c r e a s e Estimate Estimate Actual ~stimate&' Actual Difference from t a x changes o t h e r than from t a x changes in Revenue from Tax Changes Icolumn (v! minus Column ( v i i ) ) . . % of revenue $ of revenue in Rs. Crores i n previous yr . Crores previous y e a r (i) (ii) ( iii j (iv) v) (vi) (vii) (viii) (ix) (x) (xi) 196h-65 1672 1790 Total 1/ Coverage: Customs, Union Excise D u t i e s , C o r p o r a t i o r Tax, Taxes on Income, E s t a t e Duty, I/Taxes on Wealth, h p e n d i t u r c Tax, G i f t Tax. Estimate of forthcclning y e a r over r e v i s e d e s t i m a t e of p r e v i o u s year. / Percentage of r e v i s e d e s t i m a t e of revenue f o r 1 9 6 ~ ~ - 6 5 .  ' ':::lst c %i?xre~~e-nue avail- 3 e>:-p:, s t ' ~ y ~ a k o z~ i r~~ r ~ a s e d " c is 18. able, a n ex-ante e=tir:;ate i s i~adef o r individur?l taj:e;l !:hen t h e lin:;l.l.?l. budr;et i s presented. These e s t i ~ l e ' e sare r-edc cn the basis of revised e s t k a t e s of the revenue from each tax i i l the previnus .rear and are made a t the tine the budget i.s k.resenkd ?,ut befcre the > a s e:fpir?d. Thus the t o t a l ~ c t c a l inc_r.sase i rci.;rriue :rhich r i i i a l l v taites rjl3ce n (cn:l_wa v) ?,:illa q r f o r any yzar I1nl1, from til! estimatc z'iven i n C O ~ E T L ~ v ( i v ) firstl:; kccausc .Lhe revised ectirm hr: ( c o l u n ~ ii) f o r t h e ;'sai- '!n-?." ?:illvary frcm the actual revenue from t h a t year and secorLdlTT ~ C ~ U 'lie~ ' I S ac%ual revenue f o r the year 'InT1 rill vary from the 'undget estim:?te Tor t 5 a t year. The j c i n t e i f e c t of these i,vc i.ctcrs i s given i n colunn ( v i ) . 1. : The most s t r i k i n g f e a t u r e of t h i s table i s .the very marlred extent t o trhich Finance I-EnFsters when framing t h e i r budgets have r e l i e d up02 r a t e changes and changes i n tax coverage t o gecerate the increased revenue t,hey have considered desirable. Only 2s. 163 crores or 25 percent of a to+,al estimated increase of Rs. 645 crores i n reveme over the period 1959-60 t o 1964-65 was expected t o be the outcome of the b u i l t - i n e l a s t i c i t y i n the t a ~ structure. Furtierinore, trhils t there has been considerable varia.tion around t h i s proportion i n p a r t i c u l a r years there has been no consistent treiid eveli if w ignore the extreme]-7 l o x proportion of 7 per- e cent resulting froni tne emergency budget neasures i n 1963-64, IIo~~ever, of the p i c t u e changes if the r~~hole the differences between estimated arc! a c t u a l revenue collections each year a r e a t t r i b u t e d t o under-estii;;a.tiol?s of the ~ i a t u r a lg-rol-hh of revenue a t ?re-existing r a t e s (columns (x) az2d ( , a * ').a n d none attribuiied t o the under-estinaiion of revenue from tax -- ) change:;. Thus c o l m ( x i ) i n e f f e c t gives the n z i m u m r a t e of buil-L-in e l a s t i c i t y i n the tax structure and column (kc) the miniinurn rate. nr L\J, To the extent t h a t the under-esthatlon oii future reveliue collections r e f l e c t s the f a i l u r e t o a l l o v f o r r i s i n g prices and Lllflafio:~ary increases i n income r a t h e r than any natural ccjnserra~;isn on the part of iYnisters of Finance, Vne minimum s e r i e s must be talcen a s the more r e a l i s t i c picture of the b u i l t - i n e l a s t i c i t y of Union t a x revenue. If t h i s were t o be accepted then there rrould be considerable cause f o r concern regardb: the future, f o r a llnaturaiT1a t e of grorsLh of around r 1,s percent annualljr 2s in four out of the past six years, or even a r a t e of 3 or 5 percent as i n the 1-emaining t1,70 of these years, i s very much belorr the annaal r a t e of ~rorsthof 8.5 percent i n Union tax revenues a t existin; r a t e s projected 5y J the iborkinz Group on Iiesources f o r the Fourth Pian. 21. There i s reason t o believe, however, t h a t the nininiurn figure i s grossly u n r e a l i s t i c and t h a t whilst. some deduction frorn the percen-ca;es given i n column ( x i ) must be made t o a1loi.r f o r the price r i s e f a c t o r , t h a t these maximum figures give a more r e a l i s t i c picture. averade of these maxim~un r a t e s i s 10.6 percent and the difference betr~eent h i s and the i.7orkLng Groupt s estimate of 8.5 percent, i s probably more than adeqaate t o cover the e f f e c t of inflationary increases i n incomes acd prices. 22. Tk:e j u s t i f i c a t i o n f o r t h i s i s t o be found i n t h e a n a l y s i s of p l a n f i n a n c i n g though this cov2rs b o t h S e n t x r and S t a t e revenue. Average Annual Ra'ie of Growth i n Tax Revenues through Nerr Taxation and a u d g e t Automa-tism - Center and S t a t e s F i r s t Plan Second P l a n Third P l a n A d d i t i o n a l Taxation 2.5 '7.8 8.2 Automatism 1.7 5.4 7 -5 ~ o t a i n c r e a s e from pre- l Plan l e v e l 4.1 11.6 . I!J o 23. These e s t i m a t e s a r e n o t d i r e c t l y comparable w i t h t h e animal f i w r e s irl Table 2 d e r i v e d from budget accounts. This a r i s e s n o t ox1.g from t h e f a c t t h a t t h e S t a t e s a r e i n c l u d e d b u t a l s o because t n e s e e c t i m a t e s c l a s s i f y i n c r e a s e s in revenue from a d d i t i o n a l - t a x e s -imposed a t any time d u r i n g e a c h Five-Year P l a n p e r i o d a s a d d i t i o n a l t a x a t i o n rt~hereason a n annual b a s i s such revenue i s i n c l u d e d a:: a u t o m a t i c a l l y al-is1hg e x c e p t i n t h e i n i t i a l ~ 7 e a n i~ which it i s imposed. i ? e v e r t h e l e s s t h e b u i l t - i n r a t e o f growth suggested by t h i s t a b l e i s now a b o u t 9.5 p e r c e n t and, i f we a l l o w both f o r t h e rr,ore dynamic n a t u r e o f Union t h a n o f S t a t e Taxes and f o r t h e underestimate r e s l ~ l t - 21g fran t h e c l a s s i f i c a t i o n procedure rrentioned above t h e n t h i s ra t~ s u g y e s t s t h a t -the maximum e s t i m a t e r e s u l t i n g from the p r z v i o u s e x e r c i s e i s proha5l.y r e a s o n a b l y c o r r e c t . Allowance must, of course, s t i l l be rnade f o r t ! e f f e c t ~ p o f i ~ f l a t i o n a r y r i c e and incoma i n c r e s s e s on revenue r e c e i p t s from f ived t3x r a t e s . 24 h e f u r t h e r i m p o r t a n t c o n s i d e r a tio;? must be b120ught i n b t h e p ' l c b ~ e v~henmaking o? judgment on t h e r e a s n a b l e n e s s of t h e ' b r k i n g Groupsr est5-xate . o f an 8 5 p e r c e n t n a t u r a l r a t e o f growth o f Union revenue. This i s t h e %;*end i n t h i s r a t e and it i s a p p a r e n t from Table 3 t h a t f o r Center and S t a t e s com- bined - and a f o r t i o r i f o r t h e Zenter a l o n e - t h e changes ir %he t.ax s t r u c t u r e :~hic!.l have ;>;en i n t r o d u c e d s i n c e 1951 have n o t o n l y i n c r e a s e d (both a b s o l u t e - l y and r e l a t i v e l y ) t h e amount o f a d d i t i o n a l tax =venue r a i s e d i n each p e r i o d compared w i t h t h e p r e v i o u s pried, b u t have a l s o g i v e n t h e t a x s t r u . c t u ~ r ! more b u i l t - i n e l a s t i c i t y . In t h e Second and Third P l a n p e r i o d s t h e l m i l t - i n r a t e of growth has been much Grea k r t h a n i n each of the ~ , s y - > c t i v e p r e v i o u s P l a n p e r i o d s so t h a t i f t h i s t r e n d c o n t i n u e s i n t o t h e F o u r t h I"lan, and t h e l'orking Group's e s t i ~ r ~ a t e s o u r own c a l c u l a t i o n s , both o f ?rhich a r e based. on p a s t e q e r i e n c e , a r e l i k e l y t e r r cor1.siC3erah1:7 3n the lox(: s l d e . o Once a g a i n , nowever, it must be emphasized t h a t r i s e s in m-ones i ~ c o r r e:~r.associ- a t e d rqith r i s e s k r e a l income l e a d t o d i f f i c u l t i e s i n i r ; t e r p r ~ , t i n g p a s t i e x p e r i e n c e a s a guide to t h e f u t u r e f o r which const,ant p r i c e s a r e assw~leci. Z e r t a i n l y klle markedly more i n f l a t i o n a r y s i t u a t i o n which ha s p r e v z i l e d d u r i n g e t h e T h i r d P l a n p e r i o d a s compared ~ ~ 6 tthh 1950r.s must o u a l i f y t h e concl1:sion of this paragraph. b. The Buoyancy of Union Excise Duties -. = n. - ,. - 25. The only a v a i l a b l e ex-post study of t h e f a c t o r s which have contributed t o t h e crease i n e x c i s e duty revenue covers t h e period 1953-54 t o 1 9 6 1 - 6 2 7 Whilst t h i s i s somewhat dated i t does provide a u s e f u l s t a r t i n g point f o r t h e a n a l y s i s of more r e c e n t changes, 76. The t o t a l revenue from these d u t i e s after deducting tile S t a t e s 1 share in then, increased by Rs. 331 crores from Rs. 79 c r o r e s in 1953-s$ t o R s . h l 0 c r o r e s i n 1961-62e This i n c r e a s e was derived i n t h e f o l l o x i n g manner : . 1 Revenue from increase in consumption of goods taxed i n 1953-54 and of goods s u b j e c t t o t a x i n subsequent y e a r s Rs. 66 c r o r e s 20% 2. Revenue from increased r a t e s of duty RS .l9b crores 53% 3. Revenue from increased coverage - Rs. 7 1 c r o r e s 22% A Total Rs.331 -- crores 100% 27. The b a s i s of t h e d i s t i n c t i o n be-t;\reen t h e f i r s t and second f a c t o r s i n t h e above t a b l e i s simple in r e s p e c t of goods a l r e a d y taxed i n 1953-5L though not n e c e s s a r i l y simple t o q u a n t w . For goods s u b j e c t t o tax f o r t h e f i r s t time a f t e r 1953-St the breakdo-m i s e f f e c t e d by attri'outing t o f a c t o r "311 (revenue from increased coverage! t h e revenue r a i s e d from t h e neta Lax in t h e f u l l f i n a n c i a l year following t h a t i n which each item w a s introdzced. The remainin; revenue i s then attribuLed t o increased consumption of t h e item s i n c e it becarce taxable and changes i n t h e r a t e of t a x upon it. 23. One of t h e s t r i k i n g f e a t u r e s of t h i s t a b l e i s t h e r e l a t i v e l y small importance of increased coverage of e x c i s e duty i n generating increased revenue e s p e c i a l l y in Lhe l i g h t of t h e considerable e f f o r t s made by t h e Government over t h e period t o widen t h e t a x base. Furthermore, t h i s s t i l l appears t o be t h e case i n r e s p e c t of t h e extensions made i n t h e t a x sub- sequent t o t h e above s t a t i s t i c a l a n a l y s i s being made, From t h e s i t u a t i o n in 1953-54 when 15 commodities were taxed (tobacco, cotton c l o t h , sugar, matches, t i r e s and tubes, vegetable products, motor s p i r i t , t e a , coffee, s t e e 1 ingots, kerosene, a r t i f i c i a l s i l k , soap, cement and f o o t t ~ e a r ) t h e , coverage has expanded u n t i i in 1962, 67 commodities were covered and 69 in 1965. Yet t h e following t a b l e i n d i c a t e s t h e r e l a t i v e l y small increase i n revenue xhich has r e s u l t e d from t h i s increased coverage. Proportion of T o t a l Excise Revexue i n 1964-65 derived from: ( a ) 15 commodities taxed up t o 1953-54 .. . .. .. .. between. 1953-54 and 1959-60 D O e 59% in 1960-61 . .. .. .. ( b ) 17 commodities taxed f o r t h e f i r s t time 25% i n 1961-62 . .. .. .. ( c ) 9 commodities taxed f o r the f i r s t time 1% (d) 16 commodities taxed f o r t h e first ( e ) 10 commodities taxed f o r t h e f i r s t time timein 1962-63 . . .. .. a 7% ;8 : -/ r t I of t h e Central Excise Reorganization Committee, 1963. 29. Dimiriishhg returns t o increased coverage should xot be silr- prising. I n f a c t broadly 26 additional excisable commodities have been introduced during both "ve Second and Third Plan periods but a t the moment the 26 iEtroduced during the Second Plan a r e almost twice a s productive of revenue a s those Lntroduced i n the 1960's. Likewise i n t h e i r t u r n the 1s duties i n existence before the Second Plan a r e aSout twice a s important i n terms of revenue production as those introd.uceci during the Second Plan. Nany of the items included i n excise duty coverage in the l a s t decade have yielded l i t t l e more than one or two crores of revenue in 1964-65 and only a handful - notably d i e s e l o i l , i r o n and s t e e l products, cotton yarn, motor vehicles, and rayon- have yielded more than 10 crores. 30. Unless basic foodstuffs :are t o be taxed or a comprellensi.~e t a x imposed on services including the d i r e c t emplopent of domestic labor - both of which f o r d i f f e r e n t reasons w would not approve of e this - tendency t o diminishing returns from the extension of the excise tax base w i l l continue. It follows t h a t any autonomous a c t i o n by the Government t o reinforce the b u i l t - i n f l e x i b i l i t y of excise duties, would have t o be effected perhaps even more than in the past primarily through the inposition of steeper r a t e s of tax. ?I-. The attached chart indicates the l e v e l t o which tax r a t e s had been pushed by 1963-64. The r a t e s a r e expressed ad valorem on the basis --I- of the whole output of each comrnodl~~ irrespective of whether a i l the items within any- category or only a proportion of them a r e subject t o tax. Thus a low tax r a t e might ind5cate e f f e c t i v e l y a narrotring of the t a x base through exemptions or through concessionary r a t e s r a t h e r than a c t u a l l y low r a t e s on the p a r t l c u l a r items within the commodity category ~ l h i c ha r e subject t o tax. SJhilst r a i s i n g the r a t e i n such cases could be interpreted a s a xidenin2 of t h e tax base i f i t i s obtained by reducir~: the range of exemptions or of concessionary r a t e s , i n f a c t on the basis of the analysis given i n the chart it rrould be reflected i n an increase in the ?ate of tax. 32. The wide v a r i a t i o n i n r a t e s imposed i s immediately apparent. O f course the highest r a t e s of over 3CO percent have bee2 imposed f o r balance of pa,ments reasons on d i e s e l o i l and mo5or s p i r i t - and t h i s i s a l s o i n p a r t t r u e of the tax on kerosene - but whatever the primary motrve the i n t e r n a l f i s c a l e f f e c t on private disposable income i s s t i l l operative. What i s very s t r i k i n g i s the f a c t t h a t two-thirds of the commoditi.es a r e taxed e f f e c t i v e l y a t r a t e s below 20 percent, Even leaving aside those materials a d intermediate products such a s pig iron, soda ash, i r o n and s t e e l products, s t e e l ingots, aluminium, copper and copper allo;rs, etc., where f a c t o r s other than the reductiol? of personal disposable r e a l income a r e l i k e l y t o have detemined tax r a t e s , t h i s s t i l l leaves many conmodities r,rhich enter i n t o personal consumption and p a r t i c u l a r l y luxury consumption upon rhich the r a t e of tax i s quite lovr - i n t e r n a l combustion engines, foot- rrear, woolen f a b r i c s , e i e c t r i c motors, cinematograph films exposed, s i l k f a b r l c s , e l e c t r i c fans, coffee, motor vehicles, chinaware and porcelainxrare, wireless s e t s , ~ramophoncs, cigare t t ~ and tobacco. s  0 20 40 60 00 0 10 I20 140 160 100 LOO I 'L , SILVER ............ ............. 2. COTTON YARN. TWIST B T R A . H ED I PIG ..... .....-. . . . . . - . . . . . . .I , S M A ASn-.. ....... ....... -.------.I 1 IRON 8 R D CS STEEL P O U T . I 6 PETROLEUM PRODUCTS N . 0 S. r .. 7 &YER,NE.. ..........-.--.-...-... ........... I A R T SILX . . . . . . . . . . . . I 9 CAUSTIC SODA .......... .......... I CENTRAL EXCISE la ELECTRlC WIRES B C A B L E S - - ---------I $1 M G . N O N ESSENTIAL O I L S I P R O C S S S E D > . - I IP'COTTON FABRICS IP.L.I---------- ---- I 3 INTERNAL COMBUSTION ENGINES. IQSTEEL INGOTS.-. - - - - - - - - - - - ----- #%PATENT M E D l C l N E S - - - ....... ....... LI N U 16 A,I" , PLY WOOD. -. .- - - - - - - --- - -- -- la SOAP ------- - 19 ASBESTOS CEMENT PRODUCT-- -------- Z I T C O W E R 8 COPPER ALLOY-------- --- ............. 2, *INc . . . . . . . . . . . . . a ACIDS .............. 21 F O O T W E A R . ............---------- WOOLLEN FABRICS- . . . - - - - - - - - - - - - . 2s ELECTR,C MOTORS .................... X CINEMATOGRAPH FILMS EXPOSED...... 2, SILK FABRICS 28 ELECTRIC FANS-.. .--- - .--.. - 29 SUGAR I("ANOSARI.. ...-...-.--.... %JUTE MANUFACTURES ............... X I C O F c E E .........----.--.-....... VEHICLES.. .--........--.-.-. . S ELEC. B U L B S 8 FLUOREXENT T U B E S - - - - - Z4 CHINAWARE 8 P O R C E L A I N W A R E - - - - - - - - 3) T E A . . . . . . . . . . . . . . . - - - - - - - - - - . =GLASS 8 GLASSWARE--------.----- 37 WIRELESS RECElVlNG SETS........... % ............-............. GRAMOPHONES. ............-.-- a WOOLLEN YARN. ........-......... 41 S I N T H E n C ORGANIC OYE S T U F F S - - - ------ - 42 ELECTRIC BATTERIES .........-...----- a PAINTS B VARNISHES........ OL VEGETABLE PROOUCT....... ......... 6 COTTON FdBRICS (COM M I L L S 1 ----- ---,- 4, PLAST,CS ....................... 4 C E L L O P H A N E ..................... 8 49 P A P E R . . 'Yl TIN PLATES ........................ .............-.-.... I L F 4 5 ASPHALT, B I T U M E N 8 T A R - - - - . - - - - - - - Y R A n N 8 SYNTHETIC FIBRES 8 Y A R N - - - Ei 5% COSMZTICS B TOILET P R E P A R A T I O N - ~ - ~ - - ~ % CIGARS 8 CHEROOTS ................. --- -- AIR-~~N~OX$~~~G 5 5 REFRGERATING 8 I SUGAR b PI.. ," ..............---. ....................... 58 T I R E S ...-..................-- ')9 CYCLE P A R T S ...................... a FUR,CE ' OIL.. ...............-... 6 1 C,GARETTES. ..--...........-.----. ..... 62 UNMAUFACTURED TOBACCO- . . . . . . Q OlESELOIL N O S .................... W MATCHES. ..................... ........................ 66 vApORISING OIL.. ...........-....- 6 7 MOTOR S P I R I T ................---. ALL COMMODITIES----- - - - - VEGETABLE O I L S 8 FATS---------- I MIX B H A ~ I N E R I T R A N S P O R T EOVIF'MENT--- MANUFACTURED F O O D. . . . . . . . . . ......... MANuFMuREO B E M R A G E S A N D TOBACCO- MINERAL FUELS LUBRICANTS AND-- RELATED MATERIALS. COO5 aIfMAz.- -- ARTICLES------ ------ - L. - 33 . Whilst autonomous increases in revenue from excise duty must, then, i n the future more so than i n the past, be senerated by r a t e kc-reases the need t o do so i s now l e s s than i n tile past, This i s due t o the f a c t t h a t the increased s t r u c t u r e of r a t e s and coverage which now e x i s t s as compared with previous years has increased the built-in e l a s t i c i t y of excise duties. This can be seen from the following table. These sho:r f o r each year the anticipated increase i n revenue over the revised estimate of the previous year a t the r a t e s of tax existing i n the f i r s t of each p a i r of years. Table 3 : B C E ESTIlHATES O BUILT-IN ELASTICITY O EXCISE I)UTTi?S U GT F F Ex ante estimates of increase - Percentage ex ante Estimates of r Y . - I in ~xczse Revenue over Previous Year before Tax Changes Increase i n Excise Revenue over Previous Year before Tax Changes - 1959-60 Rs. 6 crores 1960-61 RS. 8 crores 1961-62 Rs. 1 1 crores 1962-63 RS. 2 1 crores 1963-64 Rs. 30 crores 196L-65 RS. 47 c r o r e s y 1965-66 Rs. 54 crores 1/ Revised estimate f o r 1964-65 5 3b. It i s apparent t h a t since the end OZ the Second Plan period the estimated b u i l t - i n r a t e of gro-Ah of excise duty a s estimated ex a ~ t e a t budget time has approximately trebled f r o ~ n2-3 percent t o around 7 percent. --- Thus the predominance of the autonomous f a c t o r s - Z p a r t i c u l a r l y o r a t e clianges - the i n the past, can be viewed a s r e p r e ~ e n t ~ g e s s e n t i a l groundwork necessary f o r making the excise duty a more dynamic tax instrument. -, ' ; -,i; . Ho~!~ever, whilst t h i s increased e l a s t i c i t y of the tax i s significant, i t s t i l l f a l l s markedly short of the 11.6 percent riatural r a t e of growth assumed by the idorking Group on Resources. 1% is b;rptk2c to 2sswfi-s t h a t a s i g n i f i c a n t part of the difference bettreen, say, a 7 percent bui1.t-in r a t e of growth and the actual r a t e of growth of revenue over the Tnird Plan period of 1 7 percent has been the r e s u l t of an underestinlation of the nakdral of S u n - ? ~ c y of erci-se' ,?utizs ra-bhcr than an underestima t l o ~ i the e f f e c t of r.3+2 2nd coTd7<:rage cliznges. It i s , h o ~ e v s r , dangerous t o d.c; so. The follorrin,- table indicates t h a t an average annual increase of almost 9 percent i11 revenue has beer, budgeted f o r d u r i ~ g the Third Plan as a r e s u l t of tax c h a ~ g e sthough the changes i n the 1963-6h budget sometihat d i s t o r t the general picture i n t h i s regard. Nevertheless unless the estimates of the revenue implications of budget changes ( p a r t i c u l a r l y those i n 1963-64), have been exaggerated, there i s i n s u f f i c i e n t difference between the aggregate budget estimates i n the t a b l e (average 13.7 percent) and the 17 percent a c t u a l increase i n revenue t o enable the 11.6 percent natural increase assumed by the itorking Group t o be attained. Thus i t s attainment must be based on the favorable trend in t h i s regard which was noted In nara. 33 above. Table k: PERCENTAGE BWCT ESTDWEZS O IFCFij3ASES 1 1 EXCISE EVZIJUE F 1 ATTRIBUTABLE EX A T TO ( a ) BUILT-IN ELASTICITY AND (b) BUEET CIIi:GZS NE (a) Built-in Elas3icity (b) Budget Changes Average 4.8% . 