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I write on the “underrecoveries” in the last budget, at Yahoo.

As the time closes in for the Budget in mid-March, the question on the mind of everyone is: will we get a lower tax rate? For most of the people watching, the budget doesn't begin until the finance minister says "tax slabs" and ends immediately thereafter. But the underlying assumption for lowering direct taxes is that a lower tax rate will result in greater compliance with more taxpayers coming forth to pay; the overall result being that tax collections increase.

While this has happened in general, the tax collections have been very low this year, despite large slab changes in the last budget. The total tax receipts have gone up only 7% till December, making it a pretty bad year — only 2008 and 2009 were worse. It is thus likely that the government starts to take a hard look at where they must cut down the deficit, and they provide an estimate of "Revenue Foregone" under various proposals.

Let's take a look at the "losses" that the government faces through lower taxes or tariffs on various elements. And more importantly, if it looks likely that some of these

Lower Excise Duty : 187,000 cr.

The current tax laws provide for lower excise duties if a company is in a specified area (like Himachal Pradesh, Uttarkhand or the North East). And then other products get a reduced excise duty - all of which have an estimated lower revenue of Rs. 187,000 cr. Sadly, we don't have a further breakup of the taxes foregone.

Much of the lowering of excise duty was due to the financial crisis of 2008-09, from which we have recovered handsomely. The reasons for the exemptions to remain are weak, and I expect many of these excise duty exemptions to be removed, and the duty restored to the levels pre-2008.

In the light of a GST that may only happen next year, it's time to get the rates of excise/VAT and service tax aligned anyhow, which will only mean that excise rates will go up.

Lower customs duty: 200,000 cr.

On diamonds and Gold: 48,000 cr.
On Crude Oil: 40,000 cr.

Customs duty on Crude was a low 5% (since removed as oil prices went up again) and that has resulted in a loss of 40,000 cr. — now some of this loss is notional, as some of the crude we import is refined and products are exported; however we will learn that the profits on such refine+export models is further untaxed through export promotion schemes.

Many of the diamonds we import are re-exported, but we retain most of the gold we import. Gold imports are difficult to change — a higher duty on gold imports makes it more attractive to smuggle in gold (a big thing in the 80s). However, India has "doubled" the import duty for gold to Rs. 570 per 10 grams (from Rs. 300) which is more aligned with the prices today.

Further the import of cotton loses India 2,000 crores in duties, and importing ships and aircrafts a further 3,000 cr. Removal of exemptions on electrical machinery — a demand by the large electric manufacturers in India — would have given us an estimated 10,140 cr. of revenue in 2010-11. We are likely to see customs duty changes to gather more revenue this year.

Export Promotion: 54,000 cr. in duties, 19,000 cr. in income taxes

India offers exporters certain exemptions — from duty free imports, to zero income tax on export profits. Just duty concessions to various kinds of firms denied India an income of 54,000 crores, though it is unlikely that so much would have been imported had there been full customs duty.

Special Economic Zones (SEZs) have been created for exports and companies will pay no taxes on profits earned here; reduced or no income taxes apply for companies that export certain kinds of items (like STPI for software). With the Minimum Alternate Tax, these companies have to pay about 20% tax anyhow; this might not be considered in the calculation that such export promotion schemes have lost us Rs. 19,000 cr. in taxable income.

Such promotions have a cost — one of the reasons regional language software in India is difficult to come by is that software companies focused on exports rather than serving local needs. After all, why sell locally and pay taxes on profits when you can sell abroad and pay nothing? This is the downside of making an Infosys or a TCS.

Accelerated Depreciation: Rs. 35,000 cr.

The Indian government supports renewable energy by providing a higher depreciation for wind energy projects, upto 80% a year. While this provides for greater investment, the loss that the government incurs is fairly large, for a return that, till now, seems much lower (at least for wind power).

While it's necessary to keep incentives going, it is retrograde to concentrate them in certain areas. Renewable energy through wind power skews incentives towards just that solution — certain others (like natural gas, nuclear or hydro) might give just the same level of "clean" per kilowatt generated, and need a broader programme.

Section 80C: 37,424 cr.

