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The fiscal mathematics of each Union budget hinges on one key assumption: the projection for revenue growth over the course of the year. Over the past few years, the finance ministry has consistently over-estimated revenue projections, leading to a revenue shortfall. Such projections make for a rosy fiscal deficit target when the budget is presented but cause grief at the end of the fiscal year, when the targets are missed.

In the last budget, Arun Jaitley projected tax revenues to increase by 18% to 13.64 trillion. In the first half of the fiscal year ending March 2015, only 36% of that target had been met. If that trend holds till the end of the year, Jaitley is going to miss the revenue target by a wide margin. As the chart below indicates, Jaitley is not alone in making over-optimistic revenue projections.

The gap between revenue projections and actual revenues was widest at the start of the previous decade before narrowing in the middle of that decade. Fast economic growth meant that revenue collections actually exceeded projections for a few years. But over the past three years, revenue collections have been significantly lower than what were projected. On the one hand, a slowing growth engine and declining profitability of companies have adversely affected tax revenues. On the other, the compulsion to lower the fiscal deficit figure has led the finance ministry to pursue over-optimistic revenue targets.

Put another way, the assumed tax buoyancy has been significantly lower than the actual tax buoyancy in recent years, as the second chart shows.

The growing divergence between the actual and projected tax buoyancy reflects the weaknesses in revenue management in India. As the first report of the Tax Administration Reform Commission (TARC) headed by Parthasarathi Shome pointed out, tax projections in India are often divorced from economic realities. This not only leads to unrealistic targets but also puts taxmen under undue pressure to meet targets assigned to them.

The TARC report pointed out that tax planning in India is marred by the “complete absence of economic, statistical, behavioural, or operations research-based analysis of policy".

“Pre-budget discussions are usually back-of-the-envelope calculations of revenue impact," said the TARC report submitted last year. “The impact on a taxpayer is considered in a cursory manner, if at all. Retrospective amendments clustered during 2009-12 may reflect this lackadaisical approach. In turn, this reflects complete lack of accountability at any level except on grounds of lagging behind in revenue collection."

The TARC report pointed out that in most modern economies, the revenue target is dynamic, and the projection is changed during the course of the year reflecting the changed economic outlook. In contrast, the revenue projection is fixed in India, and the pursuit of ‘blind revenue targets’ puts enormous pressure on tax officials, who in turn push even honest taxpayers to contribute more revenue or postpone making due refunds, in particular during the last quarter of the fiscal year. Such policies would be illegal in other law-abiding societies, the TARC report commented. Using over-optimistic revenue projections to meet fiscal deficit targets can be counter-productive since coercive government action to raise revenues can dampen investor sentiment, hurting growth and revenue collection in the medium term, the TARC report pointed out.

On Saturday, Jaitley should be careful in making revenue projections for the next fiscal. An over-optimistic target is likely to send out a disturbing signal to taxpayers and investors, and further dent the credibility of the finance ministry.

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