September 20, 2019, saw the highest rise in the Indian stock market in a decade because the government announced a big tax cut for the corporate sector in India. This was a clear response to the flood of bad news about the declining Indian economy. This was the seventh policy announcement since August 23rd. The first six of them hardly had an impact on sentiments or the stock markets and bad news continued to pour in. So, the government decided to make the seventh one a mega announcement, to boost business sentiment and please the stock markets. It was also designed to signal to the foreign investors, a day before the PM was to leave for the US.
Will this have the desired impact on the economy? The tax concession to businesses will lead to an increase in their current post-tax profits. No wonder, the stock market reacted euphorically. The government expects this to lead to an increase in demand in the economy and the end of the recessionary conditions prevailing at present.
A parallel is drawn with the US, where Mr Trump cut tax rates which boosted the US economy. But the Indian economy is very different from the US economy or other developed economies. Those economies are largely in the organised sector and their taxation begins at a fraction of the per capita income, so that most businesses are in the tax net. India is dominated by the unorganised sector with low incomes and the taxation begins at about four times the per capita income so that the vast majority of the businesses earn incomes below the taxable limit. So, a tax cut benefits all businesses in the US but in India it benefits about one per cent of the businesses.
The stock market has a few thousand companies registered. These are controlled by less than one per cent of the population. So, the wealth effect of a rise in stock market will benefit a tiny fraction of the population. These are the wealthy and their consumption hardly changes with their incomes; so they are unlikely to increase their consumption. Those, especially from the middle classes, who have invested in Mutual Funds, etc., will also benefit but by small amounts; so any increase in consumption by these people will be small compared to the size of the economy.
Would the additional money accruing to the businesses be invested in creating capacity? If that were to happen, demand would rise. Unfortunately, creation of new capacity depends on the increase in demand. Many of the big companies have been sitting on cash rather than investing. If company A can produce 100 cars but it is only selling 70, then why would it invest in creating further capacity for producing 20 cars? If it were to do so, its spare capacity would rise to 50 and profitability would be further hit. So, most of the extra profit generated due to the tax cut would not lead to an increase in demand. Anyway, investment decisions are made in the long run and their impact would not be immediate.
Some have argued that the companies could give more bonus to their workers or not retrench workers as has been happening. It is said that this would boost demand in the festive season. But if capacity utilisation remains low, retrenchment would continue. Contract workers were the first to face unemployment and now VRS is being offered to the permanent staff as well. As long as capacity utilisation continues to be low, businesses will act cautiously and hold on to reserves rather than give more bonus or employ more people. For the same reason, companies are unlikely to give greater discounts to the consumers, since they have already given what they could before the start of the festive season. And, they have noticed that in spite of the large discounts being given, the demand has continued to fall. Given the uncertainty, increased discounts are unlikely.
The government has said that it would forego revenue of Rs 1.45 lakh crore due to the tax cuts. Presumably this takes into account the earlier concessions, like to the auto sector and to institutional investors. But it does not account for the Rs 70,000 crores of recapitalisation of the banks or the Rs 50,000 crores of incentive to exports or the Rs 20,000 crores fund for finishing houses. Thus, the implication is that the Fiscal Deficit would rise by Rs 2.85 lakh crore. This is assuming that there will be no budgetary implications of other proposals like, easing of FDI norms or help to MSMEs or accelerated refund of GST.
The Fiscal Deficit would also be higher than the Budget estimates since the estimation was done on the incorrect data on Revised Estimates of the previous year. Last year showed a short fall of Rs 1.6 lakh crore compared to the estimate used in the Budget. So, to fulfil the target this year, the tax collection would have to rise by about 25 per cent while it is rising by about five per cent. Thus, there is likely to be a shortfall of revenue by at least Rs 1.6 lakh crore over the Budget estimate.
Further, the Budget is based on the assumption of a 12 per cent rate of growth of the economy but it is barely growing at about 8 per cent. Since the economy is still in a downslide and even if it grows at eight per cent, there will be a further short fall in revenue of Rs 44,000 crores. Apart from the additional Rs 60,000 crores from the RBI, no additional resources are in sight. Thus, adding all this together, the Fiscal Deficit would rise by about Rs 4.3 lakh crores.
But, 42 per cent of the revenue collected goes to the States. So, of the revenue loss due to tax cuts, short fall of revenue due to over-estimation of revenue due to incorrect assumption about the Revised Estimate of last year and shortfall of revenue due to slower growth of the economy, the Centre would lose 58 per cent, So, the Centre's revenue loss would be about Rs 2.1 lakh crore and the States would lose about Rs 1.4 lakh crore. So, the Centre's Fiscal Deficit would rise by Rs 2.1 lakh crores plus the additional expenditures announced. Adding this to the Rs 7.04 lakh crore Fiscal Deficit shown in the Budget, the figure would rise to about Rs 10.5 lakh crore. The States' Fiscal Deficit would rise by Rs 1.4 lakh crore.
Additionally, since the growth rate assumed is incorrect, the GDP instead of being Rs 211 lakh crores assumed in the budget would be Rs 200 lakh crores. The implication is that the Fiscal Deficit shown in the Budget as 3.3 per cent would turn out to be 5.3 per cent of the GDP. If the deficit pushed on to the public sector and the State governments is added up, the total would be around 11.5 per cent.
The implication is that in spite of the increased level of deficit in the Budget, demand would not be boosted by the concessions to the corporates. The problem did not originate in low levels of profits but in demand being short from the unorganised sectors. The low level of profits are a result of shortage of demand and lower level of production.Raising the level of profits will hardly increase demand, as argued above.
If the additional 2.3 per cent of the GDP had been spent on the unorganised sectors—farmers, workers under MGNREGS and cottage sector— and on social infrastructure, especially in rural areas, demand would have perked up leading to higher capacity utilisation, profits and invest-ment. The issue is: why has the government not done what was more desirable with the resources made available by the higher Fiscal Deficit? Who is the government listening to?
The author, an eminent economist, is the Malcolm Adiseshiah Chair Professor, Institute of Social Sciences, New Delhi. He is the author of Indian Economy Since Independence: Persisting Colonial Disruption, published by Vision Books. He can be contacted at e-mail: nuramarku[at]gmail.com and arunkumar1000[at]hotmail.com