Tax cuts will not beget growth

The basic philosophy of the budget is that tax cuts will place more monies in the hands of the companies and the rich, they will invest this money and the economy will rev up. But such a thing has not happened and will not happen.

The Finance Minister (FM) has given relief to the individual taxpayer. The government will suffer a revenue loss of Rs 40k crore from this. The reductions in Minimum Alternate Tax and other taxes payable by corporations will lead to a further loss of Rs 25k crore.

The FM has proposed to cover this loss of Rs 65k crore by an increased borrowings leading to an increase in the fiscal deficit from present about 3.4 percent to 3.8 percent in the coming year.

I have been a supporter of increasing fiscal deficit for jumpstarting growth. That would have taken place if the FM used the borrowed money to increase investments. But the FM has increased the fiscal deficit to give more money to the rich.

The FM seems to believe that relief to the taxpayer will put more money in her hands and that money will be used for increased consumption or investment. An increase in consumption is indeed likely to take place.

But the beneficial impact of this increase may be muted because the taxpayers come from the richer sections of the society and part of the additional monies in their hands will find its way in the purchase of gold or foreign goods.

Say, a reduction of Rs 100 is made in the individual income tax. Of this, we may assume that Rs 50 will go to increased consumption. Of this, Rs 25 will go to consumption of gold or foreign goods.

Of the remaining Rs 25, maybe Rs 15 will go in the purchase of goods made by big companies. The demand for the goods produced by the small industries will increase by a paltry Rs 10; while the burden on the common man will increase by Rs 100.

There is little possibility of this leading to increased investment as well. Reason is that a businessperson having more money in her hands will yet invest it only if there is demand in the economy — from the common woman.

But there is nothing in this budget that would lead to an increase in demand from her. A businesswoman will, for example, invest in a new restaurant only if the common person has more money to eat out. If she does not have money to invest, she will borrow from relatives or banks and make the investment anyways even without tax reliefs.

There is little possibility of her using the money for investment if there is no demand. In the result, the tax cuts will not lead to a proportionate increase in domestic consumption because part of the money will go in the purchase of gold or foreign goods; it will also not lead to an increase in investment because the net burden on the common woman will increase. It will only lead to a loss of revenue for the government.

There will be more damage. The government is already reeling under the loss of revenue of Rs 145k crore from the reduction in the Corporate Income Tax last September. The present cut in the individual taxes and Minimum Alternate Tax on businesses will lead to a further loss of Rs 65k crore.

This huge amount of Rs 210k crore will be made up by increased borrowings. Thus, the FM has projected a fiscal deficit of 3.8 percent against about 3.5 percent in the present year ending March 2020. This increased borrowing will lead to an increased burden of interest to be paid in the coming future.

This interest amount will obviously not be paid from the collection of direct taxes which have been reduced as discussed above. This amount will necessarily, therefore, will be raised from indirect taxes such as GST or import taxes.

These taxes will impose a burden on the common woman, reduce her purchasing power, lead to reduction the demand in the market and slowdown the economy. Part of the money can also be raised from disinvestment. But this too is only encashment of the investment made with the taxes collected from the common woman in the past.

Thus, the FM has given tax reliefs to the rich and imposed tax burden on the poor — whether in the past, present or future. The latter will lead to reduced demand and prevent the increase in investment. The fundamental misconception of the FM is that she is trying to increase investment without increasing demand. This will simply not happen.

The FM has expressed happiness that India's rank in the global trading index has improved from 80 in 2018 to 68 in 2019. She has concluded that India has become more adept in foreign trade. The actual situation appears to be exactly the opposite.

The reason is that this improvement appears to be due to an increase in imports; not exports. The FM has herself acknowledged that imports are rising courtesy Free Trade Agreements made by us. She has also said that she will strengthen safeguard- and dumping duties and investigate subsidisation of imported goods.

It is clear that imports are rising. Thus, the improvement in our rank in the trading index is due to the weakening of our economy and increased inefficiency of our businesses, leading to an increase in imports! That said kudos to the FM for increasing the import duties on labour-intensive goods like footwear and furniture. However, this is a turtle-like small step when the need was to make a jump like a kangaroo.

The FM should understand that the root cause of less exports and more imports are the rents extracted by our bureaucracy and judiciary. The only immediate solution is to impose high import duties until we solve these structural issues.

The FM has indeed raised the issue of governance but deflected it towards the increased use of technology. While that is commendable, it does not solve the obstructions created by these organs of the State. We should appreciate that mere use of technology will not help as we are seeing in GST.

A parallel No 2 economy has already developed as it was previously. The shopkeepers today routinely ask the customer to pay GST if she wants a bill for the purchase. Therefore, this budget will not deliver.

The purchasing power of the common man will remain subdued, the small industries will remain under pressure from imports, our exports will continue to flounder and the economy will remain in the slow mode.

(The writer is formerly Professor of Economics at IIM, Bengaluru)