8 9$ 1/ c. The Buoyancy of Personal Income Tax- I__ 36. Tabulation of t h e d e t a i l e d income t a x revenue s t a t i s t i c s i s always s e v e r a l years delayed and unfortunately the most recent s t a t i s t i c s t h a t a r e a v a i l a b l e a r e iii respect of t h e f i s c a l year 1961-62. Number of Assessees I_- Icccne Assessed I-=--- R s o crares -, m. z d Rs. crores 3.; . The period of six years covered by t h e above t a b l e was oce over t ~ h i c hn a t i o n a l income increased by 50 percent and per c a p i t a a a t i o n a l income by n e a r l y one-third. Despite t h i s i t can be seen t h a t revenue from personal income t a x a t i o n increased by only 42 percent, FurfJherriore, t h i s modest increase rlms e f f e c i e d only a s a r e s u l t of a very conslzlcrable expansion of t h e tax base i n terms of t o t a l assessed inconies of 75 percent vhich was i t s e l f dependent upon a doubling of t h e number of assessees. This expansion of t h e tax base i s c e r t a i n l y t o be r,:elcomed. i n f a c t i n t a country i n 1-~hich h e r e a r e 27 million nori-faim househo1.d~esrninz RE. 5,500 crores, t h e tax base of 1 million assessees and l e s s than . R s 1,000 m o r e s of assessable income s t i l l appears very narrow, :;o:!e-,rer, even with t h e ~ n d e n i n gof t h e base t o t h i s extent, a t a x system t a i l o r e d t o t h e need f o r an increased mobilization of resomces, shou1.d certairlly have generated an expansion of revenue considerably i n excess of t n e 42 percent achieved over the period given t i e 30% increase i n per c a p i t a n a t i o n a l income. The f a i l u r e t o do s o i n IndLa must be a t t r i b u t a b l e p a r t l y t o changes i n t h e s i z e p a t t e r n of assessed income and p a r t l y i o t h e s t r u c t u r e of t a x r a t e s which a r e levied. 3- The following t a b l e r e f l e c t s orie of t h e major chanzes i n the s i z e d i s t r z b u t i o n of assessed incomes over t h e six-year period. - iIncomei dTax,l sSuper-tax,Hindu Undivided families. Deposits l e v i e d upoil i/ n ~ v u a and upon Surcharges and Anquity  Plumber of Assessees T o t a l assessed income over Rs. 5 lakhs 1h3 101 11 II 11 R s . h lakhs 230 162 11 II II Rs. 3 lakhs 370 298 II II Rs. 2 lakhs 740 4 60 2C >, . It can be seen t h a t the rlumSer of taxpayers in these to? iinco:l:e brackets apparently declined over t h e period, KO-tever, altho1:gh i r ~ 1955-56 t h e 7h0 taxpayers assessed with income of more than R s . 2 lakhs accounted f o r less than 0.2 percent of t h e t o t a l number of taxpayers, they accoun-Led f o r almost 6 percent or" assessed income and f o r 25 per- cent of t a x revenue. The decl-ille t o 61~0 i n the number cf taxpayers Ir, t h i s category reduced t h e i r assessable income from 2s. 32 c r o r e s in 1955-56 t o Rs. 25' crores i n 1961-62 and t h e i r t a x payment i n t h e sarl.e r a t i o from Rs. 22 crores t o Rs. 17 crores ( s e e t a b l e beloauj, This decl?ne, furthermore, reduced t h e c o n t r i b u t i ~ nof these taxpayers t o t o t a l assessed income and t o t o t a l payment in 1961-62 t o $5 percent, and 13 percent respectively. Assessed Income and Tax Payment of Per sons and ISindu Undividad Families Having Assessed Income i n Excess of Rs. 2 l a l l s - -- Assessed Income R s . crores - Tax paynent R s o crores _ P - L9. This change i n t h e assessed income s t r u c t u r e could in p r k l c i n i e be t h e outcome of a p o l i c y t o reduce extreme i n e q u a l i t i e s i n tile dis- t r i b u t i o n of income. I n these circumstances t h e e f f e c t on both the absolute and t h e r e l a t i v e contributions of t h e high income groups t o t o t a l t a x revenue r~ouldhave t o be accepted ( z i v e n t h e r a t e s t r u c t u r e ) a s a necessary conconlitant of t h a t policy. I n the circumstances i n India, hovever, t h i s change i n the assessed income s t r u c t u r e can be i n t e r p r e t e d a s a r e f l e c t i o n not of any marked change in income r c c e i v c d \ a t t h e t o p end of t h e income s c a l e over t h i s period s o much a s a r e f l e c t i o n of increased evasion aiid avoidance of taxation. 1: 4 . l l h i l s t t h i s change i n the s i z e d i s t r i b u t i o n of assessed inccne i 1~oit.d n general c r e a t e revenue problems when t h e r a t e s t r u c t u r e i s progressive, the problem i n I n d i a has been aggravated by t h e p a r i i c i l l a r r a t e s t r u c t u r e which has been introduced. For w h i l s t t h i s stru.cture i s very highly progressive a t the top end of t h e income s c a l e and, i n f a c t , reaches some of t h e Kghest r a t e s anj- here j.n the world, belotr t h i s l e v e l t h e r a t e s a r e very modest. Certainly a t incone l e v e l s be lor^ R s . 20,000 p e r annun, a s the follorsing t a b l e shoars, t a x r a t e s i n 1961-62 were very lor^. Yet over 94' percent of assessees were t o be found belox t h i s level. It i s not s u r p r i s i n g t h e r e f o r e t h a t r d t h t a x r a t e s a t t h e l e v e l a t r.~hichtheg- stood i l i 1961--62 and with so l i t t l e progression up t o t h i s incoKe level, t h a t t h i s 95 percent contributed l e s s than 20 percent of t o t a l personal income tax revenue, I f the decline i n the absolute number of assessees a t the top end of tile income scale and of the aggregate of t h e i r assessable incomes, tEre not t o undermine the buoyancy of the personal income tax, then the l e v e l of r a t e s farther down the income s t r u c t u r e and the degree of progressiveness they imply, should have been markedly increased. I n any case irrespec%ive of the decline i n assessable income which has taken place a t the top end of the income scale, i f income t a x i s t o be made i n t o a more dynamic source of revenue f o r development purposes, the l e v e l of r a t e s ar.d the degree of progression loruzr dorm should have been stepped up. C 4 ~ . In f a c t i n 1963-64 such an increase ; a s e f f z c k d - t h r o u a the imposition of a special surcharge of percent on the lovest incolre t a :- payers r i s i n g pro,:ressively t o 10 percent, The e f f e c t of -this surchar,e on t o t a l tax revenue i s apparent from Table 1 After a ].on2 period of . sluggishness during which income tax revenue a c t u a l l y declirAedfrom 1.763-61 t o 1961-62 and increased by Bs. 20 crores frorr, 1961-62 t o 1962-63, i n 1963-6L it shot up by 3s. 73 crores - an increase of 40 percent, The surcharge was abolished i n 196i~-65though on income l e v c l s abovg 3s. 15,000 i t has been replaced by an L m u i t y Deposit schexe. l: i the t a x changes of 1964 and 1965 i t can be seen from the t a b l e ti1a.t tax r a t e s have f a l l e n very h e m f l y from t h e i r 1963-64 l e v e l and t h a t f o r 1965-66 they a r e c o n s i s t e n t l j lo-mr f c r a l l ilrcome groEps compared r d ~ i l 1964-65. They a r e i n f a c t l i t t l e higher than -the 1961-62 r a t e s ar.d corn- pared 16th t h a t year a r e loirer f o r incomesup t o 2s. 5 , 0 0 0 , ~ / Tab!.e 5: EF!?ECTIE RATES O DJCO;B T X ON INCOidE I.EIOLi;YEARIGD~! AT SE3CV.D F P LEVELS O IlJCOT/IE F R IiARKED TAXPA322 !.IITH i-2022 THAN 0I.B C:!ILD F O (in perceni; of taxable income) R s . 3,OCO L,ooo 5,000 6,000 7,000 8, oco 9,000 10, OOC 15, COO 20, OGO -/ Differences in r a t e s of tax on a holly earned and on wholly unearned income do not become operative u n t i l income l e v e l s above Rs. 10,000 and e- en then the difference i s q u i t e snall. Y A m u i t y Deposit scheme becomes e f f e c t i v e a t income l e v e l s above R s . 15,000 (graduated r a t e s from 5% a t the botkom t o 12.5$ on incomes above Tcs. 70,OOC ---- The F e ' r u a r ; 1966 ')udl,et has reduce:' ra k s or i~lconesUI) t o Rs. 7,k30. For h~comes2'r)ove & i s l e v e l t'm r a t e s nl-e s l i g h t l y hiyh-2r; e.g., a t 3s. 10,000 t'ne r a t e r i s e s from 5.45 t o 5.63 an? a t 3s. 15,080 it r i s e s from 8.6;~ to 9.2%. Thus the rattts are s t i l l mc:rl:edl-y lower than the 1964-65 r a t e s . !43. It i s a t t h i s point t h a t disagreement a r i s e s regarding the p o l i t i c a l / s o c i a l f e a s i b i l i t y of signlf i c a n t l y stepping up the r a t e s of tax imposed upon those who i n f a c t constitute the Indian middle class, other than i n a short-run emergency s i t u a t i o n a s i n 1963-64. O the n one hand there a r e those who argue t h a t in absolute terms people tsho earn say, Rs. 5,000 per annum and even those who earn Rs. 20,000 per annun a r e by no means r i c h i n absolute terms and thus t h e i r a b i l i t y t o pay taxation i s not so great t h a t any permanent increase i n tax r a t e s t o d l i c h n they are subject can be contemplat,ed, G the other hand, there a r e those rl~hoargue t h a t I!richnesslt i s a r e l a t i v e term and t h a t within t h e i r osr! country these people a r e earning incomes many tirnes greater than the average income. Both these argumenb have been presented with a wealth of s t a t i s t i c a l support t o indicate i n the f i r s t case t h a t the Indian incoxe receiver i n the middle-income groups i s already overtaxed as compared with people i n l'comparablelt income groups i n other countries and in the secoild case t h a t he i s under-taxed by comparison with people i n these same countries, viz: 1st Argument - - Percentage w of Income Taken i n m T G j . e d Individual with T o Children Income India U.K. U.S.A. Japan Burma 2~Ial.aya Rs - d P - % - d ' ,J . - - % % 7: 10,000 6.9 004 nil 12,9 5.8 1-.2 20,300 1.6.8 12.3 8.6 20.0 13.3 3.8 Source : B. A. Palkhivala : "Tne Highest Taxed I J a t i ~ n ~ ~ . 2nd Srgurriei~t - - of Burden U - . P - Taxes on Income i n Selected Countries i n Recent Ysars-DC Income taxes paid on income a t vsri- Country Level of income up t o which no ous income levels - taxes paid as a tax i s paid ( s t a t e d a s a m u l t i - percentage of earned income t o Se ple of average p e r c a p i t a income) LO 20 100'r- times the per capita natiorial incomc -. India U.K. U.S.A. Japan Burma ?Ialaya Source: U.N. Economic Survey of Asia and t h e Far East, 1960, - &!I .. There seems l i t t l e doubt t o us t h a t the f i r s t argument i s extrenely xeak. To bef:in with there a r e i n f a c t deveLoping countries which even a t the low absolute levels of income pertaining in India, have imposed a heavier income tax burden than i n India. Japan i s already i l l u s t r a t e d i n the f i r s t argument above and I s r a e l i s a f u r t h e r case.  Arnual Income i n Rupees Converted a.i Tax a s Percentate of Income O f f l c i a l Rate of Exchan~e India Japan Israsl 4,500 6, coo 9yOCO 12,000 15,000 20,000 Source : Extracted from Flanriing Commission Paper: l l h u a l Pl-sri 1963-64 - The Fiscs.1 Task I' j., 5 , However, on more general grounds it seems t o us t h a t the discussion of the income t a x problem merely r a i s e s i n a f a r rnore obvious and expllcii; form than the discussion of other t a x and pseudo t a x measures, the most general of a l l problems ? e l a t i n g t o the mobilization of resources f o r devel- opmenfu in an ecoi~omyin which per c a p i t a income i s extremely lo:!. This is simply the question, asswntng the absorptive capacity e x i s t s which enables u a s u f f i c i e n t voltllne of i n v e s t i b l e resources t o be e f f e c t i v e l ~ t i l i z e d f o r the r a t e of growth of n a t i o n a l income by say, 6.5 percent ( t h e Fourth Plan Target), whether it i s l l f a i r l l , llpracticalll, " p o l i t i c a l l y f e a s i b l e n , etc., t o squeeze domestic consumption t o t h e extent n e c e s s a v t o mobilize the resources which sucn an investment e f f o r t requires. If reservations were t o be e n t e r t a i n e d regarding t i e f e a s i b i l i t y of pusbk-g the ilzcome t a x e f f o r t t o t h e extent required because of the poverty of v i r t u a l l y a l l sections of t h e community i n absolute terms, then these reservations must equally be entertair-ed f o r a l l branches of t h e f i s c a l e f f o r t a l b e i t t h a t these a r e l i k e l y t o squeeze consunlption l e s s explici.tly by r a i s i n g consumer goods prices. I n f a c t the reservatioris ir! respect ol" these other measures would presumably be magi~ifiedby the redliaa-Lion Lhat tax measures other than income taxes (and c a p i t a l taxes) would i n a l l probability Zmpose themselves on those v~hoa r e poor not only i~ absolute terms but a l s o i n r e l a t i v e terms. Thus t o e n t e r t a i n such reservations tiould be tantamount t o saying fuhat the a b i l i t y t o mobilize increased resources domestically had been exhausted and t h a t e i t h e r the r a t e of investment and of growth must be reduced o r a l t e r n a t i v e l y , r e c o g ~ i z j n g ( a t l e a s t by hypothesis) t h a t t h e devel-oprnental p o t e n t i a l of t h e count;-y ' ~ o u l d ,a s a consequence, be under-utilized, the volume of n e t c a p i t a l 5nr~or.t~ should be stepped up. Whilst the degree of p o l i t i c a l d i s c i p l i n e ar,d en?.ighlen- e ment t h a t i s required w i l l be high, w do not accept t h a t the capacity t o r a i s e increased developmental resources through t i e f i s c a l system has been exhausted and thus ws do not accept the b a s i s of the more s p e c i f i c arguineiit of Case I above i n respect of r a t e s of income tax. d. The Buoyancy of Corporation Tax -- 116. The most buoyant of a l l the taxes l e v i e d by the Center has been the corporation tax. Over the period of the f i r s t f o u r years of t h e Third Plan the revenue from t h i s t a x has r i s e n . more than t h r e e f o l d from i t s 1960-61 l e v e l of Rs. 1 1 crores. It is, furthermore, t h e -tax which has been most 1 c o n s i s t e n t l y u n d e r e s t k a t e d by Finance r l i n i s t e r s both absollitely and r e l a t i v e l y in terms of tine buoyancy of i t s revenue generation. This f a c t makes t h e analysis of t h e changes i n revenue which have occurred in order t o d i s t i n g u i s h b e t m e n t h e b u i l t - i n and t h e autonomous changes, p a r t i c d a r l y difficult. This i s p a r t l y f o r t h e obvious reason t h a t t h e ex a n t e breakdorm given a t budget time i s based on revenue estimates which prove i n t h e event t o be markedly out of l i n e with t h e a c t u a l outcome. Secondly, however, because or' t h e complexity of both t h e company tax system and of changes i n t h a t system from year t o year, i t would i n t h i s instance 5 e p a r t i c u l a r 3 hazardous t o a s s i g n all. or even most of t h e v a r i a t i o n s from estimates which occur t o the underestimation of t h e b u i l t - i n e l a s t i c i t y of t h e t a x structure. I n p a r t i c u l a r the introduction of a completely new tax base i n t h e form of the super p r o f i t s t a x i 1963-6b and i t s replacement by the s u r t a x OE n company p r o f i t s i n 1964-65, were measures which were bound t o r a b e pro3lerns of estimating t h e revenue e f f e c t of a t a x change. / d; ,' 1 . Furthermore, the analysis of c h a g e s i n c o v o r a t i o n t a x revenue cannot be undertaken i n terms of t h e simple formal r a t e of tax ~ ~ h i c s ih imposed, This i n f a c t was increased i n t i e 1962-63 budget from 45 percent t o SO percent. To begin with even t h i s formal r a t e of corporate tax i s no a l o n g e ~ s i x p l e f l a t r a t e since the super p r o f i t s t a x and l a t e r the s u r t a x have e f f e c t i v e l y made t h e formal r a t e s t r u c t u r e progressive i n r e l a t i o n t o O r a t e of ret-urn on c a p i t a l (variously defined) N T i n r e l a t i o n t o -the absolute l e v e l of prof i t s . Nore importarltly, however, the t a x provisions f o r companies permit a whole v a r i e t y of deductions froltl taxable p r o f i t s f o r new firms, investment outlay, exports,multiple shift-working, e t c . and these e f f e c t i v e l y niake nonsense of the use of changes i n the formal r a t e s t r u c t u r e f o r ar:algzing changes in corporate t a x revenue.l/ - 118. Because of these d i f f i c u l t i e s , t h e aore f r u i t f u l a p p o a c h t o t h i s probiem i s tkirough company account s t u d i e s o These give us some idea of the v a r i a t i o n s which have occurred in t h e e f f e c t i v e r a t e of t a x on company e p r o f i t s over time. However, t h e f igirres which w can derive from these stud2es a r e of t a x provisions but these t.411 serve o w purpose. -Provision by Companies as Percentage of Pre-Tax Tax I Profits- Tax Provision as Percentage of Fre-Tax P r o f i t s RBW -- -* I-, Economic Times5 7tage Approx. Annual Percep- Change in Tax :is - a/ The Reserve Bank study has embraced 1,333 s e l e c t e d medium and l a r g e public l i m i t e d companies s i n c e 1961-62; p r i o r t o t h a t the samnple covered 1,001 companies. Data f o r 1963-64 not y e t available. Economic Times study covers the 51 l a r g e s t public l i m i t e d companies. - 1/ Thcse ccncessions are f u l l y elaborated l a t e r i n t h i s Report !chapter 111). b?. I n gerieral i t appears t h a t the r a t e of tax provisiorr by companies increased by about 13 percent from 2960-61 t o 1961-62 and by about 1 7 per- cent from 1961-62 t o 1962-63. I n the l a s t year a s l i g h t f a l l of about 4 percent has occurred. Hocrever, tax payments i n practice tend t o l a 2 one year behind tax provisions. This i s f o r the simple reason t h a t ccmpanies pay tax i n any one year !In" on the basis of p r o f i t s earned i n the previous year, n-1, but a t the r a t e s of tax announced a t budget t i n e f o r the year I1n1l. Thus, in accounting f o r their. own f i n a n c i a l a c t i v i t i e s i n year 'In1' they provide f o r the t a x payment which they estima+,e they w i l l have t o make on the p r o f i t s earned i n t h a t year. Therefore, irL r e l a t i n g changes in tax revenue derived from the Government accou?ts t o changes i n tax r a t e s derived from the sample of cornpay accounts, a one- yea? l a g i s required, Changes ix Corporation Tax Revenue Related t o Changes i T a x Rates n ----- and t o Changes in Taxable P r o f i t s --- (RS, crores) Corporation Annual Annual Increase Attributable to: Tax Increase ( a ) Ck~angesin ( b ) Chznges in Revenue Tax Rates Tax Base SC. Changes i n the average r a t e of tax on p r o f i t s seem t o have been of dominant iriportance in deterinining the growth of corporate tax revenue in 1962-63 and i n 1963-64, However, in the most recent year (1964-6jj the average t a x ra3e derived from the company account studies declined and thus the rghole of the i ~ c r e a s ei n tax revenue, a f t e r allo~aing o r this f a l l in f the tax rate, had t o be derived from an increase i n taxable profits. The b u i l t - i n e l a s t i c i t y of corporation taxation as reflected i n these annual figures varies, therefore, from 1 2 percent in 1962-63 and 7 percent i n 1963-6L t o 25 percent i n 196b-6s. The average f o r these three p a r s is 15 percent. 9. Given the problem of timing involved hen dealiag snth the assessment and collection of corporate +&ation, t h i s i s probably the nearest estimate ~rhichcan be derived f o r future projections of revenne from t h i s tax. A s such i t comes out much higher than the assumption of the llorking Group on Resources which was that t h i s revenue would r i s e by 8 percent per annu11during t i e Fourth Plan period. This assumption was based on revenue experience over the period 1955-56 t o 1961-62 during which formal tax r a t e s on p r o f i t s remained unchanged. Since then the basic r a t e of t a x of 70% on p r o f i t s in excess of a given return on capitalhas been imposed. It could nave been expected, therefore, t h a t both of these changes would have i ~ c r e n s e dthe natural r a t e of groisth of the corporation tax above t h a t assumed by the Working Group. 52. However, t h e 1965 budget introduced f u r t h e r t a x concessions which p a r t i c u l a r l y a f f e c t the marginal r a t e o f t a x or. those fi.ms which a r e gmwing both in terms of t h e i r aggregate generation of taxable p r o f i t s and i n terms of t h e growth i n t h e i r p h y s i c a l output. It i s n o t p o s s i b l e a t t h i s s t a g e to e s t i m a t e t h e e f f e c t of t h e s e measures upon tine n a t u r a l r a t e o f growth of revenue from company t a x a t i o n b u t it w i l l c e r t a i n l y be s i g n i f i c a n t . For i n s t a n c e the most important of the concessions i s a 20 p e r c e n t t a x c r e d i t i n r e s p e c t o f increased. p r o f i t s t a x l i a b i l i t y up t o a maximum o f 1 0 p e r c e n t of p r o f i t s t a x payment. Up t o t h i s maxihum t h e marginal r a t e of t a x i s e f f e c t i v e l y reduced t o 40 p e r c e n t f o r com7anies r-rhich would otherwise h a x been pa;ring 5 0 p e r c e n t and t o 56 p e r c e n t f o r those tlr;?o would otlienrise have been paying 70 p e r c e n t a t t h e margin. This concession alor,e would, t i ~ e r e f o i = , reduce o u r assumed average r a t e of i n c r e a s e i n corporation t a x revenue froril around 15 p e r c e n t t o l i t t l e o v e r 12 percent. The o t h e r major concessio.3 has been r e s t r i c t e d t o a few i n d u s t r i e s and thus i t s aggregate e f f e c t rjn t h e grovth o f revenue i s l i k e l y t o be small. 