With the government swimming in tax revenues, it makes little economic, or revenue, sense to reintroduce the long term capital gains tax after a hiatus of 14 years. Why?!
Budget 2019 can best be described as one made possible by an ongoing revolution in tax collection. This revolution is beginning to make possible another revolution in income transfers to the bottom third of the population. The tax revenue and possibilities for change were documented in an earlier article by Arvind Virmani and myself (Smart Policies for Redistribution, IE, January 29, 2018). The Budget contains a highly laudable introduction of health insurance to the bottom 40 %. We do not know its cost as yet, but we can surmise that eventually it is likely to cost somewhere around Rs. 20,000 crores a year.
Another part of redistribution is the increase in the minimum support prices for farmers to 1.5 times the cost of production (the cost as estimated by the government Commission on Costs and Prices). One estimate of the cost of this increase is the Rs. 29,000 crores increase in the food subsidy budget for 2018-19 – the government buys from farmers at a higher price but still sells wheat and rice in the rations shops at Rs. 2/kg and Rs 3/kg, respectively.
This transfer from the centre, largely to farmers, is certain. In addition, states like Madhya Pradesh and Telangana are transferring incomes to the farmer. As Sunil Jain has pointed out in the pages of Financial Express, the MP scheme has a major moral hazard problem – farmers, or traders, can dump supply in the market, lower the price, receive a subsidy from the government (difference between market price and MSP), and then (possibly) sell at a higher market price!
In contrast, Telangana has announced a direct benefit transfer policy for farmers (somewhat along the lines argued By Virmani and myself!). Each farmer is likely to get Rs. 8000 a year for each acre of cultivation.
What is happening? We all thought that the states were in big debt, that they were constrained from having a fiscal deficit (FD) to be no more than 3 % of GDP, but they are spending freely, and providing income to the poor. And the central government is doing the same – transfer to poor farmers, and transfer to the poorest 100 million families in the form of health care.
What is happening is that India is undergoing a fiscal revolution – in direct taxes (thanks to demonetization) and indirect taxes (thanks to GST). In the pre-budget article, Virmani and I had clearly stated that “This tax buoyancy opens doors for a reformist fiscal policy – doors that can lead to greater tax collection, lower tax rates, and greater, and more efficient, tax redistribution. Doors that can lead to a golden era of fiscal policy. We expect that a blueprint will be laid out for such reforms in the Budget to be presented on February 1st.”
However, when FM Jaitley presented the FD numbers for 2017/18, expert economists and analysts found that they had reason to complain about fiscal profligacy. The FD estimate for 2017/18 was reported as 3.5 % of GDP, handily slipping the original target of 3.2 %. It is noteworthy that the consensus of FD estimates emerging from the foreign and domestic banks was very close to 3.5 % of GDP. Natural inclination, therefore, was for experts to give each other high-fives and say how right they were in forecasting the populism of the Modi government.
But this urge to be right (reputations depend on being right!) has prevented analysts from paying any heed to the warnings issued by CEA Arvind Subramaniam and FM Jaitley. Finance Minister Jaitley said this in the budget speech itself! “In 2017-18, Central Government will be receiving GST revenues only for 11 months, instead of 12 months. This will have a fiscal effect.” (emphasis added).
In the Economic Survey, the CEA said: “The GST was unveiled after comprehensive preparations, calculations and multi-stage consultations, yet the sheer magnitude of change meant that it needed to be carefully managed. The Government is navigating the change and challenges, including the possibility that a substantial portion of the last-month GST collections may spill over to the next year.” Also in the ES: “Considering that more than half of the direct tax collections are normally realized during the last four months of the financial year, the budget targets for the current year are still not out of sight”.
The 3.5 % FD estimate meant that, given expenditures, total revenues had slipped by about Rs. 65,000 crores. Normally, indirect tax revenue collections in March are twice that of an average month (this has held true for the last fifteen years). End of the year filing pressures make this happen. With GST smoothing, it is very unlikely that March 2018 GST revenue (the one not included in the revenue statement of the FY 2017/18 budget) will be twice that of the February 2018 GST revenue.
Assume March GST revenue to be close to the run-rate observed to date – around Rs. 90,000 crores (actually it is a bit more, around Rs. 95,000 crores but who is counting). The center will receive Rs. 26,000 crore, and the excess fiscal deficit is almost cut in half. Now assume that the GST March 2018 revenue is Rs. 130,000 crores – the center receives Rs. 38,000 crores, and the FD for 2017/18 is close to 3.3 % of GDP!
Given high tax revenues, and sensible redistribution to the poor (all those opposed, please speak up!), what was the regression in the Budget? Tragically, and ironically, it was an additional tax revenue that is the dream of “traditional” revenue collectors. It was the introduction of a 10 % tax on long-term capital gains.
I have to indulge in a bit of disclosure here. Back in 2003, I prepared a note for the Kelkar committee on direct taxes, a committee that included Mr. Arbind Modi, the person in charge of drafting a blue-print for direct taxes by the Modi government. As it turned out, the recommendation of this committee – elimination of long-term capital gains (LTCG) tax, a 10 % short term gain tax (later increased to 15 %), and the introduction of a securities transaction tax – was introduced by Finance Minister Mr. P. Chidambaram in the 2004/5 Budget.
The STT has yielded a steady revenue of around Rs. 8,000 crore a year, and is estimated to yield Rs. 11,000 crore next fiscal year. The argument for the introduction of STT in 2003 was that certainty of tax revenue regardless of market conditions was to be preferred over fluctuating revenues (i.e. a bird in hand should be preferred to one bird in the bush). STT is obtained on transactions – as long as transactions are there, STT revenue is obtained. If revenue concerns were paramount (and they manifestly were not as documented above), the government could have increased the STT by 50 % i.e. a certain revenue of around Rs. 16,000 crore from STT rather than anticipated (and uncertain) tax revenue of Rs.20,000 crores a year from LTCG – or close to zero if the stock market average for the year would fall.
It is useful to note the capital gains collections for FY 2014/15, as released by MoF just a few weeks ago. In that fiscal year, the stock market went up 32 % and the STCG were Rs. 73.3 thousand crores. At a 15 % tax rate, STCG yielded Rs 11 thousand crores – not much more than the STT tax collection of Rs. 7.4 thcr.
A big data unknown is the mix of sales of equities on a short-term and a long-term basis in 2014/15. If that mix was 50-50 in 2014/15, then we know that LTCG, with a 32 % gain in the market, and a 10 % tax rate, would have yielded Rs. 7.3 thousand crores. Note that this is virtually identical to the revenue gain from a 50 % increase in the STT. And it is uncertain – hence, a “safe” conclusion is that the LTCG tax was ill-advised, and purely so on revenue considerations.
The Modi government needs to be congratulated for helping transform the fiscal landscape, and making tax revenue a non-problem. The government can now think up efficient ways of transferring this income to the poor. This is happening – so why the introduction of yet another tax, something even RBI governor has rightly complained about?
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