You get a tax exemption of Rs 100,000 on investing in certain kinds of savings instruments, buying a provident fund, buying insurance, paying your housing loan principal or for your child's tuition fees. This costs the government a whopping 37,000 cr. in terms of taxes you would have otherwise paid. This amount is nearly as much as is used by the whole NREGA program every year.

Since the upcoming Direct Tax Code (DTC) has no exemption system like it, it is likely that the 80(C) structure will change, and reduce the effective savings rates.

And to end:

The government provides a tax exemption to contributions given to political parties (Section 80GGC). This has cost the government Rs. 191 crores, which would have helped run parliament for about 100 days — or the number of days it wasn't allowed to run because of parliamentary disruption. Essentially, you — the taxpayer — have elected your MP who disrupts parliament and costs it money that could have been recovered by taxing the person who gave the MP the money so he could campaign and get elected by you.

But I don't expect that to change.

At Yahoo, I write about how it’s all right to be wrong when investing:

In 1973, the Kreditbanken (bank) at Norrmalmstorg in Stockholm was attacked by robbers, who held bank employees hostage for five days. After the drama, it was evident that the hostages sympathized with their captors, even though they were held against their will. The situation is now considered an academic study — the Stockholm Syndrome — where people get emotionally attached to people who obviously try to do them harm.

More apparent, perhaps was the case of Jaycee Lee Dugard, who was held for 18 long years — from 1991 to 2009 — but got so emotionally attached to her abductor that she even helped him in his business and met customers. Being an unwilling hostage, or in other cases, just being in an unwelcome situation with no way out, makes us rationalize in favour of our position.

Less dramatically, we become hostage to our own opinion. We simply can't let go of what we believe is "normal", even in the face of facts. If your blood tests show you have a high cholesterol level, your immediate reaction is to hope the problem will go away on its own, or imagine that the tests were incorrect. A person abused at work — sometimes with lewd suggestions — will initially justify it as harmless workplace banter. The victims of a drunken driving accident will side with the driver saying how good a driver he "usually" is. We simply don't want to see it, even if we know it.

In the financial world, our beliefs are tested often. In 2011, the markets fell over 24%, with the situation in December as dire as it could be; the government was running out of money, industry was slowing down, inflation was high and everything looked bleak. In January 2012, we saw the Nifty and Sensex rise 12%, with no apparent improvement in any of the other pieces of data. This rise has bewildered most analysts, who continue to believe, at every stage, that the market will reverse back down. Consistently, nearly every day, the market sees a rise, but the sage opinion is that this is a fake rally, and that this will come down like a ton of bricks.

It might. The analysis may be spot on, that the Indian story has hit a pause button and not worthy of very high valuations. But at some point, we need to admit that the tide has turned, and prices keep moving north. Our conviction is worth the paper it was never written on — but we carry the weight of it on our shoulders altogether too long. Such irrationality can cost money —a trader that stays short despite a stop loss being broken, almost in anger against such a furiously rising market, continues to lose until eventually giving up. An investor who decides a stock is great and watches it fall, keeps buying until the stock becomes an abnormally large investment, and later feels serious regret when other stocks do better.

If you strongly believed in the Indian telecom story, it was lost on the stocks. From Bharti Airtel to Reliance Communications, the stock prices are way lower than their highs in 2007. We have more air travel than ever before, but airline stocks are in the doldrums. India is spending an enormous amount of money on infrastructure, but the road-builders and power-plant-owners are scraping the bottom of the barrel in the markets. Yet, the question I first get when I say all this is: "Good time to buy?"

The correct way to deal with markets is to expect to be wrong. You have to consciously look for information that counters your thought process. If banks are supposed to be in trouble, then look at their positive results, and look at how strongly the RBI is supporting the system. If buying IT companies on a falling rupee sounds exciting, consider reports that customers are quite aware of the fall and demand corresponding concessions, which they don't reverse easily as the rupee recovers. If you like to buy stocks when they make a new one-year-low, test out how many times you would have made money investing in a broad array of such stocks in the past. (I have checked, and results are horrendously negative at a portfolio level though there are a few that will shine)

It's not easy to stay fluid and keep switching sides as the tide turns — society values loyalty much more than rationality. Being wrong is okay, but staying wrong is evil; in the markets, we can't get married to our opinion.