53- In summary, w h i l s t on t h e b a s i s o f our otm e s t i m a t e s we r-rould i:a-~e tended t o argue u n t i l the submission of the 1965 budget proposals t h a t t::e IJorking Group on Resources had been unduly cautious i n i t s assunption ~f an 8 p e r c e n t n a t u r a l g m ~ t h n corporate t a x revenue, t h e s ~ i proposals make u s less convinced. C e r t a i n l y t h e r a t e o f growt looks l i k e beGeing n e a r e r t o 8 p e r c e n t than t o our e s t i m a t e o f 15 percent,- 9 - 1/ These e s t i m a t e s have a g a i n been u p s e t by t h e 1966 budget wh- c h has i i n c r e a s e d the b a s i c r a t e o f company t a x from 50 p e r c e n t t o 5'5 p e r c e n t and decreased the s u r t a x r a t e from 40 p e r c e n t t o 35' percent.  I1: EVALUATION OF --, FISCAL PXs3WANCE 54. It i s a p p a r e n t t h a t a mere statemeilt of t h e m.agnitude of a Govern- ment's a g g r e g a t e and i n d i v i d u a l tax revenue collec-Lions and o f t h e v a r i a t i o n s t h e i r c o l l e c t i o n s over time and of t h e major f a c b r s r e s p o n s i b l e f o r t h e i r v a r i a t i o n s , i s of l i t t l e use f o r a p p r a i s i n g i t s revenue p e r f a n a n c e i n any meanirigful tray. For d0ir.g t h i s it i s n e c e s s a r y t o judge t h e i r magni.tudes i n r e l a t i o n t o o t h e r s i g n i f i c a n t magnitudes i n t h e economy. This s p p r a i s a l can be undertaken a t t h r e e l e v e l s . These t h r e e l e v e l s r d l l r e p r e s e n t l e v e l s of c o n s i d e r a t i o n which have an i n c r e a s i n g degree of ecolzomic s i g n i f L - . c ;pan e : a s s o c i a t e d xhrith them. To begin w i t h t h e revenue perfomlance can be looked a t i n i s o l a t i o n from o t h e r Government r e s p o n s i b i l i t i e s and considered sirripkr i n r e l a t i o n to magnitudes such a s n a t i o n a l income. Secondly, t h e performance can be judged in r e l a t i o n t o t h e Government's budgetary requirements and t h i ~ d l y , It can be judged i n r e l a t i o n t o the c o u n t r y t s developmental requirelnalts. Revenue Performance in Vacuo 55 h e have a l r e a d y noted t h a t Center revenue has i n c r e a s e d a t an annnal average r a t e of 1 0 ~ e r c e n ts i n c e 1951-52 and by almost 20 p e r c e n t a n n ~ a l l y i n c e s 1960-61. T."ith a n average a n n u a l r a t e of gro5rth o f n a t i o n a l income a t c u m c n t p r i c e s o f j u s t o v e r 4.5 p e r c e n t s i n c e 1951-52, t h i s t h a t Senter t a x revenue has i n c r e a s e d from 5.1 p e r c e n t o f n a t l o n a l incone a t t h e beginning of t h e F i r s t P l a n t o 6.2 p e r c e n t in 1960-51 and up t o 9.4 p e r c e n t i n 1963-6!:. The growtn of revenue d?rring t h e f i r s t t h r e e ; e a r s o f t h e Third Placi has Seen p a r t i c u l a r l y s t r i k i n g . Out of an i n c r e a s e i n n a t i o n a l Sncome o f R s . 31 bi.llLon, Center. t a x a t i o n went up by 8s. 736 m i l l i o r i which r n p r e s e n t e d a margf n a l r a t e o f C e ~ t e r a x a t i o n of 23 p e r c e n t . If xJ allow f o r t h e 7.2 p e r c e n t i n c r e a s e 5n t .e p o p u l a t i o n over t h e s e t h r e e y e a r s a d argue t h a t , p a r t i c u l a r k r i n a c c u n t , ~ s a poor a s I n d i a , t h e scope f o r i n c r e a s e i n t a x a t i o n should be judeed a f t e r . a1lo.r- i n g f o r t h e i n c r e a s e in income r e q u i r e d f o r supporting t h e i n c r e a s e d popul-ation, then t a x a t i o n has absorbed approximately 37 p e r c e n t of t h e i n c r e m n t to na5ion- a 1 i ~ c o m e . I h i l e t h i s r e c o r d s i g n i f i e s c o n s i d e r a b l e a p p l i c a t i o n by t h e Govern- ment t o t h e t a s k of i n c r e a s i n g p u b l i c revenue, tile outcome i s s t i l l t o l e a v e I n d i a , f o r what t h e comparison i s wortk, anongst those c o u n t r i e s hose t a x l e v e l i s average-to-low. This r e f l e c t s , of course, t h e v e r y low l e v e l of pviblic revenue mobilization from rzrhick; t h e c o u n t r y commeilced on i t s program o f planned development. It a l s o r e f l e c t s t h e c l o s e d n a t u r e of the economy f o r it i s a 7 p a r e n t t h a t t a x a b l e c a p a c i t y i s h e a v i l y dependent upon the a u a n t i t a t i 7 1 e s i g n i f i c a n c e of e x t e r n a l economic r e l a t i o r i s h i p s i n t h e economic a c t i v i t y o f t h e country.L/ B. lievenue Performance i n iiela t i o n t o %dge t a m R e a ~ l - i r e ~t s , er 56. More r e l e v a n t t h a n t h e a t t e m p t t o judge t a x performance in i s o l a t i o n i s t h e q u e s t i o n o f i t s r e l a t i o n s h i p t o t h e budgetary requirements o f t h e Go~rernnent. I n I n d i a , a s i n most o t h e r c o u n t r i e s , t h i s q u e s t i o n i s confused by t h e manner in which t h e Governmentts accounts a r e presented. T h i s p r e s e n t a ti03i s e s s e n t i a l l y devised to f a c i l i t a t e p a r l i a m e n t a r y 6 - 1/ See, f o r example IBRD " T a x ~ b l eC a p a c i t y in Developing Countries" ( ~ e ~ o r t prepared by S y l v a i n P l a s s c h a e r t , 1962) and H.H. H i n r i c k s llDeterminants of Government Revenue Shares iunong Less-Developed Coult,ries" ( ~ c o n o m i c J o u r n a l , September 1965). consideration of expenditure and revenue proposals and t h e i r control through the executive and a u d i t i n g bodies. The presentation has l i t t l e signi:ficance in terms of t h e economic impact of d i f f e r e n t t r a n s a c t i o n s - current and c a p i t a l items a r e n o t c l e a r l y distinguished, expenditures on goods and s e r v i c e s a r e not distinguished from t r a n s f e r expenditures, etc. A s a r e s u l t of this form of presentation i t becomes impossible t o take t h e bud- g e t a s published in order t o judge i t s expansionary/contrac tionary e f f e c t on the econoqy, and n e i t h e r i s i t possible t o take statements by l f i n i s t e r s of Finance about t h e i r revenue surpluses or d e f i c i t s a t t h e i r f a c e valile. T'i. Recognizing t h e d e f i c i e n c i e s of t h e conventional budget prezen<,a- t i o n s , t h e Government in I n d i a has s i n c e 1957-58 published annually a separate budget doc e n t which presents t h e Central Govemnent accounts on an economic basis., 17 This annual document c e r t a i n l y s i m p l i f i e s t h e task of appraising the budge-tary position of t h e Government. It has not, however, made any v i s i b l e impact on the Government i n t e r n s of 3he presen- t a t i o n of i t s annual budget proposals. The Piinister of Finance s t i l l uses t h e conventional c l a s s i f i c a t i o n . TIlie pep7itteil : ~ .n :?is $5 - iir . budget speech, f o r instance, t o claim t h a t f o r 1965-66 the budget r;as expected t o show an over-all surplus of Rs. 4 crores whereas in f a c t the expansionary e f f e c t of Government a c t i v i t i e s on the economy .;as a s -iild-i- cated a l i t t l e l a t e r in t h i s section, expected t o be over Rs. 850 crores out of a t o t a l l e v e l of current and c a p i t a l account expenditure of Rs. 3900 crores. It i s not possible, of course, t o go on from t h i s t o s t a i e c a t e g o r i c a l l y t h a t t h e use of economically meaningless magnitudes i n a budget speech influences t h e taxation/expenditure program which the Government adopts. After a l l , the budget speech is a p o l i t i c a l occasion and not only, o r even mainly, an occasion f o r an economic a p p r a i s a l of t h e economy. Nevertheless, we a r e concerned, f o r instance, i;hat t h e supposed surplus a n t i c i p a t e d f o r the f i s c a 1 year 1965-66 c? t ul;cl-: ,l.iae: t a x i r a t e s was p a r t of t h e j u s t i f i c a t i o n f o r t h e n e t reduction in expec'ed t a x revenge r e s u l t i n g from the tw. measures introduced in t h a Pi:>rch i;365 o budget. H w deeply committed t o t h e conventional presentation of fhs budgetary accounts t h e W i s . t e r l s policy acivisors are, it is not possible t o say, Obviously, t h e economic advisors a r e under no i l l u s i o n s , but we would c e r t a i n l y not be s o confident regarding high o f f i c i a l s i n t h e more t e c h i c a l departments concerned with the formulation of t h e budget, taxation policy, e t c . 2 r; 2 I. The following t a b l e presents the current account of the Central ~ o v e m m e n ta s presented i n the Economic C l a s s i f i c a t i o n . -/ 1 An Economic C l a s s i f i c a t i o n of t h e Central Government Budget ('annual) Economic Division, Department of Economic Affairs, Ministry of Finance.  Table 6: CENTIillL G V F i C T ClJFEUJT ACCOUNT E O EW H ( R s . crores) A. Current Income 1 Taxes on Income . and Wealth 154 200 237 322 4 4 497 556 2. IndirectTaxes 4.22 528 636 738 948 1,053 1,122 3, Profits 68 88 11 119 -1Oh 91 93. 4. Other Incomes 91 134 1b3 172 21 10 228 253 B. Current W n d i t u r e - 662 1. Civilian 382 608 645 724 764 930 976 2. Defense 280 274 313 473 814 828 867 C. - on Current Savings - 154 - -- Account - 74 68 - 179 139 112 178 I.'?. The general pattern of budgetary development is r e a d i l y apparent from t h i s table. Despite the quite impresstve t a x e f f o r t of the Union Government which has approxirnacely doubled both total current income and t a x income i n 1964-65 compared with 1960-61 ancl, which represented an increase in income over t h i s period of over Rs. 900 crores, Government savings increased by a mere Rs. L4 crores above i t s 1960-61 l e v e l of Rs. 68 crores. The primary cause of t h i s poor response of Government saving t o i t s t a x e f f o r t i s t o be found, of course, i n the increase i n current e ~ e n d i ~ u r e which in turn i s a r e f l e c t i o n predominantly of a threefold increape in defense expnditure. I f defense expenditwe had r i s e n over t'ne period from 1960-61 a t the same r a t e as non-defense expenditure, Governnent saving would have amounted t o well over Rs. 500 crores i n 1964-65 instead of a mere Rs. 112 crores. A s such it would have represented approximately 3 percent of national income instead of the 0.6 percent of national income which the Center Government in f a c t contributed t o the flow of t o t a l savings. 'c. This budgetary development which has occurred over the course of the Third Plan r a i s e s many questions and broad issues of policy Lpon r.rhfch considerable conjecture and comment i s possible. For instance it has frequently been questioned whether the same t a x e f f o r t would have been made i n recent years but f o r the Chinese emergency. I f not then obviously the above estimates of a hypothetical Government savings l e v e l in the absence of any disproportionate increase i n defense expenditure becomes irre'levant. \ f i i l s t there i s obv-iously sorne va2.idi-Ly iir, t h i s point it t should not be over-emphasized. I n e f f e c t l,?ha the emergency probably did was t o advance in time t a x measures which would have been introduced more gradually. f)l. I t h i s i s t r u e then the adverse e f f e c t on Government saving f can be considered t o a r i s e over time r a t h e r than from the period vhen the increased t a x burden was in f a c t introduced. >lore fundamentally the question must be asked and has been asked by masly economists in India as t o whether the a l l o c a t i o n of nearly 5 percent of i t s national incon12 anc! 45 S ~ ~ pqrcent 9f i t s cl?r:.erlt C k i l i r a l Govcr-ment i n c o ~ . e; defense is C C : P . S ~ ~ ~ Ii~t . h t, f i n a n c i a l imp1icai;ions of the development aims which the Government has s e t i t s e l f i n the past and f o r the future. Certainly i f t h e Central Government f e e l s t h a t it has v i r t u a l l y reached the limit of i t s own taxable capacity ceiling, i f it cannot induce -Lhe generation of s u f f i c i e n t increased savings through the s t a t e budgets or through the public enter- prises, and i f a t the sane time development i s depenaent upon an increased - l e v e l of ex ante savings, then quite obviously developrnent and defense . - - a become competing a l t e r n a t i v e s . Leaving asi.de the t h i r d of these conditj.ons which is embraced by the analysis i n the next section of t h i s chapter, i t a2pears t o us t h a t whilst there i s s t i l l scope a t the Center f o r in- creased taxation, ;he problem could a t tlze m r g i n be irmnnselv cased by any possible reduction in defense expenditure, The room f o r mane.;ver which the Government has l e f t i t s e l f i n t h i s regard has been sevzrely limited by its f i n a n c i a l commitlnent t o defense. It c e r t a i n l y makes i t a l l the more imperative t h a t the f i n a n c i a l contributions of the s t a t e s and the public e n t e r p r i s e s t o the financing of %heir own developmnt should be increased; any b a r r i e r s - economic, s ~ c i a l ,administrative, - p o l i t i c a l , etc. t o an advance on these other f r o n t s would in the future put an impossible burden on the Center's capacity f o r generating the fu11Cs which t h e i r cievelopmnt program w i l l require. b2. From the current account a s given i n the above table, the l e v e l of Central Government savings can be derived. These s a d n g s a r e supple- mented by the savings of departmental e n t e r p r i s e s which appear as retained provision the inclusion of which enables p r o f i t s and by t h e i r d e ~ ~ e c i a t i o n a gross savings f i g u r e t o be derived t o match the investment f i g u r e s which a r e presented on a gross basis. Pmthermore,the current f i n a n c i a l resources of the Center include repayments received by the Government on outstanding loans. The amortization income has become an important source of financing with the increasing volume of new lending t o s t a t e s and t o non-departinental e n t e r p r i s e s which has occurred i n the past. B including t h i s item on the y income s i d e a picture i s obtained of the t o t a l new lending on the expendi- t u r e side. . 6;. The f u l l statement of the c a p i t a l account i s given in the t a b l e below:  Table 7 : CE?'T&fl.L Gr3rE:,?GIT4,rT I-. ?,TI) DE?A.RTI TITTAL UNlEZT'!1. T II\IGS 1CTTjT ,iir'ITkL i,. ( 7 . 7 - - -c r o r c s ) (Rs. i?57--1960-4- 1965- 58 61 1 6; 65 66 =' - - ----- A. Currcnt F i n a n c i a l ILcs GlJrC6S of t j h i ch: b. dctaincd p r o f i t s of d ~ p z r t n c ~ t z l c,ntcrpriscs c. De?rcciation provision 2. ! ~ m o r t i z c t i o n Incorr;~ 2. Dirc,ct and I n d i r e c t invcstrncnt s 1. D i r e c t Investrr,ents b. $!on-dcpa-tnental enterprises c. Others C . L-xpcnditure Surplus Ecf ore Eorrowing (Tzble continued on pz5o 39)  (2s. crores) 1957- 19611- 1963- 1964- 1965- D. Domestic Rorrowing other than I r o x t h e Reserve Rank . , . l l n z n c c d by: of which: b. Other nss is t a n c e 91 196 3L1 I? CO L77 64 i ( n t h e expcncllturc s i d e of t h c c z p i - t g l r?ccount t h e l i r e c - L iliT7c;s . t- , have Seen r . a u p 6 tooetiicr vrit'h i",s e:;:peiicl- m n t s o_" f,hc C e n t r s i ( ; o ~ e i - ~ i i ) n t II, t u r r on t h e i ' i n m c i n g of investncr.ts i n o t n e ~ .s e c t o r s . This 1 z t . t e c c.-tk?-r.i-. C.. ,,-' J i s referi-~;i!t o ;s i l l d i r e c t invest;nc n': c - q e n d i t u r c and if,co?nsi.sts c ' purc!~z.scs i . . t of s h a r e s , next l ~ n d i n zrnd grzi?ts f o r c a p i t a l f c ~ m a t l o r . P ~ r of' t,l-lc I - ~ n r i ~ z ~ i s n c t f o r m a l l ~ rl i n k c d t o investmePts and sor:e of t 3 e lentlir,; i.s Lo c;ov~;rt?- ment T i n a n c i a 1 ips t i t ~ ~ i o n o r t h e I ' i i ~ a ~ ~ c iof g p r i v z t e Invcs t ~ . c r : ' ~ s . f s n However, a s .icril.l ~ p p a r e n tfrcr~;t h e t a b l e , t h e ht-!l'~ of t h e i..:x.l:-ect i n ~st- i ment c::pcr_ditures ? r e trznsfc-I-s of f i n a : l c i a l r e s o u r c e s $ 0 t k i ~St;tc:s ;.n? t o nor,-ciepartmental e u t s r p r i ~ e s . 6.5. It i s i n f ~ c t h e . c ; ~ r a n s f e r s ~ " h i c h i i n s t e 1-0th th:_ to-t2.l a::si:nt t t dcr r c ' c r ~ l t z expencilturl;~I ,:?n; 0v.e g e a r and t h e i n c r e a s e i:? ti5s ~x.pendi'ii-:.re i i over % . k e . They no>; account f o r arol-~:id two-thircis 0,' tile t ' o t z l 2nd of t'!i: i n c r c z s e of '7s. 8G0 c r o r e s i!; t1ri.s t o t 2 1 s i a c e :i.?hC-61., is. GCii c r o r k s hks n been : s c c a u n t of l o ~ n s n i ',2;rzritr; o s t z t e s a~ic! nm-r?efartr:?ntal p3~1kllc ~ t e ~ t e r p i - i s e s . The S<;::-C,cs i n ;:jzrticulzr have ccnsidsr.ab1; 1 ~ ~ r ~ t . ti;~;T;~r s ~ c i ~ r emazds up3n t h Center Tor c;pi_tel 5 n d s L c t h i r z b s o l l ~ . t et e r n s . !?c a s a p r o p o r t i o n of ~1.1 c p i t a l e ; : p ~ n ~ i t u r I:,;e t h e Ccnter 2nd the2 nor.: accc;u:it c t f o r ~11nrc::i~s e 1.3 h~l. of t h E t o t 21.. ~ 1 . ni :lese r o v ~ i l i gctenznds upor. t h e !:cntt;r for c a ~ ) i . t . z i'unds zive acided 1rei;:bt to ti>*>p n i ~ . l ;r.,nde i n P~ragrap'rl61 l a t o v s t h a t t h e S t a t e s 2.3. tl-ie pvk.lic e n k c r p r i e e s nus-t b e e q ) c c t e d t o ;eilcrzte more of t h e i r f i n a n c i a l requirements thenselves p a r t i c u l a r l y i f the current expenditure co.mitments of the Center (notably on defense) erode away the p o t e n t i a l Govern~entsavings, 66 Certainly the combination of an increase in gross saving by the Center of Rs. 89 crores from 1960-61 t o 1964-65 rJith an increase i n net lending ( a f t e r amortization repayments) t o the S t a t e s and public enter- p r i s e s of around Rs. 400 crores over t h i s same period has been a primary cause of the r i s e in the Government's expenditure surplus by R s . 525 cr.9ree. The increase in the Government's own investment outlays of over Hs. 250 crores has of co~rrsea l s o contributed s i g n i f i c a n t l y t o t h i s r i s e . 67 Part of t h e e x p e ~ d i t u r esurplus has been covered by domestic borrowing other t'nan from the Reserve Bank. This borro~ringi s restric:lve i n i t s e f f e c t on the economy f o r i t represents a channeling of funds from the private sector t o the Government. It comprises in particul.ar tne n e t revenue deriveci from small savings and f r ~ m market issues of loans. Snal 1 s a r h g s accounted f o r Rs. lo4 crores of t h e borrowing i n 1960-61 and -thus represented over one-half of a l l non-Reserve Bank domestic borrowj.ng in t h a t year but i t has grown r e l a t i v e l y slorzrly t o around Rs. 130 crores both i n 1963-64 and i n 1964-65. Funds raised from market loans have varied con- siderably and the f a l l i n t o t a l domestic borroxing i n 196L-65 i s l a r g e l y a r e f l e c t i o n of the f a l l i n the n e t amount r a i s e d through market, borrobztng. Government bond issues (excl.uding the p a r t taken over by the Reserve B a l k ) have t o a l a r g e extent Seen absorbed by the f i n a n c i a l i n s t i t u t i o n s and i n f a c t i n the four years up t o 1963 there has been a n e t decl-ine i n the holdings held outside the i n s t i t u t i o n s , This growing importance of the i n s t i t a t i o n s r e f l e c t s the growing tendency f o r household sav-bgs t o be chan- neled t o t h e Government through the contributions to l i f e insurance pol-icies and t o provident funds. Table 8 r BWNE-%HIP OF GQVSRNMENT BONDS (GENER &JD STATES COMBP~ED! Rs. crores Percent Commercial acd Cooperative Banks 643 Insurance 457 Provident Funds 312 Finance Corporations, Trusts, etc. 1 11 Others - L56 OA T T L (other than those held by Reserve Bank) 1,979 1007; 68. "B" i Table 7 sho?is tile o v e r e l l e,q~enditun. s u r &us n of the Central Government a f t e r allowing f o r r e s t r i c t i v e domestic borrowkg. This surplus i s financed by n e t drawings on the Reserve Bank and by foreign assistance (both borrowing and grants). I n n e i t h e r case i s t h e r e any r e s t r i c t i v e c f l : 3 a t 0:: the ;r:rchasklg p o r o r f i o n c i s l p o s i t i o n and spcrding c a p c i t y of the r : ~ t the ecor.i!r:r. of The surylus w p w s s r i t s 2 c e t cut- payment from the Gowynmcnt. I t s s i p i T i c a n c e i n re12 Lion t o naticic31 i n c o ~ e i s s'nor-m belora. Table 9. : NET OUT-PAYMDJTS F O I THE CENTRAL G V R M lT RP O E N Ei Percent of Rs. crores - National Income f,? . The o v e r a l l expenditure surplus i s financed p a r t l y by a n e t drswiag on the Beserve Bank. Thus t h e concept of " d e f i c i t financing" i s derived before taking c ~ e d i f o r the purchase o f Croverment bonds by t h e - t kercrve 3ank. Thesc y r c h a s e s nay be rcade f o r sabsenuefit re-sale o r r'cr xom conthuous investment. I n e i t h e r case they add t o t h e volume of n e t '30rrot7ing by t h e Government from t h e Reserve Bank. '70. The balance of t h e d e l i c i t i s financed out of f o r e i g n funds. O Thj-s a s s i s t a n c e includes n e t e x t e r n a l borrowing, grants and P L - ~ ~ imports. The treatment of t h e l a t t e r in t h e Indian f i n a n c i a l accounts i s e:rtremely com- pl.icat,ed and has resultecl k, cor;sj-derable misunderstandin; aKd controversy, Thes c o x p 2 - e ~ i i , ~ e s e exn::xir:eci h f u l l in Report Zo. 6(b). ar For tine p r e s e n t a t i o n i n Table 9 above we have considered t h e of new counterpart f m d s i n any one year which l a r g e l y corresponds t o t h e PL-480 i a p o r t s in t h a t year - a s f o r e i g n a s s i s t a n c e and have excluded a l l subsequent uses of t h e s e furids f o r the financing of s p e c i f i c p r o j e c t s . ?.