A new-found confidence over the well-handled Covid-19 crisis found its way into Budget 2021. This is reflected in three aspects of the budget. One, the finance minister ignored suggestions to tax the rich with a higher surcharge or a Covid-19 cess. Two, the government has gone for growth with a large push on capital spending. Three, the FM has cleaned up the balance sheet of the government and removed the anomaly of using off-balance sheet items to show lower borrowings.
Money with Monika
The Corona Conversations
Decoding the Rs 20 trillion package
We’ve gone from asking for a 10% of GDP covid-19 relief government plan to a grumble about the announced ₹20 trillion package (which is 10% of GDP) being just 1% of GDP, because the fiscal (what the government spends out of its annual budget) spend is only ₹2 trillion. We seem to care about where the money is coming from and not where it is going and what it is going to do.
A basic question first: why does the government need to spend its way out of this crisis? The covid-induced lockdown has caused both a demand and a supply side shock to the system. This situation needs an external entity—the government—to give lifelines of both income, cheap foodstuffs and credit (through its bank—the central bank) to people who most need them. How much should it spend and for what? Countries like the US, some parts of the EU and Japan announced spends of around 10% of GDP and are using the money for direct cash transfers to a workforce that has been furloughed or is out of work, to open liquidity windows, to buy bonds from corporates directly by the central banks and for existing unemployment benefits that have soared. The developed countries that have the good historical fortune of owning global reserve currencies—that the rest of the world buys to store value—are simply printing currency (it’s also called monetizing their debt) to fund their deficits.
A too-long budget speech that was abruptly cut short, budget proposals that disappointed markets and income tax paying Indians. A fatigue with more good intentions rather than a big push for real change. That’s the story of Budget 2020.
The 35 million Indians who bear the disproportionate burden on income tax in India were waiting to get something from this budget. The dual tax system announced by the FM looks at a lower tax regime for those who are willing to give up on the deductions and exemptions. People with incomes up to ₹15 lakh a year benefit if they give up on their tax breaks and pay a lower rate. The FM said that they will gain up to ₹78,000 a year. Though if you add the common deductions, this number changes to the negative. It gets worse for those with incomes over ₹15 lakh if they move to the new tax regime. According to the FM, the state is letting go of about ₹40,000 crore of revenue due to this—or this is the money in the hands of the people if everybody migrates to the new system. But it does not seem that everybody will move since the benefits are not clear at all. It does look like the government has not thought this proposal through and not counted all the deductions that an average household avails. Start adding the others and the move to the new tax regime is not recommended because it leaves you worse off.
Putting at rest months of post-budget gloom, the Indian markets roared back on Friday as the finance minister announced a reduction in corporate income tax. In an unexpected move, the dismissed-as-a-newbie to finance,Nirmala Sitharaman used a smart nudge to get the existing firms to on-board a lower tax regime, while she announced the reduction of the tax rate for new firms. Firms incorporated on or after 1 October 2019, that do not avail any tax break, will now pay 15% (effective rate is 17.01% post surcharge and cess) as corporate income tax, down from the existing top marginal rate of 34.94% for firms of turnover over ₹400 crore.
Promising to be the elephant that accepts a few mounds of rice from a small paddy field when given voluntarily, rather than come in and trample the entire field in the quest for that paddy, finance minister Nirmala Sitharaman sounded the trumpet call on tax evasion. This was bad news for the super rich in India who earn more than ₹2 crore as they will pay much more tax than before due to the new surcharge. This is certainly more than just a few mounds of rice and is going to impact both consumption and savings by this category of people. This is clearly an eat-the-rich budget. No change in rates, slabs or deductions for the rest of the people.
Many years ago, on a vacation in Singapore, I was surprised to see the number of babies all over town. It looked like a baby boom in the city state. Cute, chubby babies everywhere. You can take the journalist out of the office on a holiday but you cannot take the office out of the journalist. So I dug deeper, asked people we knew, spoke to some locals and found that the government was worried about the falling population numbers and used taxes to solve this problem. The Parenthood Tax Rebate is a tax break given to tax residents to nudge them into making babies.
India’s new finance minister is crowdsourcing ideas for the budget and I want to suggest reworking the capital gains tax structure to nudge Indians into making the right choice in their asset allocation and product choices. The current tax matrix does not follow a first principle approach and is the result of annual tinkering with the rates and rules. There are two parts to this argument. First, the definition of what asset becomes “long-term” is crucial from a financial planning point of view. India has this definition backwards where we call a one-year holding period for equity as long-term, real estate goes long-term at two years and debt profits at three years. Unfortunately, tax policy has been made by people who sat on defined benefit pensions and had no personal understanding of market-linked financial products. They relied on theoretical models and academic versions of what households do. The result is the current mess. Financial planning 101 is that you use bonds and fixed income for either generating current income, for example, for the retired or for short- and medium-term money needs like a down payment of a home in two years or a college fee fund in the next three years. Long-term on this asset class should kick in after one year and not three.
Equity went “long-term” at year one, but this is an asset that is part of the long-term holding of a household and builds wealth. Long-term should kick in on, or after, the seventh year, given the data that a seven-year holding period for a broad market index in equity reduces the risk of volatility. There is a gradual slide down to a zero long-term capital gains status at the end of year seven. Tax equity profits as short-term till the seventh year. Have the rates slide down over the short-term tenure such that rates are high in year one and go down towards zero over the seven-year period. Real estate should go long-term from two years to at least 10 years, the current two-year holding period defies logic. Again use a sliding scale of short-term rates towards a lower long-term capital gains tax. If the policy direction is towards financialization, then tax long-term capital gains from real estate at 10% at the end of 10 years to give the equity culture a boost.
Two, switches within an asset class need to have the same rules. Today the lack of logic in the free switches allowed within asset classes is driving money towards certain products. For example, profits from long-term capital gains in real estate can be invested in certain bonds to go tax-free. Or they can be invested into another property to go untaxed. There is no tax on switching in insurance products. But each time you punish a poorly performing equity fund manager to redeem and buy another better performing fund, or in a debt fund, you have to pay capital gains tax. Use a first principle approach to solve the problem of thinking about switches and then apply to the various asset classes, rather than perpetuate a flawed system.
Back-of-the-envelope calculations say that capital gains revenue is just 3% of the total income tax revenue that’s collected from individual taxpayers. The wonks in the ministry of finance should do some modelling to see what this new system will deliver and what this will do to the financialization of the economy. Just tinkering with tenure and rates will not give the deep foundation needed to take India to a tax-buoyant $5 trillion economy in the next five years.
Monika Halan is consulting editor at Mint and writes on household finance, policy and regulation
Friday morning, 31 May 2019, was ripe with promise for stock markets. Eight thousand steaming people had witnessed the new government being sworn in. People had braved traffic and human jams at the entry gate, multiple security checks and then the worst summer day that Delhi regularly throws at its people. A 40-degree humid evening turned the water bottles kept on every seat into a hot beverage. Friday morning messages and rumours pegged Amit Shah as the next finance minister (FM) taking the markets up sharply—the markets seemed to like the fact that Shah understood the stock market and owned just short of 250 stocks himself. But as names of different ministers were announced, the market threw a small temper tantrum when its expectations were not met. But we know that markets are manic depressive in the short term and soon enough rethink the tantrum as news gets digested. By Monday morning the markets were back to feeling happy with the world and India’s first full-time woman finance minister Nirmala Sitharaman. Indira Gandhi’s brief additional charge as FM in 1970-71 leading a $62 billion GDP does not compare with the challenge Sitharaman faces to take the almost $3 trillion economy to $5 trillion over her tenure.