Should FM listen to I-T reduction clamour in Union Budget?

One set of economists has explained the fall in the GDP in the second quarter to a low of 5.4 per cent as a cyclical blip from which recovery to the higher growth trajectory would be fast. But others see it as more structural, from which recovery is contingent on the government making some more big-bang reforms.

Assuming that this is a cyclical blip, here are some proposals for the budget:

Should income taxes be reduced?
Under the new tax regime, someone with an annual income of Rs 12 lakh incurs an income tax (including cess) of Rs 71,500 at an effective tax rate (total tax divided by income) of 5.96 per cent.

Assume that this person spends Rs 45,000 on EMI & non-tax deductions and another Rs 45,000 on other monthly purchases (including tax).

Let us break this Rs 45,000 into two – 10 per cent (Rs4,500) on fuel, 90 per cent (Rs 40,500) on others. As not all goods attract GST, let’s assume 25 per cent of others is spent on zero-GST goods and the rest on those with varying GST rates. Here, the effective GST rate taken is 12.20 per cent, as mentioned by FM. The tax rate for fuel is taken as 122 per cent, which is the average rate as state taxes vary. Thus, out of this Rs 45,000, fuel tax is Rs 2,473 (122 per cent of Rs 2,027) and GST is Rs 3,303 (12.20 per cent of Rs 30,375, nil on Rs 10,125), for a total annual expenditure tax of Rs 69,312 (Rs 5,776 * 12).

Thus, income and expenditure taxes paid are about the same. So, a reduction in income taxes benefits only the relatively well-off, whereas a reduction in expenditure taxes will benefit even those not in the tax bracket.

So, any tax reduction should only be through expenditure taxes, and FM should ignore the clamour for income tax reduction.

Should corporate taxes be increased?
Corporates are owned by their shareholders, and most large corporations are listed on stock exchanges. Their shares are accessible to all of us directly or through mutual funds and indirectly as members of provident and pension funds who have large equity portfolios.

So, a higher corporate tax means lower profits, which depress share prices and dividends, which in turn affect the value of our investment and retirement portfolios. In other words, corporations are all of us and not some distant, impersonal entity. This is especially true when the share of FII ownership is reducing and retail and DII ownership is increasing.

Also, long-term capital gains (LTCG) taxes from equity investments are nil up to Rs 1.25 lakh and do not relate to your tax slab.

Thus, a Rs 10 lakh equity portfolio earning 12.50 per cent LTCG is totally tax-free, which obviously benefits the better off. Moreover, higher corporate profits mean a higher amount available for business investments, which is required for job creation. With capital raising from NSE hitting record highs in both quantum and number of issues (which includes many SME IPOs), a hike in corporate tax will surely spoil the party.

Should capital expenditure be increased?
Capital expenditures create assets such as roads and railways. In the previous Union Budget, though a record capex was budgeted, the achievement was trailing, and many economists cite this as the reason for the Q2 slowdown, which coincided with the election code of conduct.

Capital expenditure facilitates private investment and provides the lead that private investment follows. Hence, this year, too, FM should aim for higher capex as there is a better probability of achieving the target.

Capex by the Centre assumes higher priority as state budgets have become an exercise of competitive populism of freebies, which even the BJP is guilty of. Moreover, any cut in taxes will have to be matched with a cut in discretionary expenditures as salary, pension, and interest are committed expenditures, and borrowing is capped.

So, any tax cut without structural reforms to reduce committed expenditure will result in trimming the much-needed capex.

Other measures

• The government missed the opportunity to bring down the stake in listed PSUs in the booming stock markets, though it received a lot of dividends. With the depreciation in rupee, fuel inflation can be prevented by not hiking fuel prices and making PSU fuel retailers absorb the losses. Any loss in their dividends can be offset by going for a higher dividend from others to balance the fiscal math.
• MSP and fertiliser subsidies shall be gradually reduced and an equal amount increased in PM KISAN so that farmers choose crops suitable to their land's soil and climate and that are profitable.
• Focus of Railways should be on safety, carrying capacity and speed, in that order for both freight and passengers. Railways should primarily cater to the masses and premiumisation should be only in the space, if any, after meeting the needs of the masses
• Trump on steroids, the question of AI being a net destroyer or creator of jobs, increasing extreme climate events, the need to transition to a carbon-less economy, an economy saddled with low-paying jobs, and stubborn inflation will make life tough for the finance minister. The only solace seems to be peace with China. Let us hope our FM does a class act on Saturday.

(The writer is an ex-banker and currently teaches economics & finance.)