-I , -. I n summary, t h e p i c t u r e which emerges from t h i s budge4;ary arlsly..-.is i s one i n which the r e s p o n s i b i l i t y of t h e Central Government f o r f i n a ~ c ~ g c a p i t a l expenditure in the public s e c t o r has more tiian doubled ql:er t:?.~ tour;? of the Third Plan and now stands a t over R s . 1,8(10 cro r e z . The nsiq ca?rse f o r t h i s is t h e increased c a l l s made upon the Center by the S t a t e s and t h e public s e c t o r i n d u s t r i e s . Despite a major t a x e f f o r t , Gwernment annus1 c u r r e n t account saving i n the firs.:, four - - c a r s c f the Third Plan h a s i-nccased Sy a mnre 3s. 52-73 c r o r z s w s ~ m e t h i n go - ~ I - s . 131) crcires due tr, :: r i s b g ? !l ;> burc!c;i of defense e:.:yendit;ure. Togetncr v i t h t h e otllor sources o f saving (depyeci.atie;; p r o v i s i c a :~ud r e t a i n e d prof -its) approxinately 2 0 p e r c e n t o f th-? d i r e c t and i n d i r e c t c a p i t a l expenditure of the Center has heen financed o u t of the internal s a v i n g of the Center. Furthermore, d e s p i t e s t r i c t rreasures to ensurs tilr t p r i v a t e ssvin,rls are chameled i n t o t,he Government's account these i.1 s o m : e a r s (e.g., 196~)-~.51 1961~-65) to have contributed l i t t l e mow than 20 t o '25 percent of the c a p i t a l f u n d s n-:nuired and a t b e s t ( s . ~ . , 1963-6L) a:mu-t 33 percent. - F i s c a l Performance in Relation t o Development Bequirements (1) - Introduction ' 7 ;< i L . The general conclusion which emerges from t h e previous two sections i s t h a t d e s p i t e a reasonably d i s c i p l i n e d c e n t r a l t a x policy over t n s period of t h e three Plans and more s p e c i f i c a l l y since 1960-61, t h a t the Government's f i n a n c i a l a c t i o n s have been markedly expansionary, and have become even more expansionary i n t h e l a s t two years compared with previous years. This has r e f l e c t e d ( a ) t h e growth of Government consumption p a r t i c u l a r l y on defense, (b) an inadequate increase i n t h e i n v e s t i b l e surplus of S t a t e and public e n t e r p r i s e s , and ( c ) t h e growth in t h e public s e c t o r ' s derriand f o r inveskible funds. It is, hot~ever, only i n a wider context t h a t the impact of t h i s f i n a n c i a l performance can be judged. What e s s e n t i a l l y we require t o deter- mine is whether the perforirnance of t h e Indian economy i n terms of i t s development needs could have been b e t t e r met by a markedly d i f f e r e n t r"klaE- c i a 1 policy, This general question can be broken down i n t o a s e r i e s of f u r t h e r questions; e.g., !.Jould f u r t h e r taxation o r f i n a n c i a l mobiliea5lon generally have permitted m increase in i n v e s t r e n t ? Could investnsnt have been increased without any f u r t h e r increases in taxation? Uhat e f f e c t would such a expansionary policy have had on the general l e v e l of p r i c e s ? Bas the ? kli'lation 3f t h e p a s t lfYrno!~tA~s been the outcone of a? o w r - e x p a r i s i c n z o r -- h s u f l i c i u o ? ~ ~s t ~ i c t i v i e a n c i a l pollcy9 !d.?s t h e m , and i s there s t i l 1 , u l - ~ f n i ; b . c l t c ? l j 7 : choice t o bn. z.zde 'oekrcer, st.lSle ;>riccs aild :::rovth 01- 9 r ~ . h q con- : t s i s k n t ;:it? ?ach ~ t h t ? and i.:nd2r *.';i.?tr ~ ? ~ i . ~ l . s t ? nill? s .~ ~i il c t!?fs ~3n~ieLLenc::arisCI': 73. Presented i n tine most aggregative form the objective of f i n s n c i a l policy should be t o ensure t h a t the aggregate l e v e l of both consurnption (including public consumption) demand and of investment demand i s adequate but no more than adequate t o take off from the market the supply of goods and services a t current p r i c e s which a r e p o t e n t i a l l y capable of being pro- duced within t h e country plus those which a r e expected t o be made a v a i l a b l e i n an unrequited manner ( g r a n t s and loans) from overseas. I f i n f a c t t n i s p o t e n t i a l i s being r e a l i z e d a t current l e v e l s of consumption and i n v s s t i ~ e n t then it f o l l o t ~ stha% any increase in investment demand must be o f f s e t by a comparable f a l l i n consumption demand. This can be e f f e c t e d e i t h e r through a possible increase in voluntary saving o r through an increase i n compulsory public saving. Any f a i l u r e t o keep the aggregate l e v e l of demand t ~ i t h i a t h e limit of t h i s p o t e n t i a l market output from domestic produc-bion and f r o m c a p i t a l imports w i l l l e a d t o an i n f l a t i o n a r y r i s e i n both f a c t o r and gcods prices. Conversely any f a i l u r e on t h e p a r t of f i n a n c i a l policy t o permit a level of demand which i s adequate in t h e above sense w i l l r e s u l t in a waste i n productive p o t e n t i a l which i n any c o u n t r y t ~ o u l dbe r e g r e t t a b l e but t ~ h i c hi n India i s l i t e r a l l y a matter of l i f e and death. For t h i s margin of u n u t i l i z e d productive resource could 5e used e i t h e r f o r produ&g consuner goods t o s a t i s f y immediate personal needs o r f o r producing investnent goods t o s a t i s f y f u t u r e consumer needs. 74- The b a s i c short,coming in tfij.s aggregative a n a l y s i s is t h a t it i m - p l i c i t l y assunes a very high degree of f1exiSilit;r in t h e F a t t e r n of a v a i l a b l e output whether produced doinestically o r overseas. I n so doing it assuxzs away a l l t h e s t r u c t u r a l prob3.ems which represent some of t h e most major as- p e c t s of t h e development problem in general. If t h e r e are, in f a c t , s t r u c t u r a l imbalances which cannot r e a d i l y be overcome and if these imbal- ances a r e i n s e c t o r s of t h e economy which a r e of v i t a l s i g n i f i c a n c e e i t h e r q u a n t i t a t i v e l y o r q u a l i t a t i v e l y f o r mseting t h e f i n a l b i l l of goods 5~11lch consumers ( i n c l u d i n g t h e Government) and i n v e s t o r s a r e deinanding, t h e n bottlenecks w i l . 1 occur in tine econoqv. I n these circurns tances t i e p r r ~ >osr'.- t i o n i n t h e previous paragraph i s v 5 . r t u d l y u s e l e s s a s a guid.e t o flnancj.al p o l i c y ma1:ing. To begin with, t h e question ariseswhether it is p o s s i b k through f i s c a l , monetary and a d m i n i s t r a t i v e devices t o adapt t h e p a t t e r n of aggregate den.ac! so t h a t it r e l i e v e s t h e pressure on s u p p l i e s from tile bottleneck s e c t o r s . Secondly,the question has t o be answered whether, even a f t e r allowing f o r any r e l i e f of t h i s kind through induced v a r i a j ~ i o n s i n t h e p a t t e r n of demand, t h e t o t a l demand which is t o be genera+,ed LT tile economy i s t o be determined by t h e a v a i l a b l e su.pply from t h e tot-Lleneck s e c t o r s o r by t h e a v a i l a 3 l e su-pply of goods qnd s e r v i c e s the e c m o q r would be a b l e t o produce were t h e bottlenecks not t o e x i s t . And f i n a l l y and very c l o s e l y l i n k e d with t h e previous point, is t h e question of how "fixed" t h e bottlenecks a c t u a l l y are; i n p a r t i c u l a r a r e t h e y responsive t o changes in r e l a t i v e p r i c e s . 7'5. I n t h e context of I n d i a two bottleneck s e c t o r s in the p a t t e r n gf supply s t a n d out above a l l o t h e r s . These a r e t h e f o r e i g n exchange b o t t l e - neck and the agricultural bottlenecl:, I f t h e p o t e n t i a l l y productive resources of labor, n a t u r a l resources and of c a p i t a l cou1.d r e a d i l y be switched t o producing ( and s e l l i n g ) exports, t o producing import-sa-~inggoods and services, and t o producing a g r i c u l t u r a l output, then ti?e two most important bottlenecks t o a hlgh t o t a l l e v e l of output in t h e economy would be re:novec;',. 76. The Indian Government has in p r a c t i c e d e a l t with t h e f i r s t of these bottlenecks - t h a t of f o r e i g n exchange -p r i m a r i l y throligh a d n i n i s t r a - t i v e action, This has taken t h e form of a developmalt s t r a t e g y which aiins in t h e longer run a t reducing f o r any given l e v e l of n a t i o n a l output t h e econonqrls dependence on imported i n p u t s and in t h e s h o r t run a t r a t i a n h g t h e a v a i l a b l e f o r e i g n exchange through a system of import l i c e n s e s and f o r e i g n exchange entitlements. Increased customs d u t i e s have been used t o some e x t e n t f o r adapting t h e p a t t e r n of demand away from importea goods but t h i s has only occurred during t h e period of t h e Tliird Plan arid even now i s of l i t t l e s i g n i f i c a n c e a s compared with t h e a d m i n i s t r a t i v e c o n t r o l s over foreign exchange a v a i l a b i l i t y , It i s t h e argumen-k of a ~ o t h e r ~ r of t t h i s Report t h a t t h e adjilstment of t h e domestic p a t t e r n of deniand sllould be encouraged much f u r t h e r by t h e i n t r o d r ~ c t i o ni n d i v i d u a l l y o r in combination of measures such a s increased customs d u t i e s , f e e s f o r import l i c e n s e s o r some other forms of e f f e c t i v e devaluation of t h e rupee. The b a s i s of t i l l s argument i s t h a t the a l l o c a t i o n of scarce f o r e i g n exchange both between s e c t o r s and w i t h h s e c t o r s w i l l be more e f f e c i e n t if a & i n i s t r a t i v e a c t i o n i s replaced by a p r i c e meci~anism a t l e a s t o u t s i d e c f c e r t a i n p r i o r i b j s e c t o r s . However, i t i s inco-r,ceivable t o u s t h a t anyone ?.iould sugii;est t h a t t h e vhole o f t h i s b o t t l e n e c k problem could o r should k solved w i t h o u t some a d m i n i s t r a t i v e r e s t r i c t i o n s on f o r e i g n exchange a v a i l a b i l i t y - e. g., f o r l u x u r y i m p o r t s , non-business t r a v e l , c a p i t a l e x p o r t s , c t c . 77. Looked a t i n t h i s way, t h e l e v e l or" n a t i o n a l e x p e n d i t u r e x h i c h t h e Government should aim a t , i n r e l a t i o n t o t h e f o r e i g n exchanze ' o o t t l z - neck, should be one wliich c a l l s f o r t h a volume o f o u t p u t ~ J h i c h , whi.1s-L it may n o t f u l l y u t i l i z e t h e t o t a l p r o d u c t i v e p o t e n t i a l o f t h e cc:?x?~~:.r, r e p r e s e n t s t h e maximum l e v e l ~ h i c h s s u p p o r t a b l e g i v e n t h e a v a i l a b j . l i t g i o f f o r e i g n exchange. This l e v e l of n a t i o n a l e x p e n d i t u r e i s n o t p h y s i c a l l y and u n a l b r a b l y determined. By a b e t t e r u t i l i z a t i o n of f o r e i g n exchange t h e s u p p o r t a b l e l e v e l of n a t i o l i a l o u t p u t can be i n c r e a s e d . One a s p e c t of t h i s q u e s t i o n i s t h e p r o p e r balance - n the ~ t i l i z ~ z t i o n f o r e i g n exchange i of f o r c r e a t i n g nex p r o d u c t i v e c a p a c i t y a s opposed to i t s use f o r Lore iu-i-ly a emplo3ring e x i s t i n g p r o d u c t i v e c a p a c i t y 5y makiEg inpollted s p a r e s , m t , : r i l s , e t c . , a v a i l a b l e . However, d e c i s i o n s on t h i s p r e c i s e qllestion mj-ght 'be constra7ined b y t h e f a c t t h a t f o r e i g n exchange i t s e l f i s n o t hornogen2ous b u t c o n s i s t s in p a r t of c r e d . i t s t i e d t o p r o j e c t s , t o c o u n t r i e s , t o commodities, e t c . , and t h a t some o f t h e s e a r e more o f a bottlenecic t h a n o t h e r s . 78. The second b o t t l e n e c k Is t h a t o f a g r i c u l t u r e . This r e l a t e s t o t h e simple f a c t t h a t i n c r e a s e d consumer d i s p o s a b l e incones i I n d i a l i m p l i e s predominantly i n c r e a s e d demand f o r f o o d s t u f f s . I f marlteted food s u p p l i e s do n o t keep up w i t h t h e i n c r e a s e i n food demand, t h e n a f u r t h e r b o t t l e n e c k a r i s e s to r e s t r i c t t h e Govemnent i n i t s f i n a n c i a l p o l i c y aimed a t e n s u r i n g f u l l u t i l i z a t i o n of a country' s p r o d u c t i v e potenf,lal.. T h i s b o t t l e n e c k , hotiever, r a i s e s d i f f e r e n t problems from the p o i n t o f view of f i n a n c i a l p o l i c y t h a n t h e f o r e i g n exchange b o t t l e n e c k . The d i f f e r e n c e s a r i s e from t h e f o l i o w i n g i n t a r - r e l a t e d c o n s i d e r a t i o n s . 79. F i r s t l y , w h i l s t q u a n t i t a t i v e l y t h e f o r e i g n exckange compone;.lit o f increments t o aggregate e x p e n d i t u r e i s q u i t e sr!all, q u a l i t a t i v e l y it i s c r u c i a l i n t h a t i t makes a v a i l a b l e i n p u t s which, a t l e a s t i n t h e s h o r t rdn, a r e unprocurable from domestic sources. On t h e c o n t r a r y a g r i c u l t u r a l sii7plie.s a r e c r u c i a l simply because t h e demand f o r them dominates t h e patterr: o f consumer derrand emanatirlg from increments t o d i s p o s a b l e income. Secondly, and r e l a t e d t o t h e f i r s t p o i n t , i s t h a t w h i l s t t h e b o t t l e n e c k of f o r e l g n y exchange i s ~ r ~ a r i al b o t t l e n e c k from t h e ~ o i n o f view o f i n c r e n e z t s t o t aggregate i n v e s t n e n t e x p e n d i t u r e , a g r i c u l t u r e i s p r i m a r i l y a bctt1enecl.c t o i n c r e 3 s i n g t h e l e v e l o f p r i v a t e consumer expenditure. However, by t h e f a n ? - l i a r m u l t i p l i e r / a c c e l e r a tor p r o c e s s t h e s e tx.~o e-xpenditure a g g z g a tes a r e n o t independent or" e a c h o t h e r and t h u s what a c t s a s a b ~ r r l e rt o 0 1 w i l l 1s a c t a s a b a r r i e r to t h e o t h e r u n l e s s s p e c i f i c a c t i o n t o avoid t h e outcone c a n and i s taken. and a g a i n r e l a t e d t o t h s f i r s t ttn?o p o i n t s o f d i f f e r - . . , ence, i s t h a t w h i l s t t h e b o t t l e n e c k of f o ~ i g n exchange can i n whole o r i n p a r t be met by p e r n i i t t i g g i t s l o n g - r ~ n and a l s o i t s short-ru-.n s c a r c i t y value to be r e f l e c t e d in i t s s u p p l y p r i z e w i t h o u t any undue i n f l a t i o n a r j e f f e c t s a r i s i n g , t h i s i s n o t a course o f a c t i o i i which i s s o r e a d i l y open i n t'ne c a s e of food s u p p l i e s . The e f f e c t o f such a c t i o n f i r s t l y on a g r i c i l l t u r a l incomes, and t k e r e f o r e on a . z r i c v . l t u r a l cor?sumer dexand, and s e c o n d l : ~on i n d u s t r i a l c o s t s through t h e d e a r n e s s a l l o r ~ a r i c eschemes, i s such t h a t r e l u c t a n c e t o use t h i s p o s s i b i l i t y na t u r n l l y a r i s e s . This i s p a r t i c u l a r l y t r u e i f t h e s c a r c i t y v a l u e i s regarded a s i n f a c t a short-n1.n phenomecon r a t h e r t h a n a s a change n e c e s s a r y t o induce t h e d e s i r a b l e i n c r e a s e kc-I o u t p u t i n t h e l o n g e r run. Final-ly, and once a e a i n r e l a t e d t o t h e ~rz.~?irzll:.e p o i n t s of d i f f e r e n c e , i i l some r e s p e c t s it i s ~ u c h q s i e r to i ~ t i ~ d an c ~ , e ~ a d m i n i s t r a t i v e r a t i o n i n g scheme which niakes r e a s o n a b l e sense ecoqoir;:ca:.l;- and s o c i a l l y i n p r a c t i c e , f o r a l l o c a t i n g s c a r c e f o r e i g n exchange, bhzn it i s t o do s o f o r food s u p p l i e s . The d i f f e r e n c e stems from obvS.ous d i f -;"erericer or? b o t h t h e s u p p l y s i d e and o n t h e demand s i d e of -Line markets f o r th?sc? ~ T ? G i n p u t s , though a s a c o u n t e m e i g h t to t h i s t h e r e i s one r e s p e c t 5n 1,:hici; an a d m i n i s t r a t i v e r a t i o n i n g scheme i s e a s i e r t o i n t r o d u c e f o r fooc; tkar, l o r Toreign exchange. T h i s i s t h a t th9 a l l o c a t i o n t o sac;? cocsuner cai? 5 ~ m a r k . uniform i n t h z case ~ f food. 80. n P - u s , w h i l s t c o n c e p t u a l l y t k s e two bottlenec!cs c ~ be t r o a f e d a s r a i s i n g t h e same g e n e r a l probler? of r e s t r a i ~ 5 i gt h e e x t e n t -to :.?hich f i n a i l c i a 1 p o l i c y t o ? w a n d t h e I.evel of demand can be pushed, t h e y r a l s e ma;-kedly d i . f f ~ r c n t s s u e s from t h e p o i n t of v%ew of f i n a n c i a l p o l i c y . L i k - i r i s e , i n makizg a j u d p e n t i ! r ~ ; l a t i o i zt o t h e f i n a r l c i a l xequi.rer,:e!?t; i ' ~ r ~ h economic ~ r o ~ on t the f i n a n c i a l & p l i c y of the G o v e m j e n t i n t h e p a s % o r t n a t p r o j e c t e d Tor t h e f u t u r e it i s n e c e s s a r y t o a ~ p r a i s et h i s p o l i c y ns3i3~t;. t h e background o f t h e s e two major c o n s t r a i n t s o n dsvelopnert, an5 nart:' nu3.arly n a g x i n s t t h e s h o ~ t - r u n and lor,g-run i ~ ~ l it ico a s of t ' n 5 s ~ c c i l s t r a t n t s . The F o r e i g n Exchange i3otCeneck (2) - . ----.-- 81. i F i r s t l y , we r e q u i r e t judge vhether, l e a v i ~ i g~ s j d e t s mul.tip'.i.er o e f l e c t on c o n s m e r demand f o r f o o d s t u f f , t h e l e v e l of inves%ie;.!'~ mtlLa:: has been too h i g h in r e l a t i c n t o tile f o r e i g n exchanqe bol,tler,eck. Sen-t,~;j.ii- l y t h e r e s u l t a n t f o r e i g n exchange demand h a s exceeded the suppl.,'r a t LrLe g i v e n r a t e o f exchange b u t we h a ~ r ea l r e a d y r e j e c - k d t h i s a,c a n s e f u l o r v a l i d criter-clon. ia t e v e r t h e i r shortcomings, a d ~ i n i s t ~t r v e c o n t r o l s have taken t h e p l a c e o f a p r i c e s y s t e n in undertaking t h e a l l o c a t , i o n -task. Un- doub+&dly, t h e s t r a i n on an over-worked a d m i n i s t r a t i v e machj-ne might have been l e s s , and t h u s i t s e f f i c i e n c y i n c r e a s e d , i f t h e l e v e l of i n v e s h ~ e - : thad been l e s s b u t t h i s i s merely t o u n d e r l b - e t h e u n d e s i r a b i l i t y o f stkw+:-kkig a tr; c o n t r o l t o o much by a d n i n i s t r a t i ~ e c t i o n r a t h e r t h a n by price-ratior,'l.ilg. It b ~ o a l dindeed be sad is' because o f a p ~ d i l - e c t l i - o n o r a c b - n j n l s t ~ a t i v e f d e v i c e s r a t h e r t h a n p r i c e s , t h e r a t e o f expansion had t o be cur.t,a;led be- cause o f a b o t t l e n e c k c o n s t i t u t e d by t h e f o r e i g n exchange r a t i o i l j a g prccr:dure. 82,. I f t h i s f i r s t c r l t e r i o ~ li s r e j e c t z d , v h a t a i t e m - a t i v e can be e s t a b l i s h e d ? Here it seems n e c e s s a r y t o r e f e r back to t h e d i s t ~ i n c t - i o na l - r e a d y rnacle between f o r e i g n exchangs rnade a v a i l a b l e through l o s n z and gr.ants f o r t h e f i n a n c e o f i n v s s t m e n t p r o j e c t s o r , more g e n e r a l l y , the creaatior; o f net$ c a n a c i t y and t h a t trhich i s n o t t i e d i n t h i s manner though it might s t i l l be t i e d i n o t h e r ways (by country, c o m ~ o d i t y , e t c . ) . % r e i g n exchange f o r f i n a n c i n g t'le d i r e c t recuiremen ts f o r investment p r o j e c t s c!oes n o t appear + have been a major bottlenecl;. a I f f u r t , h e r p m j e c t s had been i d e n t i f i e d ar,d b r o u g h t t o a s t a g e of devsiopment a t v h i c h e x t e r n a l f i n a n c i n g c o u l d have been corisidered, t h e n it i s probable t h a t a p u b l i c o r p r i v a t e l e n d e r c o u l d have been found t o make t h e funds a v a i l a b l e . C e r t a i n l y it would Y-aVe been n e c e s s a r y to f i n d such a l e n d e r f o r , w i t h v e r y r a r e e x c e p t i o n s , no f r e e f o r e i g n exchange h a s been used t o f i n a n c e t h e e x t e r n a l element o f new p r o j e c t s . Of c o u r s e , t h e r e would have been a l i m i t to such a n expansion i n f o r e i g n p r o j e c t l e n d i n g b u t t h e r e i s no s i g n t h a t t h i s l i m i t had i n f a c t been r e ~ c h z d d u r i ~ g h e Third Plan t - w i t n e s s t h e growth i n t h e u n u t l 7 i z e d nprojec"Yiid't comitments. 83. However, t h i s i s n o t tine c a s e w i t h f o r e i g n exchange a v a i l a b l e f o r p r o v i d i n g goods and s e r v i c e s n o t d i r e c t l y l i n k e d to new p r o j e c t s . p a r t of t h e i n v e s t w n t demand r e p r e s e n t s a n i n d i r e c t demand. f o r imports rhrhich a r e rel4lsired by t h o s e i n d u s t r i e s which a r e d i r e c t l y s u p p l y i n g t h e domestic c o m ~ o n e n tof investment p r o j e c t s . It i s i n f a c t w i d e l y b e l i e v e d , and it i s confi.rmed 5~ a n o t h e r p a r t o f our Report, t h a t t h o s e I n d i a n i n d u s t r i e s which a r e depeiAdent upon imported s p a r e s , components, m a t e r i a l s , e t c . , have been working a t less t h a n f u l l c a p a c i t y i n r e c e n t y e a r s due p r i m a r i l y t o an i n s u f f i c i e n t supply of f s r e i g n exchange t o i n c r e a s e o u t p u t . I f t h i s h a s been t r u e i n r e s p e c t of many o f t h e domestic i n d u s t r i e s s a t i s f y i n g irivestment demand, t h e n Kie atre s t i o n a r i s e s a s to whether i n v e s t m e n t demand h a s n o t been e x c e s s i v e i n r e l a t i o n t o t h i s c r i t i c a l b o t t l e n e c k of f o r e i g n exchange f o r maintenance imports. S71ci an e x c e s s i v e l e v e l o f demand would be r e f l e c t e d in a g e n e r a l 1engthenir.g of p r o j e c t c o n s t r u c t i o n p e r i o d s due t o d e l a y s in domestic procurements i n r i s e s i n t h e p r i c e s o f d o m e s t i c a l l y produced c a p i t a l goods and i n t h e need f o r i n c r e z s l n g l p s e v e r e c o n t r o l s on the a l l o c a t i o n of i n p u t s to meet investment demacd. En- doubtedly, a s t h e Missi.on1s i n d u s t r i a l team h a s emphasized, p r o j e c t cc,~ls+,-.uctioi? p e r i o d s i n I n d i a 1 s p u b l i c s e c t o r have been i n o r d i n a t e l y l o n g and ~ r l c e s f tlie o domestic goods and s e r v i c e s r e q u i r e d have r i s e n . I n i t s a n a l y s i s o f -t;.iese d e l a y s and c o s t i n c r e a s e s , major emphasis i s given to prob!.ems r e l a t i n g t o . 