State of the economy may restrict fiscal manoeuvrability

State of the economy may restrict fiscal manoeuvrability

Challenges facing Indian Finance Minister over Budget 2020

Satya Mohanty

Finance & Corporate Affairs Minister Nirmala Sitharaman with Minister of State for Finance Anurag Singh Thakur before the Budget Session of Parliament in New Delhi on Friday, July 5, 2019 (PIB Picture)

New Delhi, January 28, 2020

While one way of looking at the Union Budget is through the lens of accounting, it is also an important tool for changing the behaviour of an economy by optimal allocation of real resources. 

The irony of the current situation is that a lot is expected from the government in a stagflation-like situation when fiscal space is highly restricted. 

India’s tax to GDP ratio is falling slowly and is expected to be below 7% of GDP.

Income tax has grown at 3% against targeted 19%. CGST still continues to be problem growing much below the nominal growth rate of the economy though it has  perked up during the last two months. Net shortfall in revenue is expected to be 0.5% of GDP.  

Austerity Budget

Expenditure has been compressed and essentially an austerity budget is in place. 

The fiscal deficit is likely to see a slippage to 3.75% against targeted 3.3%. 

Given  this background, the clamour for an income tax cut on one hand and redistributive spending on the other is gaining force. Having reduced the corporate tax rate which brings down revenue by Rs 1.57 lakh crore, now the argument for  reduction is personal income tax and GST is ostensibly from an equity angle.

An increase in redistributive spend is pushed as an argument for  easing the hardship of a large number of people who have been affected by the slowdown.

And why not, considering the reduction in corporate tax rates was itself a leap of faith which did not immediately  result in increased investment, with India Inc sitting on Rs 6 lakh crore because current capacity utilization is 70% only.

Expectations demand that the government invests to reverse the slowdown through infrastructure spend and productive expenditure.

Targeting fiscal consolidation

In the background of slippages in fiscal deficit targets,  fiscal consolidation is more likely to become a medium-term target over a period of four years without being an immediate bother for the government. Logically, the government is expected to go for expenditure route to provide stimulus to the slowing economy rather than by providing tax cuts.

With the public sector being stretched with an expanded fiscal deficit and public debt being 69% of the GDP currently, fiscal manoeuvrability is extremely limited.

But the government has indicated preference for investment driven growth. 

The introduction of the National Infrastructure Pipeline by introducing a tax cut is a pointer to the preferred course. Redistributive spending during such time is unlikely to grow beyond the nominal GDP growth rate.

Quality expenditure in productive areas designated as rail, road, urban, etc may revive the demand in the core sector and improve the revenue base for the future.

But the dividend income from RBI at Rs. 1.57 lakh crore is one off in nature and divestment target of BPCL and Air India may show slippage.

There is some hope that the pending judgment of the Telecom case in Supreme Court could result in an upside in expected telecom proceeds. But that may not be enough. 

Wealth Tax possible

Given the sub-par performance of tax revenue — there will be further loss because of reduction in corporate tax — the government will have to think in terms of new taxes such as a wealth tax.

In India, wealth is substantially more concentrated than income.

Credit Suisse’s estimation is the share of the top 1% of the population of India is 53% of wealth.

Economist Ruchir Sharma found out a few years ago that out of 2.5 million millionaires only 40,000 file tax returns. First thing the government should try to do is bring these eight million persons into the wealth tax net with 1 % tax every year for property and capital value until monetisation of wealth takes place .

As per Karvy Private, personal wealth of individuals in India was Rs 450 lakh crore in FY’ 2019.

With direct equity accounting for over 60%, fixed deposit, insurance and cash being 14% and physical asset being Rs 167 lakh crore.

By 2024 it is likely to be Rs 800 lakh crore.

This new scenario asks for new taxes. A wealth tax at 1% by self declaration but explaining every holding with a threshold of 30 crore can be the beginning. Meanwhile, geo- tagging etc can go on. But nearly 70% is in direct equity and other trackable investment.

Hence wealth tax on them can be easily collected.  The difference  is tax will be collected in advance of monetisation with provision for final adjustment when final monetisation takes place. This may provide an impetus to investment in real assets.

While reduction of corporate tax has provided an incentive for capital accumulation within the firm,  this may do the reverse.

Withdrawing subsidies

Resolute action on withdrawing some counter productive subsidies will release certain amount of expenditure rigidity. Except food subsidy, which is part of a legal mandate, both fertiliser and petroleum subsidy can be rolled back to release Rs 1.2 lakh crore, which will be 0.6% of the GDP.

This will enable the government to take up schemes it intends to and to moderate fiscal deficit.

Fertiliser subsidy has led to the gold-plating of fertiliser companies’ accounts and the distribution of benefit has been between the industry and the farmers.

A highly subsidised nitrogenous fertiliser rules supreme at the cost of phosphoric and potash.

Over-usage of urea in turn has led to the reduction of production while increasing expenditure. 

To improve acceptability  of subsidy roll back the present Rs. 6000 under PM Kisan can be enhanced to Rs 7000. Petroleum subsidy of Rs 40,000 crore need to be withdrawn except for LPG subsidy to Ujjwala beneficiaries.

Subsidies of 10%-20% of the cylinder cost is not very consequential.

Kerosene subsidy is nothing but a continuation of legacy.  

Revenue forgone in the form of tax exemptions and incentives to corporates was Rs 1.09 lakh crore during 2018-2019. Since the corporate tax rates have been brought down substantially, some of these exemptions need to be withdrawn.

Unusual problems require unusual solutions. 

New instruments needed

One cannot battle current fiscal crisis with the tools and instruments used in the previous crisis. The features and contours of the crisis have changed and require new instruments and a new way of tackling the crisis.

The narrative of the traditional economics  which has become a gospel believes that taxing wealth would inevitably result in slower growth, fewer jobs and lower incomes taking a leaf from the inverse relationship between taxes and growth is not unassailable as it is not supported by data, particularly when there is a small tax.

Experience and empirics point in the reverse direction.

Similarly, withdrawal of dysfunctional subsidy  does not exacerbate deprivation.

The Finance Minister will have to bite the bullet.

Satya Mohanty is Former Secretary to the Government of India and currently Adjunct Professor of  Economics at Jamia Millia Islamia University based in New Delhi.

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