Monday, April 25, 2011

Taxes on vehicles increased

According to a news report, the Government has raised vehicle taxes. It was only in the middle of last year that the taxes were reduced, so why the sudden reversal?

There are three factors that could be the causes:

1. There are too many vehicles on the road, there is a need to restrict the number being imported.
2. The Government is short of tax revenue.
3. Possible problems with the balance of payments.

The most likely scenario is a combination of items two and three.

Taxes on household appliances and cars were cut in the middle of last year and further cuts to VAT and income tax were announced in November. People were generally pleased and there was a marked increase in economic activity.

There was however a flaw in the budget - there was no reduction in state expenditure. Thus although the rates of some taxes were cut there could be no reduction in the overall tax collected if the budget deficit was to be met. In more simple terms the same amount of tax would be collected by different means.

In fact the Government was expecting to collect more taxes (151 billion rupees more, total tax revenue was targeted at 963.5 billion rupees, up from 828.2 billion rupees in 2010). The higher tax collection was necessary to finance increased expenditure (total current expenditure will go up to 1,017 billion rupees from 926.0 billion in 2010, the largest part of the increase - 49 billion rupees, being spent on salaries).

Therefor the Government was hoping to collect more in taxes, but at the same time tax rates were cut. How does one square this particular circle?

This is workable provided growth in volumes offsets the reduction in rates. It is likely that this has not happened. Recent price increases in fuel, gas, bread and electricity indicate a need for increased revenue, which is consistent with the increase in car duties.

Is there an issue with the balance of payments as well? The surge in imports of vehicles has undoubtedly put this under pressure, but as there are no figures available it is difficult to be certain. The recent IMF review did note that the forex reserve target was missed, although this was blamed on an early repayment of a loan from Iran.

The increase in traffic is partly due to the increase in economic activity and while this is a problem, I don't think it is enough to have caused a rethink in policy.

The increase in taxes will dampen activity and will cause worries about policy. Businesses do not like to see constant changes in tax rates, it adds to uncertainty and what changes take place should be within a clearly discernible policy framework.

People were pleasantly surprised when taxes were cut and one only needs to witness the spurt in activity in the last five months to see its benefits.

In order to reap maximum benefit the lower taxes need to stay, but to do this the Government must tighten its belt and cut its spending.

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