7 r o j e c t planning, changes in p r o j e c t s d u r i n g t h e i r e x e c u t i o n , changes i n f i m n c i a l arrangements, managerial problems, e t c !.There d e l a ; ~due to doxe s t i c p r o c u r e ~ e n ti s d i s c u s s e d , problems o t h e r than t h o s e a r i s i n g direcCL.y~ u t of o t h e s h o r t a g e of maintenance imports f o r s u p p l i e r s a r e emphasized. Hoxever it i s made c l e a r t h a t p a r t o f t h e d i f f i c u l t y has stemrred from t h i s l a t t e r cause; tinat s u p p l i e s o f c a p i t a l goods and o t h e r domestic i n p u t s r e q u i r e d to nee+, invest.ment demand have been h e l d up and have r i s e n i n p r i c e due t o S n a ' . > i l i b j t o meet a l l demands imposed upon them which in i t s t u r n has resulttee, i n t c r a l i a , from an inadequate supply o f f o r e l g n exchange f o r s p a r e s , e s s e n t i a l imported components, etc. Furthermore, both t h e p r e s s u r e on t h e i n t e r n s 1 m a t e r i a l s c o n t r o l system and much o f t h e r i s e i n t h e p r i c e s o f domee+Jical.!Jyr s u p p l i e d i n p u t s , i s evidence o f market imbalance i n t h e s e s e c t o r s . It does n o t , however, a p p e a r t o u s t h a t i n v e s b e n t demand was g r o s s l y e x c e s s i v e . Some re- d u c t i o n would have p e m i t t e d a s l i g h t l y i n c r e a s e d r a t e o f p r o j e c t i m p l e ~ . e n t a t i o n and would have r e l i e v e d some o f t h e p r e s s u r e on t h e c o n t r o l system and on p r i c e s . However, t h e main emphasis o f o u r argument i s t h a t t h e d i f f i c u l t i e s were mainly on t h e s u p p l y s i d e o f t h e problem and were n o t i n e v i t a b l e . It is o u r view t h a t t h e l e v e l o f investment demand which t h e government promoted would c e r t a i n l y have been more w i t h i n t h e bounds o f t h e f o r e i g n exchange con- s t r a i n t on domes t i c procurement i f t h e t o t a l f o r e i g n exchange r e s o u r c e s had been b e t t e r a l l o c a t e d - s p e c i f i c a l l y i f more o f t h e t o t a l had been a l l o c a h e d t o t h e p r ~ ~ s i o n s o - c a l l e d maintenance imports and. I f t h e a l l o c a t i o n had been of more e f f i c i e n t . T J c i t e t h e inadequacy o f maintenance imports s i n u l t a n e o u s l y ne  ~ly w i t h t h e e x i s t e n c e o f l a r g e unused o r s l o ~ ~ used a i d comm~tmentsand p o t e n t i a l c o r n m i - b n t s . I n p a r t t h i s i s a q u e s t i o n of t h e t y i n g of f o r e i g n e x c h a n s by l e n d e r s and a i d - g i v e r s t o p a r t i c u l a r purposes and c o m o d i t i ? ~ . I n f a c t it 5s a m a t t e r of t h e tqhole system o f i m p o r t c o n t r o l s 9rhich h a s been the s u b j e c t of a s e p a r a t e s t u d y by t h e r n i s s i o n . ~ / Had t h e d i s p o s i t i o n o f f o r e i g n excharlee been improved by l a r g e r and moi-e e f f i c i e n t a l l o c a t i o n to s o - c a l l e d m a i n t e n a ~ c eim- p o r t s , it i s s t i l E p o s s i b l e t h a t investment demand m u l d s t i l l have been ex- c e s s i v e w i t h o u t a n a b s o l u t e i n c r e a s e in t h e t o t a l volume o f f o r e i g n exchan:e. Our u l t i m a t e judgment, t h e r e f o r e , on t h i s m a t t e r depends on Tfi~hat t2i:e 3s ws g i v e n . I f no change i n t h e f a c t o r s b e a r i n g on t h e su.pp1y of do1aesti.c c a y . i t a l goods and r e l a t e d s e r v i c e s i s assumed to nave been p o s s i b l e t h e n s o m reduc-Con i n i n v e s t m e n t dernand m u l d have been d e s i r a b l e . On the o t h e r hand, i.f the a l t e r n a t i v e p o l i c y measures t o i n c r e a s e t h e s u p p l y and improve t h e u t i l i z a t i o n of f o r e i g n exchange f o r rnaincxnance i m p o r t s were a t a l l f e a s i b l e by clec-i, ,0-'1S 4" o f b o t h t h e a i d - g i v e r s and t h e Sovernnent o f I n d i a , then 1Je wollld s t m n ~ l y argue t h a t any r e d u c t i o n i n i n v s s t m e n t demand should be t r e g t e d a s the I - ~ z s t desirable alternative. 84. The above a n a l y s i s l o o k s a t t h e problem o f f i n a n c i a l expansior: i n r e l a t i o n t o t h e f o r e i m exchange b o t t l e n e c k m e r e l y i n terms o f t h e l e v e l of 'in- vestment demand i n i s o l a t i o n w i t h o u t r e f e r e n c e t o t h e q u e s t i o n o f whether Clie domestic funds have been made a v a i l a b l e too much o r too l i t t l e from non-ex- p a n s i o n a r y s o u r c e s such a s i n c r e a s e d p u b l i c a d p r i v a t e savings. I n o t h e r 3rcrdr given the l e v e l of p r i v a t e s a e . n g s , would a l e s s eqiafisionary budget o r p c b l i c s e c t o r s a v i n g s s i t u a t i o n g e n e r a l l y (trhatever i t s o t h e r m e r i t s ) have made a v a i l - a b l e more f o r e i g n exchange s o t h a t e i t h e r an i n c r e a s e i n invgstment c o l d 4 nave taken p l a c e o r a l t e r n a t i l - e l y t h e a c t u z l r a t e have imposed l e s s strbir, on t h e of s i l p p l ~ ? f o r e i g n exchange f o r s a t i s f r i n g t h e domestic needs o f i r l v e s b s n t goods s u p p l i e r s . Undoubtedly t h e s u p p l y o f f o r e i g n exchange f o r satis-ng t h e s e needs could have been i n c r e a s e d i.f ~ e r s o n a l consurnptlon had been 1o::er. Not o n l y ~ r o u l dimport demand have been reduced b u t a l s o t h e demand f o r e::porL a b l e goods (e,g. v e g e t a b l e o i l s ) decreased. Moreover i.t must be a c c e p t e d t h a t .r.rhilst t h e m a r g i n a l e f f e c t o f c o n s u m ~ t i o non t h e b a l a n c e o f p a . p e n t s is s;n211 (e.g. t h e average import c o n t e n t of cor?suiiption i s about 4 y z r c e n t ) , n e ~ r e ~ t h e - l e s s a g i v e n f o r e i g n exchange s a v i n g would r e p r 2 s e n t a much l a r g e r pro2ortFcn . , in r e l a t i o n t o i ~ v e s t m e n t x ~ e n d i t u r e D e s p i t e t h e s e c o n s i d e r a t i o n s 50ih~?v~r, e lie a r e n o t convinced t h a t any f u r t h e r g e n e r a l lowering o f yersona:l dis.r_iosable income i n t h e f a c e o f t h e f o r e i g n axchange s h o r t a g e :.rould havs been d e s ' i r a j l e . Certainly Tie would n o t c o ~ m t e n a n c eany p r o p o s i t i o n r.rhich i m p l i e d . t h a t a l m o s t any degree of d e f l a t i o n of p r s o n a l incomes i s j u s t i f i a b L e i n o r d e r t o e f f e c t a g i v e n r e d u c t i o n i n t h e t o t a l i m p ~ r t / ' ~ o t e n t i aelx p o r t requirements f o r m e e t k g consumer demand. On t h e c o n t r a r y we would urge t h e d e s i r a b i l i t y o f sel-ec-tiire measures aimed a t r e d u c i n g t h e adverse balance o f paynents e f f e c t o f marginal consumption. A s e l e c t i v e p o l i c y o f t h i s na5ure h a s keen p a r t i a l l y p r a c t i c e d by t h e I n d i a n a u t h o r i t i e s . This h a s been most e v i d e n t i n t h e c o n p l e t e ban on t h e import of a wide range of consumer goods and o f p e r s o n a l e q e n d i t u r e on k o r e i g n t r a v e l , e t c . and t h e i m p o s i t i o n of s t e e p t a x e s e v e n on such b a s i c , b u t iinyort- e d , n e c e s s i t i e s a s kerosene. Hoxever more p e r v a s i v e a c t i o n r e s u l t i n g frcm an i n c r e a s e in Lhe f o r e i g n exchange c o s t of consumer goods would i n our view have been d e s i r a b l e . - &/ See Report by Jear? Bancth: and Investm=nttt . " P h y s i c a l C o n t r o l s on Resource A l l o c a t i o r , ~  - ( 3 ) The Food Supply B o t t l e n e c k 85. Tbe sacond i s s u e i s t o judge arhether I n d i a n p o l i c y h a s heen t o o e x p a n s i o n a n j i n r e l a t i o n t o t h e food s u p p l y b o t t l e n e c k . It i s a p p a r e n t , of c o u r s e , t h a t food p r i c e s have r i s e n very markedly i n tine l a s t 2 y e a r s ( s e e Table X I o f Report No. 1 on A g r ' l c u l t u r a l Polic:? irl I n d i a ) . T h i s i r i i t s e l f i s prima f a c i e e ~ r i d e n c et h a t , g i v e n t h e l e v e l o f marketed s u p p l i e s and t h e i r r a t e of i n c r e a s e , the l e v e l of d i s p o s a b l e p r s o n a l inconec h a s Seen t o o high and r i s i n g t o o r a p i d l y i n t h e l i g h t o f t h e r a t e of p e r s o n a l t~, savings. i:Je a r e n o t coilvinced, h o ~ ~ e v e h a t t h i s evtdence i s s u f f l ~ L e ~ i t and secondly even i f tile evidence h a s elements o f t m t h i n it, !;re a E n o t a l t o g e t l i e r a t t r a c t e d by t'ne simple and obvious measures o f f u r t h e r f i c a ~ l c i a l r s s t r i c t i o n s which it i m p l i e s should have been taken i n t h e p a s t and s'noilld he taken i n t h e f u t u r e . 86. Tne f i r s t p o i n t r.Je ~ o t f l d of emphasize i s t h a t t h e s u ~ p l y z o ~ d s ~ u f f or of markstable food s u p p l y i s not, i n e l a s t i c i n r e s p e c t o f p r i c e c ? a n p c ~ . I n f a c t it i s a n e s s e n t i a l p a r t o f tile a r g u x e n t o f t h e a g r i c u l t u r ~ lteam of t h e Mission t h a t t h e movement i n the terms of t r a d e a g a i n s t a g r i c u l t n ~I r o n t h e mid-19501 s u n t i l 1962-63 o f f e r e d l i t t l e i n c e n t i v e t o i n c r 2 a s e d p r o d u s t i o n and t l i a t a r i s e i n t h e t r e n d r a t e of growth o f food s u p p l i e s froin 3 ~ r c e n f , p e r aiinum t o around 4.5 o r 5 p e r c e n t req:l.ires a n impmvernent i n a g r i c u 1 5 u r e 1 s terms of t r a d e . I f t h i s propositi.on sis accepted t h e n it i s a w a r e n t t'nc?t t,o t h e e x t e n t . t h a t consumer dernand i s reduced i n t h e short-run eitl-i:r 'oy r?d.tlclhg investment i t s e l f o r by reducing t h e m u l t i p l i e r e f f e c t of a given l e v e l of i n v e s t m e n t b i n c r e a s b g savings, t h a t t h e r e l a t i v e ? r i c e i n c r e a s e i n food j r e q u i r e d to e f f e c t t h e i n c r e a s e i n i t s s u p p l y >sill n o t m a t e r i a l i z e unl;2r;s non- a g r i c d t u r e p r i c e s can be e q e c t e d t o f a l l . Of collrse, i f t h i s 1o:Jer l e v e l o f consmer demand i s msde to p e r s i s t i n t o t h e l o n g e r r u n t h e n it, can be suggested t h a t t h e i n c r e a s e i n food s u 2 p l g i s i n any case no l o n g e r rnc::ired. T h i s , however, i s merely t o argue e i t h e r t h a t a lorr~err a t e o f gror.rth i n the econony n u s t be accepted o r t h a t , ~ a h i l s t investment and grokrth should be r i a i n t a i n e d , t h e r e a l c o s t of t h i s i n terms o f personal consnnptJlc!n f q r s g o r e n u s t be g r e a t e r . X e i t h e r o f t h e s e i m p l i c a t i o n s seen? t o us t o be i n e v i t a b l e . 23 t h e c o n t r a r y t h e Mission would and has argued elsewhere t h a t t h e iliz-ezss i n food p r i c e s n e c e s s a r y t o s t h u l a + , e food. s u p p l i e s must be accepted. I!!?ilst a p r i c e l e v e l somewhat lower t h a n t h a t p r e v a i l i n g d u r i n g t h e " c r 5 s i s f t ruo:.lt,hs of 1964 i s probably a p p r o p r i a t e , t h e l e v e l should be h i s h e r t h a n i n 1963 anc! much h i g h e r than i n t h e y e a r s p r i o r to 1963. I n g e n e r a l , ho.r.,~ever,the v i e x of o u r a g r i c u l t u r a l team i s t h a t what i s appropriate i n t h i s r e g a r d must ?ie judged by a p r o c e s s of " f e e l i n g t h e :Gay t o c o r r e c t d e c i s i o n s t t (paragraph 45). If t h i s view i s accepted t h e n it f o l l o w s t l i a t any f u r t h e r r e s t r i c t i o n s ?n conslvmr e x p e n d i t u r e 2nd t h e r e f o r e on food. demand i n r e c e n t yezr:: ?.~ould a v ~ h been und.esirable u n l e s s emergency r e s t r i c t i v e reasv-res could. have beer, %':en ciuricg t h e c r i s i s period. i n 1961.1. C e r t a i n l y any f u r t h e r s i g n i f i c a n t i n c r e a s e i n Li3:estnent would p r o b a b l y have bezn u n d e s i r a b l e wiynout n e g a t i n g i t s m u l t i p l i e r e f f e c t s by t a x p o l i c y , b u t we assume t h a t i n v e s t n e f i t Fras limited a n p r a y 5y t h e f o r e i g n exchange b o t t l e n e c k . 87. The argument o f the p r e v i o u s parazraph i s i l l f a c t a s p e c i f i c c a s e o f a g e n e r a l i s s u e which must be f a c e d i n a n economy which i s a t t e m p t i n g t o maximize both i+,sl e v e l o f n a t i o n a l o u t p u t and tlie r a t e of gro~rrtho f t h j - s o u t p u t . T h i s i s t h a t i n any one p e r i o d of time, i n c r e a s e d l e v e l s of m c ~ e t a r y w d e ~ a n d i l l be confronted w i t h s u p p l y b o t t l e n e c k s of i n c r e a s i n g ( s e v e r i t y u n t i l e v e n t u a l l y no increments t h a t s o e v e r t o r e a l o u t p u t r e s u l t from i n c r e a s e s in monetary desand. Horaever, before t h i s p o i n t i s reached. p r i c e s of b o t t l e n e c k s u p p l i e s w i l l i ~ c r e z s e . TZlese i n c r e a s e s i n p r i ~ e sa r e n o t t o be r e g r e t t e d f o r t h e y provide b o t h t h e i n c e n t i v e s and t h e wherewithal n e c e s s a r y t o e n a b l e t h e s u p p l y b o t t l e n e c k s to Se ov9rcome one by one and t h u s f o r t h e economy to move to h i g h e r and h i g h e r o u t p u t l e v e l s . The econony which d o e s n o t s u f f e r f m m such b o t t l e n e c k s and such p r i c e i r l c r e a s e s ( u n l e s s one b e l ' eve s i n t h e a b i l i t y o f p l a n n e r s t o a n t i c i p a t e p e r f e c t l y t h e f u t u r e demand ? a t t e r n ) i s t h e economy which h a s widespread u n d e r u t i l i z e d p r o d u c t i v e c a p a c i t y . How- e v e r , ~ h f n i l s twe vould emphasize t h e need to a c c e p t r i s i n g p r l c e s i n p a r t < - c u l a r s e c t o r s o f the econonry a s t h e c o r r o i l - a r y of o u t p u t rnasimiza t i o n and gm:.~th, t h c r e a r e two problems which must be faced. 68, F i r s t l y , i s t h e q u e s t i o n of how f a r p r i c e r i s e s can be a c c e p t ~ c l a s t h e c o s t o f o u i p u t i n c r e a s e s . I n i t i a l l y t h e c o s t i s l i k e l y to be m a l l f o r t h e b o t t l e n e c k s w i l l 5e few and e a s i l y overcome b x t t h e y w i l l r i s e u n t i l 5n p r i n c i p l e t h e c o s t becones i n f i n i t e a t t h e p o i i i t o f p h y s i c a l maxin!izati.ori of o u t p u t . The p r e c i s e p a t h t a k e n by p i c e s i n 1.9lation t o i n c r e a s e d xo!:c+a;.r~ demand v i l l depend on t h e f 1 e x i b i l i t - y o f t h e econony i n s u p p l y k g t h e -;;2",,cL% o f o u t p u t r e a u i r e d . In t h i s connection t h e emphasis i n t h e a g r i c u l t u r z l r e p o r t on e x t e n s i o n s e r v i c e s , p u b l i c i t y , c r e d i t s u p p l i e s , l a n d reform, e%. , i s of course h i g h l y relevant.The e f f e c t of a given r i s e i n f o o d p r i c e s 7 5 1 1 depend on t h e e f f e c t i v e n e s s o f a l l t h e s e o t h e r f a c t o r s which b e a r on s u c p l y a c o n d i t i o n s . O r a l t e r n a t i v e l j ~ given r a t e o f growth of food s u p p l y t r i l l be induced by a lower p r i c e r i s e tile more e f f e c t i v e a r e t h e s e o t h e r f a c t o r s . 69. It is, hoxlrever, t h e second problem ~ h - i c hi n t h e I n d i a n c o n t e x t i s perhaps o f g r e a t e s t s i g n i f i c a n c e i i i la t i o n t o t h e food s u p p l y 5 o t t l e n e c k problem. T h i s i s t h a t w h i l s t a r i s e i n fooc! p r i c e s might he a c c e p t e d s s V-e p r e - c 3 2 d i t i o n f o r over-coming t h e b o t t l e n e c k , it a t t h e same time s p a r k s o f f widespread c l a i m s f o r i n c r e a s e d rrage and s a l a r y i.ncomes. W h i l s t i n tlre s h o r t r u n i f t h e s e c l a i m s a r e g r a n t e d t h e y might be absorbed o u t of p r o f i t rnarg',?s r a t h e r than i n i n c r e a s e d p r i c e s , t h e y r.ril.1 i n z e n e r a l irlcrea s e nnn-a g r l c u l t u r ?1 p r i c e s and t h u s make f u r t h e r increases i n food p r i c e s n e c e s s a r y i f t h e t e ~ s of t r a d e betvreen a g r i c u l t u r a l and n o n - a g r i c u l t u r a l o u t p u t a r e n o t t o d e - k r i c r - a t e . A f t e r f o u r y e a r s o f r e a s o n a b l e p r i c e s t a b i l i t y up t o 1963-6b, t h e p r i c e k d e x f o r manufactured goods has gone up by 7 p e r c e n t o v e r t h e p 3 ~ y e a r and t it i s u n c e r t a i n what f u r t h e r a d j ~ s ~ e n ft o r h i g h e r wage c o s t s a r e s t i l l i n s sp Cle p i p e l i n e . T h i s i s , of course, the t y p i c a l viciou-s I ~ ~ f l a t i o n a r y f . r a l , I t s s i g n i f i c a n c e i n I n d i a i s h e i g h t e n e d by t h e v e r y p e r v a s i v e syatcms o f dearn5ss allowance brhic? have been e s t a b l i e h e d s i n c e t h e i n f i a t i o ~ a r v o r j y e a r s , 1937-l!S, and which now co7?er v i r t u a l l y a l l p u b l i c s e c t o r emplo~pent,and Yne o r g a n i z e d p r i v a t e s e c t o r o f the economy. The p r e c i s e system ador;t.ed v a r i e s from i n d u s t r y t o industzyL/but the ~ f f e tc i n g e n e r a l i s t o keep .;age r a t e s very c l o s e l g i n s t e p ~ 5 t h h a n i ~ e si n t h e c o s t of l i v i n g . c 90. It i s i n t h e l i g h t o f th9se c o n s i d e r a t i o n s r e l a t i n g t a food s!lpyly and food p r i c e s t h a t t h e f i n a i l c i a 1 p o l i c y o f t h e G o v e m e n t must be judred. It a p p a r s to us t h a t i t s e r g e s l i t . t l e c o n s t r u c t i v e purpcse t o u r g e a g e n e r a l f i n a n c i a l l y r e s t r i c t i v e p o l i c y i f t h e a n a l y s i s resented above i s accepted. For t h i s a n a l y s i s makes economic growth dependent cpon a change in r e l a t i v e - --- - - 1/ See Ltppendix f'L" of S.H. Paleka : jlevelopment:' (New York, 1962). "Problems o f 3ge P o l i c y f o r 5 c o n o ~ i c p r i c e s i n o r d e r t o e f f e c t t h e major s t r ~ l . c t u r a lchanges i n a g r i c u l t u r e t h a t ~ r o i & hdenands. i & i l s t it i s h i g h l y d e s i r a b l e t h a t t h i s change i n r e l a t i v e p r i c e s should t a k e p l a c e i n a conte:rt o f reasonable g e n e r a l p r i c e sta'nil-Lty, i t h a s t o te emphasized t h a t a r e s t r i c t i o n i s t f i n a n c i a l p o l i c y doss v i r t i - a l l y nothing rsha t s o e v e r to e f f e c t t h e r e a u i r e d change i n m l a t i v e p r i z e s 3rd. c a n n o t t h e r e f o r e do othem-ise t h a n undermi.r~et h e r a t e of gro!.rth a l b e i t t h a t it might p r e v e n t a g e n e r a l i n c r e a s e in p r i c e s . To t h e e x t e n t t h a t sorr;eti;ing approaching t h e p r e s e n t l e v e l o f food. p r i c e s i s judged a p p r o p r i s t e t o l:qduce t h e changes in food s u p p l y t h a t a r e deemed d e s i r a b l e , t h e n it i s i n a p ! ~ r ~ ? r i a t e t o argue t l : s t f i z a n c i a l p o l i c y has Seen too e q a n s i o ~ a r i n x l s t i o ? tc t h e j food supply b o t t l e n e c k . 91 T h i s , however, i s n o t i n k n d e d to s u g g e s t t h a t c o n s i d e r a b l y i ~ c r e a s e d f i n a n c i a l d i s c l p l i r i e w i l l n o t he r e n u i r e d i n t h e f u t u r e i.f t h e r a t e o f i n v e s t - ment i s i n c r e a s e d . F u r t h e r r i o ~t h e f u l l i m p l i c a t i o n s o f t h e argument ?i?.ve t o be f u l l y understood and t a c l d e d by t n e Indian a u t h o r i t i e s . To begin r ~ i t h , i f a v i c i o u s i n f l a t i o n a r y p r o c e s s i s to be avoided some i r i s u l a t i o n o f con- a g r i c u l t u r a l p r i c e s from a g r i c u l t u r z l p r i c e s i s d e s i r a b l e . F w some pToducts t h i s i s x r i r t u a l l g impossible because a g r i c u l t u r a l s u p p l i e s c o n s t i t u t e c r a c i a l . i n p u t s t o a n o n - a g r i c u l t u r a l i n d u s t r y (e. g., t e x t i l e s ) Ho~.rever, the s i t u a t i o n c r e a t e d by t h e domin3nce o f food p r i c e s in the c o s t o f l i v - h g i n d i c e s used f o r detem.ining d e a r n e s s allowance, i s a n a g g r a v a t i n g f a c t o r . be T h i s can o n t ~ broken by t h e ecceptance and, implementation o f a r e s t r a f . n e d incomes p o l i c y i n t n s non-agricultural s e c t o r o f t h e econonly. T c i s i s d i f f i c u . l t t o achieve in any count.ry and r a i s e s p a r t i c u l a r d i f f i c u . l t l e s i n a c o u n t r y a s poor a s I n d i a and. a s p o l i t i c a l l y s e n s i t i v e a s I n d i a . l J e ~ 2 r t i h e l e ~ s , if t h i s i s considered the r a t i o n a l p o l i c y -Lo pursue, t h e n it i s im-perz1;i~.re t h a t t h z G o ~ r n m e n tg r a s p s i t s i m p l i c a t i o n s and seeics tile s o c i a l acd p o l i t i c a l acceptance t o sLch an incortes policy. 