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The Economic Times

A tax cut for you in Budget won't give India the boost it needs

The annual real GDP growth estimated by the CSO at 5% for FY20 is the lowest since FY09, the year of the global economic and financial crisis. Nominal GDP growth for FY20 is estimated at a 44-year low of 7.5%. It had fallen below this level way back in FY76.

Such a low nominal GDP growth translates into low tax revenue growth, which has also suffered from a low tax buoyancy both for direct and indirect taxes so far in FY20. Tax revenues were adversely affected in this year because of the corporate income tax (CIT) reforms involving a substantive reduction in the effective tax rates. According to government's own estimates, the revenue cost of CIT reforms has been estimated at INR 1.45 lakh crore which amounts to 0.7% of FY20 nominal GDP. Central government's tax base has also been eroded by a significantly lower growth in imports due both to weak domestic demand for imports and global trade challenges.

Recent data indicate that the personal income tax (PIT), CIT, and center's indirect taxes showed buoyancies of 1.3, 0.3 and (-) 0.3 respectively in 1HFY20. The buoyancy of overall gross taxes of the center in 1HFY20 is estimated at 0.2, which is the lowest in recent history.

In order to reverse the ongoing economic slowdown, the immediate priority is to stimulate demand in the system. On the fiscal side, there are two broad ways of doing it. The first relates to increasing disposable income in the hands of the households by giving them higher exemptions and/or lower tax rates in the case of PIT. Providing additional subsidies through income transfers through schemes such as Kisan Samman Nidhi or through MGNREGA are also policy options within this group.

The Task Force on New Direct Tax Law which submitted its report in August 2019 had suggested a rationalization of the PIT rate structure. This of course would involve sacrificing some revenues which would be difficult at the current juncture, given the dismal tax revenue growth in FY20 so far. Second option is to directly increase government expenditure, particularly government capital expenditure.

Given the background of the constrained revenues in FY20, the second option appears to be the more desirable since its effect on demand can be expected to be more immediate and larger. Studies have shown that non-defence government capital expenditure has a higher multiplier effect than that of revenue expenditure. As per the RBI, the impact multiplier (short-term) and peak multiplier (peak value over a time horizon) for non-defence capital expenditure are of the magnitude of 1.81 and 5.88, respectively.

As a policy option, increase in government capital expenditure is superior at the current juncture to the other available policy options namely, increase in government revenue expenditure and an increase in household expenditure enabled by concessions in the PIT rates and additional exemptions.

Furthermore, additional purchasing power put in the hands of households, is channelized into both increasing consumption expenditure and savings. As such, the short-term effect of an increment in consumption expenditure would be less than the amount of revenue forgone in the provision of PIT concessions. The immediate need is to get maximum mileage out of the limited policy options available with the government at the least revenue cost. In the short-run therefore, a direct increase in government's capital expenditure which will also come in handy to finance the recently announced National Infrastructure Pipeline (NIP), would be the ideal policy intervention.

As the economic slowdown is arrested and growth improves, the government may introduce extensive PIT reforms aimed at increasing India's savings rate particularly that of the household sector. In the long run, emphasis has to be placed on increasing India's potential growth rate by attaining historically achieved peak investment rate of about 38-39% of GDP.

Views expressed are personal.

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