92 Secondly, r c h i l s t t h e r e i s a need to ensure t h a t t h e t e r ~ n so f t ~ a d e between a g r i c u l t u r a l and n o n - a g r i c u l t u r a l p r i c e s a r e k e p t a t t h e l e v e l r e q u i r e d f o r t h e longer-term t r e n d of a g r i c u l t u r a l o u t p u t t o be raised. and to a c c e p t t h e p o t e n t i a l l y i n f l a t i o n a r y s i t u a + , i o n t l a t t h l s genera t c s , tl;e r e a i s a n ~ e d f , t h e sane time t o avoid a s f a r a s p o s s i b l e t h e inf1ationar.y s i t u a t i o n c r e a t e d by s h o r t - r u n i n c r e a s e s in p r i c e s r e s u l t i n g frorr: h a r v e s t f a i l u r e s . C e r t a i n l y it would be f o o l i s h t o h a ~ r eto determine t h e r q t e of development i n t h e economy i n any one y e a r (even a s s u n i n g such f l e x i b i l i t y r i f i n a n c i a l p o l i c y %re e administra tivel.1, p o l i t i c a l l y and t e c h n i c a l l y rl p o s s i b l e ) by h a r v e s t v a r i a t i o n s . I n f a c - t such a p r o p o s i t i o n would i n p r a c t i c e r e s u l t i n development being t a i l o r e d to t h e p o o r e s t h a r v e s t c c n s i d e r - e d l i k e l y in t h e f u t u r e . I f t h i s i s t o be avoided, however, the s t a b i ^ l l r . a t i o n lnea s u r e s through b u f f e r s t o c k s which a r e advocated elsewhere i n the I,"lssion ' s Report., take on an added importance. 33. T h i r d l y , and l i n k e d to t h e p r e v i o u s p o i n t , i s t h e p o s s i b l e con- t l n g e n c y ( a s i n tne l a s t two y e a r s ) thrt a f a l l o c c u r s i n supplv of food be1o.r t h e t r e n d r a t e o f growt'n upon which t h e g e n e r a l rat& o f d e v e l o p ~ e n t in t h e econony has been p o s i t e d and t h a t t h i s f a l l cannot be d e a l t rt<th by s t a b i l i z a t i o n s u p p l i e s f r o m S u f f 2 r s t o c k s and/or i n p o r t s . T h i s i s 3 contingency, i n p a r t i c u l a r , r ~ h i c hmight be o f c o n s i d e r a b l e s i g n i f i c a n c e i n t h e e a r l y y e a r s o f the F o u r t h P l a n dru-ing ~ r h i c ht h e measures r e q u i r e d t s e t o a g r i c u l t u r e or, i t s h i g h e r t , x n d p a t h a r e ki::g e taken o r , a t l e a s t , w assWIe f o r t h i s argurnenl;, a r e being taken. 94 I n t h e f a c e of t h i s contingency i n 3 r d e r t o a v c i d i n f l a - t i o a a q ~ r i s e s i n food p r i c e s which s e r v e no long-run purposs on t h e suppxf s i d e , it would o n l y be p o s s i b l e t o maintain t h e r a t e o f e x r ~ a n s i o ni n t h e economsT in both r e a l and money terms if it x e r e p o s s i b l e e i t h e r t o induce o r t o f o r c e people a t any given income l e v e l t o redcce t h e i r consumption o f food and 50 i n c r e a s e t h e i r c ~ n s ~ p t i o n no^-food items and more parti.cu1arl.y of those of non-food i t e m s in r ~ h i c nt h e import c o n t e n t i s small. I d e a l l y , on1? :?~cl:l.d wish people t o employ more domes.tic s e r v a n t s and t h e s e r T a n t s t o spend ~yo-re on h a i r c u t s and shaves, rickshaw r i d e s , e t c . , e t c . , than f o r income i.ncremcx~ts t o be s p e n t t o such a l a r g e e x t e n t on food. 95. The inducements r e q u i r e d can Se provided by changing r e l a t i v e consumer p r i c e s through ad,apt.jilg t h e s t r u c t u r e of i n d i ~ c t a x e s s ~ i d subs5dies f o r t k i s purpose. The d i f f i c u l t y involved i n changing t h e p a t t e r n o f corlsumer demand by changes i n r e l a t i v e p r i c e s i s t h a t r a i s i n g food p r i c e s i s dz3arred because of i t s pervasive i n f l a t i o n a r y e f f e c t . Thus, t h e o n l y my t o p o v i d e t h e inducement i s by reducing t h e p r i c e s of non-food products. Such a policzr r a i s e s i t s O I d i f f i c u l t i e s . T begin with t h e r e i s t h e fundarlental q u e s t i o n ~ o o f how e l a s t i c t h e demand f o r food a c t u a l l y i s i n r e l a t i o n t o changes in r e l a t ' v e p r i c e s . A l l t h e evidence i n c l u d i n g t h a t of our or,r,ma g r i c u l t u r a l 17 t e a n l i s t h a t demand i s f a i r l y i n e l a s t i c . The second d i f f i c u l t y i s t h a t d e c r e a s i n g non-food p r i c e s by reducing t h e t a x upon them o r by a c t u a l l y suS- s i d i z i n g them, i n c r e a s e s c o n s u m ~ r s fr s a l lncome u n l e s s c t h e r measures ar2 taken, and t h i s income e f f e c t on t h e i!ercand f o r food might o f f s e t o r m r e t h a n o f f s e t any decline i n demand r e s u l t ' l n g from i t s i m r e 3 s e d r e l a t i v e price - e . g . , ~ e o p l e i l l have t o skimp l e s s on t h e i r food consurlption i n o r d e r w buy c l o t h i n g , a t r a n s i s t o r r a d i o , e t c . , e t c . . This incone e f f e c t , k ; o ~ e ? ~ r , a s s t a t e d o n l y a r i s e s i f no o f f s e t t i n g n e a s u r e s a r e taken. The offse!;t,?~e measure which comes immediately t o mind i s a r i s e in i i c o ~ e a x a t i o n Su-t t a t t h i s p o i n t :;re come t o t h e most obvi.ous d i f f i c u l t y zssocia41ed piith t h i s p o l i c y . This i s t h a t w h i l s t i t i s d e s i r a b l e -to make con-food p r i . c e s r e l a t i v e l y low i n o r d e r to r e l i e v e the p r e s s u r e o f demand on food s:q,plf.es, i t i s p r e c i s e l y t l ~ r o u g ht h e %axation of t h e s e conswner goods t 5 a t p e r s o n a l d i s p o s a b l e r e a l income can be reduced in o r d e r to reduce consurer denand i n g e n e r a l and t h e r e b y i n t e r a l i a t h e demand f o food i t s e l f . It i s a y p a ~ n t ~ t h a t given the j u s t i f i a b l e ban f o r s o c i a l reasons c n t.he taxa.tior. o f food, t h a t i n e v i t a b l y a dilemma a r i s e s because o f t h e f a c t t h a t t h e income ?nd t h e s u b s t i t u t i o n e f f e c t s of the t a x a t i o n o f non-food consumer goods on t h e demand f o r food, work i n t h e o p p o s i t e d l . r e c t i o n s ; t h e income e f f e c t reducing t h e demand f o r food and t h e s u b s t i t u t i o n e f f e c t i n c r e a s t n g tile dsmond f o r food. lit the same time we must l i v e s.:ith t h e f a c t t h a t in t h e l e s s ciet7c!.opd c o u n t r i e s g e n e r a l l y and in I n d i a i n p a r t i c u l a r , a s we have a l r e a d y seen, i n d i r e c t t a x a t i o n (union e x c i s e d u t i e s and s t a t e s a l e s t a x a t i o n ) i s a nore dynamic instrument o f t a x p o l i c y than p e r s o n a l income t a x a t i o n . Thus, the obvious a l t e r n a t i v e of reducing r e a l d i s ~ o s a b l eincome by i n c r e a s i n g income t a x and e f f e c t i n g a d e s i r a b l e s u b s t i t u t i o n e f f e c t by reducing k l a i r z c t t a x a t i o n i s n o t i n p r a c t i c e open to t h e GovernLent. I n any case t h e Sulk - 1/ A g r i c u l t u r a l P o l i c y in I n d i a , paragraph 79 and i'ippendix 1 . 1 of consumption of h a s i c foodst1:ffs i n h d i a i s by an income c l a s s who under any conceivable ir,co;ne t a x e x e n p t i o n limit i n I n d i a rrould b e excluded from i t s e f f e c t s . Thus, t h e dilemna r e r n a i ~ sand we brould ~ o s certa;,zl:r s u p 2 o r t t t h e I n d i a n Government i n t,he p o l i c y it has pursued i n r e g a r d to t h e covzrapa and r a t e i n c r e a s e s imposed. through t h e i r ~ d i r e c t a x s t r u c t l ~ r e . i;ie havz moreover argued in Chapter I t h a t scope s t i l l e x i s t s f o r i n c r e a s i n g i n d i r e c t n t a x r a t e s . Hor.~ever, t h e problem t h i s poses i t e r n s of f i n a n c i a l . pollc-: t o r e l i e v e p r e s s u r e Epon food s u p p l i e s i n the s h o r t - r u n i s apparent. 96 It i n f a c t pushes u s back t o t h e a l t e r n z t i v e which p r e s e n t s ifs e l f f o r d e a l i n g w i t h t h e food problem i n r e l a t i o l i t o t h e gro~o+h/inflation ;;mblen i n t h e short-run. T h i s i s t h e p o s s i b i l i b y of d e a l i n g w i t h t h e s x c e s s i v e denand. f o r food which a high r a t e o f n a t i o n a l income grorrth g e n e r a t e s , b : ~ a r a t i o n i n g system. I n p r i n c i p l e such a system would p r e v e n t food. pri.ces ( o r a f l e a s t o f f i c i a l food p r i c e s ) from r i s i n g by compulsorily l i ~ l i t i n gt h e amou.r,t o f p e r s o n a l income which can be s p e n t on food. I n ~ r a c t i c e o f c o c r s e , r a t i o n i n g would have to be r e s t r j - c t c d t o urban a r e a s and proSably even t o the major wban a r e a s . Furthermore, e s p e c i a l l y i n s coilntry l i k e I n d i a .:rith 2 l a r g e unorganiz,eci s e c t o r of s o c i e t y , major i n e a u i t i e s , black-marketeering and o t h e r shortcomings rcould have t o be accepted a s t'ne p r i c e invo1.k-ed i n d e a l i n g wiVn t h e problem i n t h i s way. For t h i s reason r a t i o n i n g could o n l y Se c o n s i d e r e d a s a s h o r t - r u n e x p e d i e n t p e ~ m i t t i n ga b r i d s e betrreen t h e p r e s e n t and a time i n t h e n o t t o o .jj.stant f u t u r e when t h e food s c p p l y problem to c a n b e q e c t ~ d have improved. e 970 One f i n a l f a c t o r needs to be brought i n t o t h e c o n s i d e r a t i o n of t h e whole problem o f f i n a n c i a l p o l i c y i n r e l a t i o n to food supply. E?Fs is t h e e x i s t e n c e of PL b80 food imports. I f it i s c o r r e c t tofiat ar, i.rlcrcase in a z r i c u l t u r a l o u t p u t can o n l y be ind.uced by permi+,tiilg food pri.ces t o r i s e v i s - a - v i s non-food p r i c e s , t h e n t h i s could e a s i l y have 'men ackS.eved by reducing PL 480 food imports. Ire t ~ o i i l d , hovrever, p r e f e r to t r e a t PL 480 sv-pplies a s g i v e n and t o a s k ? h a t l e v e l o f consumer demand and t h e F e f o r e of to.'& domestic demand i s e c o ~ o m i c a l l yd e s i r a b l e g i v e n t h e aggregate sup;:ly of f o o d s t u f f s . This i s n o t t o deny t h e v a l i d i t y o f t h e argument t h a t more PL L00 s u p p l i e s should be used f o r b u f f e r s t o c k o p e r a t i o l ? ~i n o r d e r t o o f f s e t y e a r t o y e a r f l u c t u a t i c n s i n p r i c e s and 2 s m a l l e r volume i n merely a u m e n t i n g annual s u p p l i e s immediately i r r e s p e c t i v e o f t h e g s n e r z l market situation. - (4) Concluding Remarks 98 - I!e a r c e x t r e m e l y conscious o f the f a c t t h a t t h e s u b j o c t m a t t e r o f t h i s c h a p t e r i s an a r e a of d i s c u s s i o n ir, which d e e p l y h e l d views and p r e - j u d i c e s e x i s t . For t h i s reason we f e e l impelled to s t a t e b r i e f l y o u r o ? ~ a n a l y t i c a l / i d e o l o g i c a l p o s i t i o n , This would be t o emphasize t h e a p p a r e n t l y simple and obvious, b u t o f t e n overlooked f a c t t h a t t h e economic s a l v n tion o f I n d i a both i n terms of r a i s i n g l i v i n g s t a n d a r d s and o f honorixg i t s e x t e r n a l l i a b i l i t i e s , l i e s i n r a i s i n g t h e r a t e o f growth of o u t p u t t o t h e m a x b w n e x t e n t made p o s s i b l e by t h e a v z i l a b i l i t y of b o t h domestLc and e x t e r n a l r.esouyces and in r e d u c i n g to t h e maximum e x t e n t t h e r a t e o f growth o f popu- l a t i o n . Leaving a s i d e t h i s second i + x m a s i r r e l e v a n t t o o u r i m ~ e d l a t e d i s c u s s i o n , rie would. argue t h a t t h e a u t h o r i t i e s r e s : p n s i b l e f o r monetary. and f i s c a l p o l i c y should be p r i m a r i l y concerned v i t h t 5 e impact of Tinancia1 p o l i c y i n a l l i t s a s p e c t s u.por, t h e r a t e o f growth of production. I n saflng e t h i s w a r e riot unaware ~f t h e undeniabli, d e s i r a b i l i t y f o r I n d i a i ~ p!irsub.g f ; ~ o l i c i e s3~hicl-1 i l l r e s u l t i n s t , a b i l i t y c f p r i c e s . It i s r;f;;ai-ent t o u s w t h a t even w i t h t h e cormr,endable r c c o r d in t h i s r e g a r d t h a t I n d i a k.as acnleved a t l e a s t u n t i l 1963, th? e x i s t e n c e o f r r i d e s ~ ' ~ aid f l a t i o n a r y e-xpecta- n c t i o n s l e a d s t d i s t o r t i o n s i n investrr,ent, savings/consurnption d e c i s i o n s , e t c . which work a g a i n s t developmental g o a l s a t l e a s t u n l s s s t h e s e d i s t c r t , j n g e f f e c t s can be e f f e c t i v e l y countered. Of course, these two s t a r t i n ? pcir.;ts w i t h t h e i r em.phasis on r e a l g r o ~ r t hon the one hand and s t a b l e pr'l.ces gn t h e o t h e r a s o b j e c t i v e s o f p o l i c y a r e n o t a r e a s of d i s p u t e . 1:Ihere cJi:r;~ut,e a r i s e s , hovrever, i s f i r s t l y when it comes t o t h e r e l a t Z o n s h i p o f ;non?L,lyy and f i s c a l p o l i c y t o t h e a t t a i n m e n t of t h e s e o b j e c t i v e s and secondly vhen it comes to t h e p o s s i b i l i t y of hav'ir-g to weigh -a s l i g h t l y h i g h e r r a t ? o f gmwt'n a g a i n s t a s l i g h t l y nore r a p i d r a t e o f g e n e r a l p r i c e i n c r e a s e . 99. This second p o i n t i n t h e c i r c m s t a n c e s which e x i s t i n In.,!ia i.s, ?re ? ~ o u l durge, a choice which cznnot be ignored. T I l i s i s esseriti&ll:? 3 r - c z : ~ e the c e i l i n g which c o n s t r a ixs domes t i c p r o d ~tc o n ( l e a v i n g a s i d e f o ~ e i p i exchange availability) i s n o t a r i g i d and u n a l t e r a b l e c e i l i r i g b u t one t h z t can he r a i s e d rrith ever-increa s i n g d i f f i c u l t y by spy-~ropriaties t r u c + ~ i - a 1c5anges. These changes, lic.r\rever, w i l l r e q u i r ? changes i n r e l a t i v e p r i c e s a x l , t o be r e a l i s t i c , t h e s e xi11 be precioorni~lantlyi n an upr.rard d i r e c t i o n wi+i!i t1:e i n f l a t i o n a q tlirea t which t h e s e pose when tlie overwhzli~ir-g r i c e i ~ c r e a s e p e w i l l be f o r b a s i c food. !r.'hllst w a r e condi.tiorlally riri-lling t o a c c 2 p t svch a p r i c e h c r e a s e and i t s i n f i a t i o n a r y p o t e n t i a l z s t,he i?ecessaqr p r i c e :.;.rich must be p a i d f o r growth rin t h e Indian s i t u a t i o n , T ~ .are swa>Y=,:ha!-, 05hcc:r.s J ~ ~qoulda t t a c n silcll a p r e n i m t o p r i c e s t a b i l - i t y +,hat t k e y :.rol*l.t:l be rriL.li:~g to s a c r i f i c e solre s i g n - l f t c a n t poten.trial i n c r e a s e d g r o w L h of 01-1tl311.t. It' would, h o ~ ~ e v c r , mere ~9bJZrdicet o evade t h s cnoice cilic'.i i n c e r t a i n be circumstances pus'; be made. Furthermore, it follows t h a t Ire r.;cul.ci. reject t h e s u g _ : z s t i o n t h a t t h e r i s e i n geiieral p r i c e s ~rhick!has occu.rred i n .-:-:1'-: last 2 years o r so ir, I n d i a h a s -fisu.lted from the p u r s u i t c f undisci.plined m o n e t a ~ yand f i s c a l p o l i c i e s . On the c o n t r a r y , :JT would a r p e t'na5 C?e b o t t l e n e c k o f food supply r-rtich has and Is r e s t r a - i g i n g t h e development o f t h e zcoiiomy has r e s u l t e d ix p a r t from the f a i . l u r e i r ~ the prevj-ous decade t o a c c e p t t h e i r r i p l i c a t i o n s f o r r e l a t i v e p r i c e s o f tile need to i n c r e a s e food s u p p l i e s . F a l l i n g and low p r i c e s f o r food s i n c e the mid-1950's 'nave indeed given I n d i a i t s e n v i a b l e record. i n the interna-bional league -Lable o f mcvements -in g e n e r a l p r i c e s , b u t t h i s has been a t t h e e-xpense o f t h e deve!.opment o f the a g r i c u l t u r a l marketable s u r p l ~ i s upon which economic grohTth must i~2 c o u n t r y a s poor and a s underfed a s I n d i a , be based, 100. This conclusion, hotrzver, i s , t o r e p e a t , p u t forward cond.itiorlallg. To k g i n w i t h i t i s imperative that, t h e So7;enment should f a c e up t the o i n f l s t i o n a r y dangers o f t h e acce;~tance of t h e argument by g a i n i n g a z c e ~ b n c e of an inccmes p o l i c y i n both t h e p u b l i c and p r i v a t e s e c t o r s o f t h e ecol;ony. The p e r v s s i v e dearness allo'rance system has c r e a 5sd a b u i l t - i n e s c a l l a t i o n f a c t o r which must be broken i f a v i c i o u s i n f l a t i o n s r y p r o c e s s i s t o be a a w i d . e d ~ ~ r i t . h o u tr r e s t i n g t h e r a t e o f e c o n ~ m i cgrowth. The p u r s u i t o f con- t r a c t i o n a r y monetary and f i s c a l measures i s no s u b s t i t u t e f o r such a vigorous i~zcornesp o l i c y in t h e s e circumstances. 101. F u r t h e ~ n o r e , i t ~ u s bc r e c o g n . i ~ e dt h a t x h i l s t an iiicomes p o l i c y t i t h a t trill achieve a h i g h r a t e o f gro.,~th w i t h o u t i n f 1 a t i o r . a ~ i s e s - n psrices r might be a long-';ern i d e a l , it creates s h o r t - t e r n f r i c t i o n s o f a s o c i a l / p o l i t i c a l c h a r a c t ~ r . It i s f o r t h i s reason t h a t i l l t h e s h o r t - r u n , particu1arl.y. w h i l s t t h e changes i n p o l i c y n e c e s s a r y t o p u t a g r i c u l t u r e on a h i g h e r t r e n d r a t e of growth, a r e being implemented, t h a t t h e r e i s a c a s e f o r a l i n i t e d . r a t i o n i n g scheme p r o v i d i n g a n a d m i n i s t r a t i v e l y rzrorka51e scheme can be devised. This would l i m i t t h e r i s e i n food p r i c e s to t h e l e v e l c o n s i d e r e d e c o n ~ : r , i c a ~ y d e s i r a b l e i n t h e long-run. 102 Fi,Jhilst o u r conclusi.on f o r t h e ~ a s t ,t h e n , i s t h a t f a i l u r e t o iR1~ose i n c r e a s z d f i s c a l d i s c i p l i n e h a s n o t markedly i n h i b i t e d t h e r a t e of i ~ v e s ~ e n t i n t- i economy, f o r tIx f u t u r e t h e need t o impose f u r t h e r f i n a n c i a l r 3 s t r a i i i t s if on consunption must be recognized i f it i s i n t e n d e d t h a t t h e r s t e of ir:-r-.s-t- men-t s h o u l d be increased.. The l e v e l of inves5ment s l ~ o v l dbe deteimined. 2 , ~ t h e a v a i l a b i l i t y o f f o r e i g n exchange and t h e a b i l i t y o f t h e eccnony, t e c h n i c a l l y and m a n a g e r i a l l y , t o r;lbsorb investment funds fmm Sotin e x % z r n a l and i n t e r n a l sources. I f t h i s r a t 2 o f gmr.rth g e a e r a t e s incones r:ri~ickr e s u l t in a grorr~tl-Iin food. demand i n e z c e s s o f t h e new t r e n d r z t e of growth :!i;ich i s c a l l e d f o r t h w i t h o u t a n unacceptable o r u n a t t a i n a b l e r i s e 'Ln food p r i c e s , then i n c r e a s e d taxa t i o n t o reduce p e r s o n a l d i s p o s a b l e iccolnes b e c ~ m enece r r a rY- Becaase i t a p ~ e a r st o u s t h a t t h e abili-tS. o f I n d i a t o m o b i l i z e f ~ r t h z r s a v i n g s through t h e f i s c d system has n o t beer! exhausted, we ~ o u l di n tkc-se cinclmstar,ces advocate f u r t h e r advances or, %he t a x f r o n t (iiicludi-ng public e n t e r p r i s e s u r p l u s e s ) . In doing s o , however, we s e e t h i s a s an ~ : x p a n s i c r ~ a q r p o l i c y p e r m i t t i n g t h e h i g h e r r a t e of investment t h a t , by h:Yyot;hesis, i s c o n s i d e r e d economically p o s s i b l e , and n o t a s a c o n t r a c t i c n a r y polic-7 r:Yiich i s attemptLig t o c o u n t e r a n i n f l a t i o n a r y r i s e i n p r i c e s .  1 . 1 1 C0I~LPAN.JTAXATTOIJ AID Ti16 03STkCLES TO GRO!(TH- A . Introduction 133. It was errphasized i n t h e opening paragraphs of t h e f i r s t chat)t;er of this study t h a t a c t i o n s 0 t h e Government i n t h e tax/pubE.c expendisure : f i e l d have both d i r e c t and i n d i r e c t e f f e c t s and t k i a t where t h e s e two zrou2s of e f f e c t s o p e r a t e i n opposite d i r e c t i o n s a balancing of -the d e s i r a b l e a z a i n s t tlie u n d e s i r a b l e economic consequences frorn t h e p o i n t of view of groxth becor:~es necessaqr. T h i s need i s perhaps hiore r e l e v a n t or a t l e a s t more apparent i.n t h e f i e l d of cornpaw t a x a t i o n t h a n i n o t h e r f i e l d s of t a x a t i o n . This i s onl,r i n p a r t due t o t h e obvious weight of p u b l i c i q ~ which t h e adverse e f f e c t s of coixpany t a x a t i o n r e c e i v e s from t h o s e inost c l o s e l y a f f e c t e d . I n l a r g e pa-.: it r e f l e c t s senuine concern i n a country which has a mixed p u b l i c / p r i . ~ - a t e econorrGr and which i n t e n d s t o maintain a rnixed econorny except I n c e r t a i n p r i o r i t y s e c t o r s , t h a t t h e advance or" t h e economjr a s a whole might be imget3ed by t h e f a i l u r e of t h e p r i v a t e s e c t o r t o f u l f i l l .the r e s p o i ? s i b i l i t i e s assigned t o i t due t o t h e weight and/or p a t t e r n of taxatiofi t o which it is sub2ect. lC/;* There i s one g e n e r a l circumstance t h a t makes such a possibilit.:r a. very r e a l danger i n a country a s poor a s I n d i a . This i s t h e f a c t t h a t i f ?.!e accept t h e v a l i d i t y and d e s i r a b i l i t y o,C a aevelop~ilents t r a t egg which emphasizes i n creased mobilization of f i n a n c i a l resources through t h e t a x system, then i f a socia1:Ly i n t o l e r a b l e burden i s not t o be in~posed011 t h e n a s s of very low income r e c e i v e r s and i f t h e a d n ~ i n i s t r a t i v ec o s t s of a s s e s s i n g arid ~ o l l s . : k i ~ i z t a x revenue a r e not t o be t o o g r e a t , t h e r e i s a llke2ihood t h a t t a x mczs:Lrr-s tiill be impossed on an unduly narrow segment of t h e ecoxoiny. I t f o l l o v ~ sthat, i f t h e t a x base i s d e l i n i t e d f o r t h e s e reasons t h a t t o generate a ~ i v e n volmle of revenue t a x r a t e s w i l l have t o Se high and perhaps dangerous!.::r s o . 5. - Rates of Tax on Com;?any P r d i t s -- 105. That t h e t a x a t i o n af t h e p r o f i t s of c o r p o r a t e e n t e r p r i s e In India rni;;ht be a r e f l e c t i o n of t h i s danger i s c l e a r l y suggest2d by -the general outcry of business a g a i n s t them. The f a c t u a l 'basis f r ~ m which this business a t t i t u d e stems h a s beer1 i20sl; s p e c i f i c a l l y s t a t e d by N.A. Palkhivala, a:1 a u t h o r i t y on I n d i a n income t a x law and a d i r e c t o r of Tatal s. He has s t a t e d t h a t 02 t h e p r o f i t s earned by a company and distri'outed by way of dividend, t h e t o t a l incidence af t a x betrereen t h e aompariy and t n e shareholder can go a s hFgh ris 37.8 p e r cent and t h a t "The p o s i t i o n becomes even worse when a c o r p o r a t e ~ h a r e > ~ o l c ? e r - i s i n t e r p o s e d " . l/ - 1/ Hindu Survey of I n d i a n I ~ d u s t r y , 196L, p . 27. 106. This s i t u a t i o n a r i s e s o u t of the f o l b w i n g b a s i c p a t t e r n of t a x r a t e s which a r e applicable to domestic coln2anies o t h e r than those which am c l o s e l y he1d.q Corpora t i o n Tax- / 2 Surtax General rude o 110% on r s s i d ~ e f chargeable profits,?l a f t e r deducting 10% on c a p i t a l base o r Rs. 2 lakhs (whichever i s the higher). 107. A cowany w i l l n o t normally pay s u r t a x u n t i l i t s earnings e ~ c e e d 20 t o 25 percent of i t s n e t worth though t h e p r e c i s e point a t which i t t.:ill become l i a b l e w i l l depend in p a r t i c u l a r upon the average r a + s of i n t e r e s f on i t s borrotdngs, and upon i t s debtdequity ratilo. For instance ~ i t a 2 : h 1 debt/equity r a t i o and a 7 percent r a t e of i n - k r e s t on borrowings, sur-hx o n l y becomes payable when p r o f i t s exceed 32 percent of n e t rrorth, 108. I n addition t o the basic t a x on company p r o f i t s , distrihu.ted ~ ~ r o f i t s Are taxed d . i f f e r e n t i a l l y a t 7.5 percent so t h a t i f a l l p r o f i t s are d i s t r i b u t e d the e f f e c t i v e r a t e of t a x r i s e s by t h i s amount whereas i f o n l y h a l f of r r o f i t income i s d i s t r i b u t e d , the t o t a l e f f e c t i v e r a t e r i s e s by 3.75 percent. d Furthermore, i n the event of a company i s s u i n g bonus shares, tax 9 t the r a t e of 12.5 percent i s l e v i e d on thz face value of the share issued.z/ The amol-ult of p r o f i t s which then f i n d s i t s way i n t o t h e hands of persons, i s a t t h i s s t a g e s u b j e c t t o the full r a t e s c f personal income taxation rxith a provisional 2 0 percent deduction a t source payable on behalf of the shareholder by the company. Vith r a t e s of persolla1 income a t t h e i r p r e s e n t Levels under ~~lii-ch they r i s e to a maximum r a t e a t the margin of 75 p r c e n t (incladj.-n.g the '25 p r c e n t surcharge on t a x on unearned income above Rs. 70,,0Q0, I t s apparent t h a t the f i g u r e s quoted by Palkhivala a r e nc t impcssi'ol-e. Furthzr- more, h i s c a l c u l a t i o n s leave o u t of account payments l i k e l y to be due under t h e c a p i t a l gains tax, wealc& t a x and expenditure t a x arid also t.he possi.ijill.ty 'chat; payments of g i f t t a x and of e s t a t e duty w i l l have to be made a t sorne s t a g e i n the future. -- - 1/ Ths 1966-67 budget has introduced major changes ir-1 most of t h e follor,5.ilg r a t e s of taxatlon. These a r e noted i n t h e footnotes but the su'oseaun,nt a n a l y s i s i s a r e t r o s p e c t i v e a n a l y s i s and thus the changes a r e only considered where they a r e r e l e v a n t to the conclusions which emerge from tine analysis. - 2/ The 1965-66 budget merged what had previoud-y keen two taxes (income t a x and supertax) each l e v i e d b a s i c a l l y a t the r a t e o f 25 percent on assesced p r o f i t s i n t o one t a x (the corporation t a x ) l e v i e d a t 50 percent. The 1960-67 budget has increased t h i s r a t e of corporatior. t a x to 55 pcrcerit. Chargeable p r o f i t s a r e equivalent t o p r o f i t s f o r mrporatj-on t a x Furposes (with c e r t a i n adjustments), l u s i n t e r e s t on borrowed f i n d s , l e s s corFora- E- t i o n t a x payment. The 1966- 7 budget has reduced s u r t a x t o 3 5 r c e ~ t . Under the 1966-67 budget t h i s d i s t r i b u t e d p r o f i t s t a x i s to be r e s t r i c t e d t o d i s t r i b u t i o n s i n excess of 1 0 percent of tk paid-up e q u i t y c a p i t a l of a company. The bonus share t a x on companies is abolished by the 1966-67 budget. 109. T h i s veSy b a r e s t a t e m e n t of t h e t a x i m p o s i t i o n f a l l i n g on companies and l e a v i n g o u t of account t h e p e r s o n a l t a x on d i v i d e n d s i s somewhat a t v a r i a n c e w i t h t h e 2 i c t u r e g i v e n i n t h e summarized accounts o f t h e :L,333 j o i n t s t o c k companies p u b l i s h e d by t h e Reserve %nk o f I n d i a . The summarized accounts a v a i l a b l q f o r o u r s t u d y r e l a t e to t h e accounting p e r i o d J u l y 1, 1962 t o June 30, 1 9 6 3 . d However, t h e t a x pro-rision i n t h e s e a c c o u n t s t a k e s cognizance of t h e i n c r e a s e d l i a b i l i t y f o r t a x imyosed on companies i n t h e 19/33 budget. Whilst changes i n t h e s t r u c t u r e were made i n the, subsequent t u d u e t i n 1964, t h e g e n e r a l l e v e l of c o r p o r a t e t a x a t i o n was, i f anything, s l i s k ~ t ~ ij reduced. Company P r o f i t s and Tax P r o v i s i o n -(Rs. c r o r e s ) Gross p r o f i t s 266 288 31? I n t e r e s t & Nanaging Agents' remune r a t i o n 51 57 63 P r o f i t s b e f o r e tsx 215 231 254 Tax p r o v i s i o n 82 100 129 Tax p r o v i s i o n a s p e r c e n t of p r o f i t s befo r t a x e 110. It i s w i d e l y accepc&d t h a t companies tend to o v e r - s t a t e t'neir probable f u t u r e t a x l i a b i l i t y and t h u s t'ne above r a t ? - o s can with s a f e t y be t r e a t e d a s r e f l e c t i n g maximum t a x burdens. Before tine emergency budgets o f 1963 and 1964 t h e t a b l e s u g g e s t s , t h e r e f o r e , t n a t t h e average e f f e c t i v e r a t e o f t a x on companies was around LO p r c e n t and t h a t it has now moved up to SO p e r c e n t . 111. The same g e n e r a l p i c t u r e i s p r e s e n t e d by t h e Economtc T i m e s Study of t h e a c c o u n t s o f t h e 51 p u b l i c l i m i t e d g i a n t companies (which account f o r a b o u t a t h i r d of the a s s e t s o f t h e non-Government, non-f i n a n c i a l , p u b l i c companies i n I n d i a ) . ~ h f s t u d y h a s t k advantage o f covering t h e y e a r 1363-6b. s It shows t h a t t n e average r a t e o f t a x on p r o f i t s was 46 p e r c e n t in 1952-63 and 44 p r c e n t i n 1963-64. 112. T h i s p r e s e n t a t i o n o f t h e e f f e c t i v e r a t e s o f t a x a t i o n on cozpan;. p r o f i t s i s more r e l e v a n t t o an a n a l y s i s o f c o r p o r a t e f i n a n c i n g , investne:~t, e t c . , problems t h a n t h e s u p e r f i c i a l s t a t e m e n t o f t h e b a s i c formal r a t e s . Noreover, an i n t e r n a t i o n a l comparison o f company t a x e s rarhich l o o k s merely a t t h e f o r m a l r a t e s would undoubtedly g i v e a d i s t o r t e d p i c t u r e . 113. But i n a d d i t i o n t o e s t i m a t i n g t h e average e f f e c t i v e r a t e o f t a x f a l l i n g o n a l l o r a s e l e c t i o n of companies, it is a l s o i m p o r t a n t t o know t h e . e x t e n t o f v a r i a t i o n of i n d i v i d u a l company e x p e r i e n c e around t h a t average. The Economic T i n e s Study o f t h e 51 g i a n t companies s u g g e s t s t h a t t h e degree o f d e v i a t i o n i s v e r y c o n s i d e r a b l e . On t h e one nand s e v e r a l f i r m s such a s I m p r i a l Tobacco, 3urmah S h e l l , V o l t a s , I n d i a n Cable, p a i d around 70 p e r c e n t o f t h e i r p r o f i t s in b o t h y e a r s i n t a x a t i o n . On t h e c o n t r a r y Tata I r o n and. S t e e l p a i d - 1/ P u b l i s h e d i n R.B.I. B u l l e t i n , July 1964. only 8 percent of t h e i r p r o f i t s i n t a x i n 1962-63 and 30 percent i n 1963-64 on nm-t.i?x p r o f i t s :h& ,n:prser.ted 14 p z r c c ~ t n n e t ??0i-W1 i n 1962-63 2nd :i o '20 pzrcent i n 1963-6h. Thorj a r e cr.l-7 e m ,ear t-o o t h r r casos i n y a r t i c u l 3 r g e a r s :ihich. a r e o s lorr as C ~ i s ,b u t t h o r e a r e sevc-ral cacpanie:: a r o 7 m d the LO percent e f f e c t i v e tax l e v e l . 11. 11 This i s a l s o borne out by a s p e c i a l Zeserve Eank study u n ~ ~ e r t a i ; e n on uehalf of t h e I,,ission i n respect of coinpanies belonging t o t h i r t e e n major i n d u s t r i e s included i n t h e Bankf s sample of 19333publS,c companies. Illis s p e c i a l study covered 688 companies i n 1961-52 and 647 c o ~ p a n i e s n 1762-53. i I t s broad r e s u l t s f o r each i n d u s t r y groups a r e p r e s e r ~ t e di n t h e f o l l o : ~ ? .g table. 1s 1. It can be seen that i n both y e a r s c o v ~ r e d t h e st,ud+-~ by aver hi: percent sf c o q a n i e s z l l o c a t e d l e s s tllan 30 p e r c e ~ tof t h e i r p r o f i t s q$a:i.nst t a x p a p e l i t s whilst a t t h e other extreme seven percent of cornpanizs i n 1961-62 and 25 percent i n 1942-63 a l l o c a t e d nore than 60 percent of t h e i r p r o f 5 . t ~ o r f this purpose. For c e r t a i n i n d u s t r i e s t h e spread s e e m even t,iider. For i n s t a n c e i n the f e r r o u s and non-ferrous metal products group, eleven f ~ .;hef 25 conpanics i n 1962-43 were providing more than 00 percent of t h e i r pr-of i t s f o r tax l i a b i l i t i e s and nine were providing l e s s than 30 parcent whie1-i r~ieans t h a t only i'ive of thein were prov5ding be-heen 36 percent aud 60 percent. 161. There i s no evidence immediately a v a i l a b l e t o enable t h i s p a t t e r n oi" coinpany t a x experience i n I n d i a t o be compared wi-th that; i n o.t!l~r ccuntr5.e~but our guess would be t h a t t h e spread i n Irldia i s iliu.ch wider dian i n a o s t other couritries of both t h e d e v e l q e d and l e s s developed w o r l d . Furtherri~ore, i n t h e Fp,bruaq~ 1965 b u d s t , an innovs.tion r:?ss -introdu.ceci j.nto Indiarl corlpany t a x a t i o n i n t n e form of encasiiable t a x c r e d i t s ( s e e pare;;rajih below ) . 111 ezf e c t this broadens t h e range of t a x experience by t l a v i n ~sorlc coii1l;anies en joying a ''negative" t a x burden. C . Tax Concessions t o Comganies 117* The question of i n t e r e s t i s what conditions a ccmpaiy must s3tisl.i i n order ts keep i t s average t a x burden belox t h e l e v e l of 70 percerrt or inore upon which public discussion tends t o be focussed and, xoreover, b e b n t h e average e.ffective r a t e of around 50 percent. I n f a c t , t h e s e c o l ~ d i t l o n s a stern f r o n t h e mw t a x concessions which have been granted t o cor,ipanies :and t h e weight which a t t a c h e s t o these both indiv5dually and i n combination. ApELrt f ror!l t h e i r f i n a n c i a l s i g n i f i c a n c e , some evaluation 9 ' t h e i r SigniTicance I i n terc?s of -the econonic o b j e c t i v e a t which they a r e aimed i s ciesr",rahle. In f a c t l i t t l e or no evidence i s availabZe Ui309 w k c h such an assessxerlt can be made a t t h i s s t a g e . C e r t a i n l y no evidence appears t o be a v a i l a b l e t o t h s Indj-ar! auti:oriti.es upon which they can make decisions t o continue t o rapzal., -t t o a u ~ ~ i e n or t o !r.odify t h e granting of an;r concessions. I n e v i t a b l y , t h s r d o r e , t h e quaiita$5ve a p p r a i s a l of t h c concessions tends t o be made i n a p r i o r i a n a l y t i c a l terms. ;<ore s u r p r i s i n g , I~or;ever, i s t h e f a c t t h a t with one - exception t h a Indian a u t h o r i t i e s have no idea of the q u a n t i t a t i v e s i g n i f i c a n c e of t h e t a x concessions s ~ h i c ha r e granted t o corrpanies. A s a r e s u l t , i t i s ini?ossible, Tor i n s t a n c e , t o deterliene what decrease i n t h e f o r m i r a t e s of  Table 10 Percentage of Companies Whose Tax Provision i n Relation t o P r o f i t s Number of Companies Before Tax Represented: More than 60% More than !A@ More than 40% Hore than 1Bl-62 1962-63 1'pFl-62 1962-63 1961-62 1962-63 1961-62 1 9 6 2 6 3 Sugar Cotton Textiles Jute Textiles Transport Equipment E l e c t r i c a l Machinery Machinery (N.0 .S .) Foundries & Engineering Workshops 23 Ferrous & Non-Ferrous Metal Products 24 Basic I n d u s t r i a l Chemicals 34 Medicines and Pharmaceutical Preparations 33 Other Chemical Products 20 Cement 15 Paper and Paper Products 20 TOTAL 688 647 7% 25% 26% 45% 5% 55% 55% 59% tax could be made i f c e r t a i n c o n c e s s i ~ n swere a b o l i s h e d b u t t h e t o t a l revenues from company t a x were to be k e p t unchanged. The concessions which a r e g r a n t e d t o I n d i a n companies a r e a s f o l i o w s : Development Rebate 118. i T h i s concession r e p r e s e n t s i n e f f e c t an a d d i t i o n a l d e p ~ c i ta o n pro- v i s i o n which i s allowed to a company i n competing i t s p r o f i t s f o r t a x p u q ~ o s e s i n any y e a r in which it u n d e r t a k e s e x p e n d i t u r e on c a p i t a l goods. U n t i l Xarch 1965 t h i s concession h a s been a t a imiform r a t e o f 20 p e r c e n t f o r a l l corfi?anies w i t h t h e e x c e p t i o n of t.hose purchasing new s h i p s and new c o a l m i ~ i n g mschi:-iery f o r which t h e r a t e s have been 40 p e r c e n t and 35 p e r c e n t r e s p c t i v e l y . .Urider t h e February 1965 budget p r o p o s a l s t h e s e two e:cceptional r a t e s were mai.r,tzi-ed and t h e 40 p e r c e n t r a t e extended t o e x p e n d i t u r e on t h e p l a n t i n g o f t e a bushes i n new p l a n t a t i o n a x a s . I n a d d i t i o n t h e b a s i c concession i t s e l f i s made in s e l e c t i v e . A h i g h e r r a t e o f 25 p e r c e n t was introduced f o r c o ~ ~ p a n i e s c e r t a i n p r i o r i t y i n d u s t r i e s and a lower r a t e of 15 p e r c e n t f o r a l l o t h e r conlpanies. However, t h e lower r a t e was n o t t o become e f f e c t i v e a n t i 1 1967 and so m t i l t h e n t h e d u a l r a k s were to be 25 p e r c e n t and 20 p e r c e n t . I n t h e s ~ ~ p p l s i n e n t a l y budget mea SUES i n t r o d u c e d i n August 1965 t h e s e l e c t i v i t y was f u r t h e r i t c r e a s e d by a p r o v i s i o n t h a t granted. a 35 p e r c e n t r e b a t e to t h e p r i o r i t y ir,dus+,ries o n -investment undertaken betveer, A p r i l 1965 and Earch 1970 a t which d a t e t h e 25 p e r c e n t r e b a t e proposed i n t h e March 1965 budget would beccjme o p e r a t i v e . Furthermore f o r t h e n o n - p r i o r i t y s e c t o r t h e i n t r o d u c t i o n of t h e 15 percen-6 r a t e was postponed from March 1967 t o March 1970. -a l Parti 119. Tax Holiday Exemptioa o f new companies from c o r p o r a t i o n t a x f o r a period. of f i v e y e a r s t o t h e e x t e n t of a six p e r c e n t r e t u r n on employed. c a p l t a l . High P r i o r i t y I n d u s t r i 2 s ( p a r t I11 o f 1st Schedule t o Finance 321, 1965) 120. Corporation t a x 'Levied a t hr p e r c e n t i n s t e a d o f 50 p r c e n t and sur5ax a t 3 2 p r c e n t i n s t e a d o f 40 p e r c e n t . g t Extra -Shif --.- Concession - 121. Annual d e ~ r e c i a t i o np r o v i s i o n i n c r e a s e d f o r companies working dotlSI..? o r t r e b l e s h i f t s . T h i s b c r e a s e is e f f e c t e d by i n c r e a s i n g d e p r e c i a t i c c r a t e s by 50 p e r c e n t f o r two s h i f t rnsrking and by 100 p e r c e n t f o r t h r e e s h i f t ??orking > n t h pro. r a t a adjustments f o r s h i f t work-hg which i s n o t continuous throughout t h e year. Concession to Small Companies 122. - Corporation t a x l e v i e d a t h2.5 p e r c e n t i n s t e a d o f 50 p e r c e n t on companies w i t h a s s e s s a b l e income l e s s than Rs. 25,900. Zxport Concessions 123. There a r e now t h r e e concessions t h e l a s t o f which h a s been i n t r o d u c e d i n t'ne F e b r u a r y 1965 budget. They a r e : - --- The 1966-67 budget i n c r e a s e d t h e b a s i c r a t e o f c o r p o r a t i o n t a x from 5 0 t o 55 p e r c e n t w h i l s t t h e r a t e o f s u r t a x was reduced from h O p e r c e n t t o 35 p e r c e n t . ,It t h e same t i n e t h e p r i o r i t y i n d u s t r i e s concession was changed so -that it i s now c a l c u l a t e d by a r e d u c t i o n o f 8 p e r c e n t in p r o f i t s Tram such i n d u s t r i e s brhich a r e c h a r g e a b l e to t a x a t i o n .  (i) Forty-five percent corporation t a x . h s t e a d of 50 percent on p r o f i t s a t t r i b u t a b l e to exporting. F o r t h i s purpose p r o f i t s a r e normally a t t r l b u t e d to expor55ng i n the same c r a t i o a s exports bear t t o t s 1 s a l e s of t h e comi2any. (ii) Rebate of corporation t a x e q u i ~ r a l e n tto t a x payment on a sum equal to two percent of export revenue. (iii) The F e b r u a r ~ 1965 budget has iatroduced an a d d i t i o n a l con- cession i n the form of a t a x c r e d i t c e r t i f i c a t e (sashable if t a r l i a b i l i t y i s l e s s than the value o f the c e r t i f i c s t e ) repre- s e n t i n g a s n n o t g r e a t e r than 15 percent of the export revenue. w 124. 811 t h r s e concessions are s u b j e c t t o c e r t a i n l i m i t a t i o ? ~ . The F i r s t two exclude foreign companies which do n o t d i s t f i b u t e d.iv-idends i n India. The second concession excludes a l l i n d u s t r c e s outside of the F i r s t Schedule t o the t n 1nd.ustries (~evel-opmentand ~ e ~ u iloa ) Act, 1951 and a l s o a few ii~dust:>S.es which a r e w i t h k the Schedule. The t h i r d concession b e n e f i t s expor'kers of t ~ ~ e n t y - t wproducts a t r a t e s ranging frorr! 2 percent ( f o r j u t e and t e a ) t o 15 c percent f o r c e r t a i n non-traditional exports. 125. A l l t h e above concessions with t h e excepti.cn of ( i i i ) have heen operative f o r varying periods of time. I n t h e February 1965 blldget they have been supplenented by s e v e r a l a d d i t i o n a l concessions. Several of t.hese a r e of minor importance (e .g., f o r those companies which are incurring expenditure schemes of family planiiing and f o r those foreign compailies -:rhich r e i n v e s t capi- 3 1 gains i n approved s e c t o r s of $he economy). In a d d i t i ~ n , hor.~ever, nore major concessions havz bean granted i n respect or^ c e r t a i n companies :rhose c w ~ o rtion ? t a x pa;yrr.ents and/or v?!losc excise t a x p a p . e n b ha-JZ incressed 3s com.parcd 1:it.h a base yezr and Tor those conpanies xho relocgte their. uncizrtaitings aTxy frorn LIP- ban areas- These t h m e concessions 3 r e b r i e f l y descrj.bed i n tile t i l r e ~2 3 ~ 2 . - graphs below hut t h e first two a r e more f u l l y a p ~ r a i s e dl a k r i n .this SI~apter. 7. Tax C r e d i t C e r t i f i c a t e Sased on Corpora.tilon Tax Payment 126. This ccncession i s given i n the form of a tax c r e d i t c e r t i f i c a k equivalent t o 20 percent of t h e increase in a company's t a x S i l l (including s u r t a x b u t e;:cluding p r o f i t d i s t r i b u t i c n t a x and bonus share t a x ) over a base vear. The base year assessnent i s t h e t a x assessment f o r 1965-66 and t h e scheme runs f o r the f i v e years frcm 1966-67 t o 1970-71. Whilst no t a x cu.9s'it w i l l , therefore, be granted during 1965-66, any operations by a company r;$?lch during t h i s y e a r increases its l i a b i l i t y t o corporation t a x > r i l l give r i s e to a t a x c r e d i t i n the subsequent year. There a r e provisions to enable newly e s t a b l i s h e d companies t o become e n t i t l e d to the provisions of the scheme. The scherre i s l i m i t e d , but n o t severely, to companies i n p a r t i c u l a r iridustrFes (1951 schedule). Furthermore, there i s a l i m i t of 1 0 percent of t a x payment i n any one year which can be granted a s a t a x c r e d i t . 8. Tax Credi-t C e r t i f i c a t e Based on Excise Duty Payment - 127. This concession i s i n the fern of a t a x c r e d i t a g a i n s t corporation - 1/ This concession i s explained more f u l l y i n paras. 157-161 below. t a x , t h e value o f which i s t o be d e t e r r k l e d i n ~ I a t i o vt o t h e i n c r e a s e in e x c i s e d n t y payable on i n c r e a s e d o u t p u t kl any o f the f o l l o w i n g five y~ a r s o v e r t h a t p a i d i n 1964-65 ( o r a subsequent y e a r f o r ne5rl.r e s t a b l i s h e d co..?ulies). - g Whilst t h e i n i t i a l wording of t h e r e l e v a n t c l a u s e s t a t e d t h a t I t ~ n manufactilrer - of 9 goods s h a l l be g r a n t e d a tax c r e d i t c e r t 5 f i c a t e n , t h e subsequent s e c t i o n s o f t h e l e g i s l a t i o n make it c l e a r t h a t o n l y t h e p r o d u c t i o n o f c e r t a i n goods r i l l be e l i g i b l e f o r t h e concession and t h a t t h e percentage o f t h e i n c r e a s e in up e x c i s e d u t y which w i l l b e p e r ~ i t t e di n a n y p a r t i c u l a r c a s e w i l l be ---.- t o a maximum of 2.5 p e r c e n t , I n f a c t t h e concession has been r e s t r j c t e d t o L 2 : following i n d u s t r i e s and has been g r a n t e d a t tk r a t e s snotzn i n pau'ent:lr-s ls c e ~ e n t n d n e w s p r i n t (25%), soda a s h and c a u s t i c soda (20$), and p a 2 a r (15: a >. Concession t o Companies T r a n s f e r r i n g f mm 'Jrban Areas 128. This i s r e l i e f of t a x o n c a p i t a l g a i n s from s a l e o f l a n d 2nd SclXLdfngs i n an u r b a n a r e a rzrhich i s t h e r e s u l t o f an approved d e c i s i o n to t r a n s f e r t o a n o t h e r a r e a . R e l i e f a r i s e s rpihen a company i n c u r s e x p e n d i t u r e on land, b u i l d i n g s , equipment, e t c . , a s a r e s u l t of t h e t r a n s f z r and i s based on the p r o p o r t i o n which t h i s e x p e n d i t u r e b e a r s to the capita:! g a i n s o f t h e cor?.paily. This p r o p o r t i o n i s t h e n a p p l i e d to t h e t a x on t h e c a p i t a l g a i n s in o r d e r to determine t h e r e l i e f t o be given. 129. It i s r e a d i l y a p p a r e n t from what has been s a i d so f a r t l ~ a tIndj.an Corporation t a x a t i o n h a s ~ J O i s t i n c t i v e f e a t u r e s . F i r s t l y , the iormal r a t e s d a r e h i g h and secondly, a s e r i e s of complex concessions both r e d . ~ c e s.the average e f f e c t i v e r a t e of t a x and g i v e s a wide spread o f i n d i v i d u a l corr?a:iy e x p e r i e n c e from t h i s average. Two q u e s t i o n s i n e v i t a b l y a r i s e o u t o f t h i s system. F i r s t l y , whether t h e complex concessions a r e e f f e c t i v e i n tem.,s o f t h e i r r a i s o n d f e t r e o r whether they ?sould n o t be b e t t e r r e p l a c e d 'n t o t a l o r I in p a r t b y lower f o r m a l r a t e s o f c o r p o r a t e t a x a t i o n and secondly whether Lhe c o n s t r u c t i o n o f such a complex struc$ure h a s n o t l e d to uncertai-nty r e g a r l i n g t h e f u t u r e p o s t - t a x p r o f i t e x p e c t a t i o n s o f v a r i o u s a l t e r c a t i v e compngy polLcies . . D The Complexity o f Company Taxation 130. From t h e t e c h n i c a l p o i n t of view o f tax a d m i n i s t r a t i o n and of taxpayer understanding t h e r e i s c e r t a i n l y f a r l e s s need to be concerned about, coxpl-exity when d e a l i n g w i t h coinpany t a x a t i o n t h a n when d e a l i n g with ~ e r s o n a l+ ~ r , a t t o n . Company a c c o u n t a n t s and l a y y e r s a r e more r e a d i l y to hand f o r advice t h a n i n t h e c a s e o f p e r s o n a l taxpayers. Of course t h e amount o f t a x l i t i g a t i o l Is l i k e - l y t o be a f u n c t i o n of t'ne complexity o f t h e t a x ~ s t e m though it, i s t.o be doubted whether it v a r i e s p r o p o r t i o n a t e l y . I n any c a s e we ~,:culd t e n d to +he vteu t h a t c o n s i d e r a t i o n s o f t h i s n a t u r e should t i p t h e balance i n marglnal c a s e s r a t h e r t h a n be t h e p r i m a q ~focus of a t t e n t i c n i n judging t h e r a t i o n a l e of the t a x sysixm. 131. It i s a major theme o f t h e M i s s i o n ' s f i n d i n g s t h a t t h e more d e c i s i o n s a t t h e o p e r a t i n g l e v e l t h a t can be l e f t u n f e t t e r e d by a d m i n i s t r a t i v e c o n t r o l s , t h e b e t t e r . E s s e n t i a l l y , of course, t h i s i s what a h i g h l y s e l e c t i v e f i s c a l p o l i c y o f the kind r e f l e c t e d i n t h e Indian company t a x system, at-krnpts t o achieve. It a c h i e v e s t h i s , furthermore, w h i l s t r e t a i n i n g t h e power in t h e hands of the Government t o modify t h e p a t t e r n of resource u t i l i z a t i o n from t h a t rshlch would a r i s e uqder a f r e e :]:ark& : ~ i e c l m l s ~ ~ .h i s i s brou,z!lt about T indirectl;r bjr isoclil".lin:, t h e f a c t o r s which cons-citute t h e enviromient i n which managerial dacisions a r e v o l u i t a r i l y nade r a t l l s r than by exte;idic= t h e area of control over decision-takers by f u r t h e r l i c e n s i n g and other administrative lneasures, i n order t o f o r c e t h e i t o do other than they uould riisil t o do i n a given e ~ v i r o m e n t . 132. The scope f o r ini,roducirl~s e l e c t i v e t a x concessions both i n t3r.-:Ls of t h e nuiber of concessions and t h e i r individual and coll-ective i n t e n s i . ~ ' . ~ , I s ~ h c r e a s e d , ,the higher t h e formal r a t e s of t a x . This has Seen t k e sase up u n t i l t h e present i n I n d i a . However, a novel f e a t u r e introduced Q. the , / concessior,~announced i n t h e Fcs. 1965 :m&z& i s t k a i most of C,tci-"lar? g i x n :'~nt h e f or51 of an inconte t a x c e r t i f i c a t e ( i .e., a t a x cyedi.t) r a t h e r -t?~a;i n i tlie f o r x of a reduction i n taxable income. This c11an;e enables t:ne valar: of a concessicn and the t o t a l value 02 a l l concessions t o be divorced fros! .ti-ie t a x pa;;rxent by a company f o r if t h e t a x c r e d i t i s i n excess 3f ta:: l i a b i l i t y t h e c e r t i f i c a t e i s cashable. One f u r t h e r and r e l a t e d ~ d v a n t a s eof tliis innovation i s t h a t the value of t h e concessri-on i s not dependent upon t h e rxirginal r a t e 02 t a x t o which t h e compaEy or person i.s subject e;:cepf, t o t h e ;~ e?ctent t h a t t h e Governxent e x ~ l i c i t l wislies this t o be t h e case ( e .g., a s x i t h t h e concession which represents a rebate of corporate t a x a t i o n paid over and above t h a t i n t h e base y e a r ) . 133. 73lilst i n general we would amrove o:? a highly s e l e c i i v e and t h e r e f o r e highly co~lpler,company t a x s:ist em, t h e .,,portant question t o be anmered i s how e f f e c t i v e i n p r a c t i c e it i s i n achievinz i t s objecti-ves. It i s c e r t a i n l y unlikely t h a t any economy i s a s resi~cnsivet o s e l e c t i v e f i s c a l measures a s r.;ould be desirable and t h e Indian econor~jri s perhaps l e s s s e n s i t i v e than most due t o t h e reduced cor;lpetitive pressures upon firrns which have r e s u l t e d from protection, l i c e n s i n g arranger.ien-ts, e t c . Bc~-:e~er, t even t ~ i t h k i s reservation i n mind, f i s c a l measures a r e p ~ o 3 a b l yaiore e f f e c t i v e thail i s i m ~ e d i a t e l yapparent. To bezin w i t h a l l p r i c e movcner~ts a f f e c t , and a r e intended t o a f f e c t , only a l l o c a t i o n decisions a t t h e xarg5.n. It :?auld, thereSore, be u n r e a l i s t i c t o expect t o d e t e c t major r e - a l l c c a t i o n s of rssources r e s u l t i n g from any p a r t i c u l a r tax-iiiduced p r i c e change. I n p a r t i c u l a r , i n t h i s comlection, deci-sions not t o s e t up an e n t e r p r i s e , not t o e n t e r a given industry, e t e . , f o r t a x reasons ? r i l l be dXficult t o discover outside of a comprehensive empirical study. Furthernore, t h e e f f e c t of f i s c a l measures i s i n d i r e c t l y l i k e l y t o be f a r stronger than i s r e a d i l y appare~lt . frorc t h e i r d i r e c t e f f e c t By making some l l r r n s more l i q u i d and others l e s s Liquid, t h e availabi1it;;r of funds for developcent w i l l be a l t e r e d . ? ? l i % L ~ t , therefore, f i s c a l concessions and p e n a l t i e s vight have but l i t t l e eff'ect on t h e induceinents t o do o r not t o do c e r t a i n tilings, t h e a b i l i t y t o do ti.~am can be markedly varied. T h s i s t h e point of emphasis of t h e In&an autliori'ties towards t h e t a x concessions which a r e granted t o corcpaiiies. Xssentiallg t h e i r - 1/ This f e a t u r e was i n f a c t a n t i c i p a t e d by t h e concession t o i n v e s t o r s in s e q u i t , , ~ h i - e s of new undertakings announced around Christmas 1964 and ly which i s f o ~ ~ a l embraced i n t h e present (1?65) Finance R i l l . a - g u ~ e n t i s t h a t developnier~tr e q u i r e s equity Tuncis t o be made a v a i l a b l e t o t h e p r i v a t e s e c t o r and t h a t I n t h e I n d i a n ?ontext of high personal and compan;r t a x a t i o n t h e r c i s a need f o r t h e Gover~xientt o contribute t o t h e sup~1;:r of t h e s e funds . Howeirer , they a r e um;illing 'co grant these funds inuiscrlzlina t e l j and thus t h e need has a r i s e n t o l a y down t h e c o ~ d i t i o n s which must be met i n order t o r e c e i v e what a r e regarded a s i n l a r z e measure contributions t o %lie i n v e s t i b l e funds of a colnpany .&/ 1.3b. I n this connection i t i s s i g n i f i c a n t t h a t t h r e e of t h e cor;cessl.or,s ( t h e aevelq?!i?e:i-t r e b a t e and t h e two concessions based or! ailnual irc;-e;;c.:5 'so p r o f i t s t2.x Ea3ilj.t; and t o excise duty l i a b i l i t g i ~ t r o d u c e di c t h e recczb budget) s t i - p l a t e t h a t t h e r e b a t e s should i n p a r t o r i n t o t a l be use6 so i n c r e a s e t h e equity base of t h e company. Seventy-five percent of t h e no development r e b a t e inus.t be put t o a reserve account from ~ ~ i l i c h d i ~ l d a ~ d s nust be paid f ~ ar period of e i g h t g e a r s and r"ollowi.ng tile same princl;:~l... t h e -two recent t a x c r e d i t s rilust be used f o r t h e repayrment tji" ioaxs talren ' : . 4c.:ia co:ilpany f ra;i sly f i n a n c i a l i n s t i t u t i o n a-pproved bjr t h e Govei"~ucent or f ol- t h e r ~ d e n q t i o nof i t s debentures. 13 5. It i s , of course, d i f f i c u l t t o judge how e f f e c t i v e oblisations of t h i s nature a r e i l l n~a!:inz inore equity f i n a n c e a v a i l a b l e . Cerbainly i n t h e case of development rebate t h e 75 percent r u l e can, i f a canpawJ so a ~ s i ~ e s , simply l e a d t o a s ? i t c h of reserves from f r e e reserves t o develop::!cnt rdh2T;a c reserve md t h e onl%y o n s t r a i n t i s t h e s i z e of Tree reserves i n r e l a t i o n -Lo t h e development r e b a t e reserve. Liliec~isev l i . t h t h e s e new concessioris, i.2 -;de . , 3 2 - ~ l a r g e r a f t e r - t a x p r o f i t s which they I m p l e : t~ould, i n t h e absence of t h e o b l i g a t i o n Lo pay off debentures or other lcans, have l e d t o t h e declarat2on of a l a r g e r dividend, t h i s i s s t i l l possi'ule by an appropriate reduction i n f r e e rcserves. I n f a c t t h e s e s t i p u l a t i o n s regarding t h e use t o which spe3i;"ic t a x rebates, s t c . , should be p u t , f a i i t o ackno1;ledge t h e u n i t a r y r , a t u ~ ecf t h e f i n a n c i a l operations of a company. Eiey appear, on t h e con-braq.~,t o assurie t1la.t companies operate l i k e those pernickety and/or Ill.-discipi.i.ned hcusewives who keep a s e r i e s of cash boxes i n t o which i~ione,yi s p u t each aeel: with which .to x e c t monthly/quarterly/yearl~- coi:~titraents. 136. However, d e s p i t e t h e s e r e s e r - ~ a t i o n s , given t h e volume of revenue which t h e Government f e e l s it can forego froyil conlpa~qyt a x a t i o n , it i s r i g h t t o d i r e c t tile concessions a t those coripa;lies which on the b a s i s of -the sckei~zs it has drawn up a r e assuilled t o be t h e elpanding c ~ x ~ p a n i e s prioriLy s ? c t o r s . in I f t h e c r i t e r i a used t o r e f l e c t growth a r e r e a l i s t i c , then t h e compani.3~ w i l l r e c e i v e t h e co~lcessionsw l l l Se tkose whose needs f o r c a p i t a l Zui<ds a r e likely t o be g r e a t e s t and who a r e t h e r e f o r e likely t o t r e a t t h e i n c r e a s e i n t h e i r a f t e r - t a x p r 0 f i . h a s a source of c a p i t a l flinance. For this reason it i s curioils t h z t t h e repa-pent of 'oorlmd:ii?g should be i n s i s t e d ~ p o n ;or what these co:lpacies a r e l i k e l y t o r e q u i r e i s an i n c r e a s e i n both equri.tp funds tho and borror.!e< funds. A t t h i s ?oint, h o ~ ~ e v e r , matter beconles so~~iewhz L q r s t e r i o u s , f o r t h e o b l i z a t i o n on company i n order t o be entitl-cd -to one of t h e ta: c 2 e d i t s i s t l ~ i-G t should re;oa:;r i t s debentures o r i t s loans Trom appro-ed ins1;itutlons. This seems t o put a t a x pressure on a company t o b o r r o ~ ~ , i n i t s a s s m e d circw~istances02 rapid powth, froi;: non-approved sources i n c l u d n g t h e co~a.iercial banks. kl'cernativeljr i t w l l l slm~1.ylead t o a coiipany --- -/ 1 t This ou.sstion i s e::anined rwre f u l l . ~ n the n z ~ cllc"qt9r. i paying off i t s previous borrowings and seeking approval f o r f i r t h e r bormruing, f o r the Finance a i l 1 says s p e c i f i c a l l y t h a t the t a x c r e d i t w i l l be used f o r the - repayment of loans a ~ dredemption of debent~lres; i t does not s a y t h a t it must be used t o reduce tile , indebtedness of the company from these approved sources. . E The V a r i a b i l i t y o f Conpang Taxa t i o n 137. Apart from the t o t a l weight of the tax impositian and i t s complexi@, c r i t i c i s m has a l s o been l e v i e d a t the Indian company t a x system on the ggmunds of i t s uncertainty. Both the formal r a t e s of taxation and the s t r u c i u r e of concessions have, it i s argued, been a l t e r e d so freul.~entlyt h a t n a t i o n a l ~ 1 a r . - ning of conpany policy has become impossible. 138. There i s undoubtedlj considerable fo rce in t h i s argument. FurCUher- more, the poixt, has been taken by the autllorities and a s a r e s u l t u n d e r t a k b g s have been given both i n general terms and on s p e c i f i c m a t k r s , of sorne assurancf of s t a b i l i t y . In the Feb. 1965 budget, f o r instance, the Finance Mj-nister enphasized t h a t , "A g r e a t e r degree of s t a b i l i t y in regard to the s t r u c t u r e of d i r e c t t a x a t i o n i s of v i t a l importance a s i t has a bearing on long-term decl- sions i n regard t o sav7hgs and investment. Ny budget proposals t h i s ;.ear have been designed to serve t h i s end a t l e a s t i n part". Eore speci.ficaliy, he an- riounced i n h i s 196Lr Budge% t h a t he intended t o make I2.e developmen'; rebate more s e l e c t i v e but t h a t i n order n o t t o undermirie reasona 'ole busin? s s e::pec ta i,il-,ns he was merely I1servir.g notice" t o t h i s e f f e c t . A s already noi.cd a ' s o v e ~ / hiis proposals i n tl1i.s regard have been introduced i c the Feb, I.>:'; bur?,:>t blit ,t,ile application of the lower r a t e of 15 percent does not operate unti.:L 1.967.2 Furtbzrmore , the two t a x c r e d i t cor.cessions based on in,cremei:ts t o coi-p,:3.50n t a x an$,to excise duty l i a b i l i t i e s have been iritroduced f o r a per!.od o f f i - ~ e years . d 139 I4oxever, the c r i t i c i s m must not be over-stated. T beg-i.1 r * r i t ' n , it i s o obvious t h a t no country can be expected to comence on a program of p1an:led de- velopment ~zritha complete idea of i t s implications f o r t a x purposes o r 1 6 t h tire a b i l i t y to implement immediately a l l the t a x i m p l i c a t i o i ~ swere they "kno:,rable". I n f a c t i n 1953, s h o r t l y a f t e r the s t a r t o f the F i r s t Five-Year P:Lan, t h ~ , Goverrment appointed a Taxation Enquiry Sommission to study the t a x sys tem 75th reference, i n t e r a l i a , t o the development program of the country. Thc "Jmr,i~- sion reported in m. It has been t h i s r e p o r t which has s e t the general p a t t e r n o f development o f the t a x s y s t e m since the mid-19SOts and given i t an underlying theme. 140. a In regard + com;lany taxation t h e Commissioi~rsemphasized Yne danger t o the develoyment of the productive capacity o f the country o f a tax burden which adversely a f f e c t e d savings and invesbnent I n the p r i v a t e sector. To prevent t h i s kiappening, they advocated s e l e c t i v e concessions implemented through t h e p a t t e r n of t a x a t i o n r~llicht ~ o u l dboth provide the wherewLthal and zncouragement t o c r u c i a l s e c t o r s of the economy. This very general reco:nmenda- h tion has motivated most o f t h e changes i n company taxation ~ ~ k i i chave occnrred. Paragraph 118. 11 Anended t o 1970 -in the August 1965 Budget. 21 Events since February 1965 i n t h i s regard have n o t r e f l e c t e d an i n c r ~ a s e d emphasis on s t a b i l i t y of the t a x s t r u c t u r s . The supplementary budget in August 1965 introduced major changes i n development rebate which superseded changes introduced only s i x mon1;hs e a r l i e r and the 1966 budget has again o presented changes i n both the r a t e and s t r u c t u ~ f corporate taxation. There has been s o w experimentation and even some f a l s e s t a r t s especially i n t h e 1950-s. I n p a r t i c u l a r t h e attenlpt t o s t i n u l a t e coinpaqy saving began with a rebate f o r r e t a i n e d ix-ofits which idas replaced i n 1956 b7 a gradilated supertax on dividends which l a s t e d u n t i l 1960. I n 196L t h e rnatter was again talcen up this time i n t h e form of a W o r m 7.5 percent t a x on d i s t r i b u t e d p r o f i t s . Likewise t h e conpulsory deposit of retained p r o f i t s w i t h t h e Government t o ensure t h e i r p r i o r i t y u t i l i z a t i o n , which was introduced i n 1956, was abolished i n 1959,and i n 1961 t h e wealth t a x on cgmpanies was a l s o repealed. The t a x holiday and t h e development rebate have beer, consS.s5ent elements i n t h e s t r u c t u r e of company t a x a t i o n though t h e r a t e on t h e 'iaJ;';er ;gas . . changed from 25 percent t o 20 percent i n 1961 and has i n t h e ciost rar;enL ondyccb a . , been made selecti.ve with two r a t e s of 25 percent and 15 percent ( t h e la%-Ler teconun,? e f f e c t i v e i n 1970). The most recent innovations have been alrned a t encouraging exports and development i n p r i o r i t y i n d u s t r i e s and b;~ t h e m r e dynamic f i r x s i n t h e econoqj. L. IL Given the f a c t t h s t t h e r e i s not and never can be any l i x e d . e t . of s s r l n c i p l e s upon which a company t a x s;rstera geared f o r development cai; ae . t i l z l l t , and c e r t a i n u no f i x e d r u l e s of thumb which can be appli-ed, eqerir;!entac~on i s i n e v i t a b l e i f d e s i r a b l e r e s u l t s a r e t o 0 s achieved. There has i n our view been too much exgerimentatian and thus t o o l i t t l e t i n e given t o allow t a x measzres t o have more than an impact effect and t o see whak impact previous t a x :!leasures have had. This i s p a r t i c u l a r l y t r u e i n t h e l i g h t of t h e conrplete Znl.lure or i t h e a u t h o r i t i e s t o undertake any study of ineasures p r e - ~ o u s l y n e , ~ s i e i l c e or t o col1ec.t Fnf orrnation conc ernj..ng even t h e a o s t obvious of maLlers such 2 s t h e f i n a n c i a l importance of p a r t i c u l a r measures i n aggregate and .to p a r t i c u l a r s e c t o r s of t h e economy. O the other izand,becailse we f e e l thc?:t f i s c a l 2 o l i c y n has a very iiiiportant r o l e t o play i n the r a t e and p a t t e r n of de.rielop;.ien'.; of t h e p r i v a t e s e c t o r i n t h e Indian context, we would be unhapp;y i f tile penc!u:l.l~r, had swung .too f a r i n t h e other d i r e c t i o n and a s a r e s u l t the r e c o g n i t i c i of r~dstalces, t h e progressive development of t h e t a x systern, e t c , had Seen . sacrificed t o stability. 1112. The second point we would make i s t h a t i n s t a b i l i t y of t a x policy i n p a r t a r i s e s out of t h e i n e v i t a b l e r o l e which t h e Goveraxent has t o play i n t h e adaptation of t h e economy t o short-run econonlic s i t u a t i o n s . These can a r i s e , f o r instance, oct of such p o l i t i c a l events a s t h e Chinese enlergency or oilt cf v a r i a t i o n s i n , say, t h e food harvest, or out 03 changes 5.n t h e expecta.tic;ns of f i n a n c i a l investors, company d i r e c t o r s , e t c . , i n t h e p r i v a t e s e c t o r of the economy. 'ke introduction of t h e super p r o f i t s t a x i n 1963, modified and replaced b the s u r t a x i n 196L, i s an ob-vious case a an emergenc,y t a x y f introduced almost i r r e s p e c t i v e of i t s desirabili-by i n terms of longer-ran developrne~talconsiderations. Similarly t h e depression i n priva.te sector r e a l investment a c t l v i t y i n t h e l a s t two years of t h e 1350's a