Capital gains tax hike is 'irrelevant fiddling'; has no impact on India’s fiscal fortunes: former PMEAC member Rathin Roy

The economist added that since spending on infrastructure is capital-intensive, it may not lead to the creation of jobs. “If you really wanted to create jobs, you would spend money on health and education,” he said.

In a free-wheeling conversation with Moneycontrol, Roy weighed in on a host of issues, including, the efficacy of employment-linked schemes, the pace of fiscal consolidation, and the need to bring back disinvestment. Edited excerpts:

Should we worry about the pace of fiscal consolidation given that too quick a pace can have a restrictive impact on growth? Could we have spent more at a time when private consumption is at a 20-year low?

The fiscal consolidation this year has been done almost entirely through cutting expenditure. We have seen this trend from FY16-19, obviously the fiscal deficit rose in FY20-21 due to the pandemic. And, again since then, expenditure has been declining. And till FY24, the decline was largely due to expenditure compression.

Cuts in the expenditure-to-GDP ratio since FY15 were typically around 90-100 percent of the reduction in fiscal deficit. This year, there has been a modest increase in revenues. But the expenditure-to-GDP ratio has again been cut. Essentially, the 0.4 percent increase in revenues and 0.3 percent cut in expenditure add up to a 0.7 percent reduction in the fiscal deficit.
You can spend if you know it will have an impact. If you cannot ascertain the impact, it is better not to spend.

Is capex an effective way to prop up the economy?

If you were to say that the government should spend more because the economy is tanking then the question arises, what should the government spend on? The government’s own answer to that question since about FY21, FY22 has been to say that they are increasing capex. The increase in capex is happening. The ratio of the revenue deficit to the fiscal deficit has declined from almost 70 percent in FY19 to about under 40 percent now. But there are questions. The government’s revenue-to-GDP ratio has gone up by 0.4 percent this year, but the government’s tax-to-GDP ratio has gone up by less than 0.1 percent. This government has been incompetent at disinvestment and therefore does not do disinvestment anymore. You cannot do disinvestment on a note sheet or through coercion. Therefore, the 0.3 percent in the revenue-to-GDP ratio is neither from taxes, nor from disinvestments but from non-tax revenues, largely from the RBI dividend and profits of PSUs. And, PSUs give you profits by reducing their own capex. This year, including the distressed equity infusion in BSNL, the total public sector capex-to-GDP ratio is 3.6 percent. It was 3.9 percent before Covid. So, the government is actually doing less capex. This is because the absorption capacity is low, and if that’s the case then how does one invest more in infrastructure.

I am told the Navi Mumbai airport will open in December 2024; it was earlier supposed to open in March 2024. I doubt it will open in December 2024. Jewar airport was supposed to open two years ago, but now they say it will open in March 2025, I don’t see it opening in March 2025. It’s been 10 years since the bullet train project was envisaged, we haven’t seen a bullet train yet.

If this is the state of play with capex wherein projects constantly face time overruns and therefore cost overruns, in that circumstance, fiscal prudence is not just about reducing the fiscal deficit-to-GDP ratio, an important part of fiscal prudence is to not spend money badly and if you know in advance you are going to spend money badly, then don’t spend it.

Also, by definition, the kind of capex you are talking about – in infrastructure -is capital-intensive so it may not create jobs. If you really wanted to create jobs, you would spend money on health and education, but then there you have a capacity and attribution problem. States majorly run health and education, so if you spend more in these sectors then states will get more money and they will get the political credit.

Do we need to bring divestment back to the table?

Non-bank public sector units are giving you profits and therefore higher dividend is because they are reducing spending on capex. So that is not a real increase in profitability. Divestment would have been a real resource because it is an asset sale, which is adding to your revenue account. We have failed on divestment year after year. For a department that was willing to do Rs 1.75 lakh crore in divestment in a given year and ended up with less than Rs 50,000 crore – it is just a bad record.

Many term the relief on personal income tax as insufficient. What is your view?

The top 3-4 percent of the Indian population pays income tax and about half of that category has benefited from the cut. I believe the relief on personal income tax is sufficient. They have increased the exemption limit. If we talk about suit, boot people and airily speak about capital gains tax, then let me tell you 98 percent of Indians do not know what is being talked about.

Was the increase on capital gains taxes justified?

The increase in capital gains tax is irrelevant fiddling. It is entirely irrelevant for the fiscal fortunes of this country. You could double capital gains tax, it would make very little difference to tax revenue collections, you could halve capital gains tax and it would make very little difference to your tax revenue collections. If the middle class is 3 percent of India, then the increase in capital gains tax is a middle-class issue? There are 42 million people belonging to the middle class in India. Do you think 42 million people pay capital gains tax? I do not think changes to the capital gains tax impact the middle class at all.

There is a narrative that household savings are lower because people are foraying into the stock markets, especially retail investors. Do you agree with this?

There are 160 million DEMAT accounts, that does not mean you have 160 million investors, many of such accounts are empty. It is also not that 160 million people are making capital gains. Now, if this is a continuing phenomenon then you would basically see household savings going up by successfully betting on the stock market. If the stock market tanks tomorrow then long-term capital gains revenues will also tank. To say, when we are feeding 800 million people, when 47 percent of our population depends on agriculture, and when real wages are stagnating, that everyone is wearing a suit and going into the market to play stocks and startups, is not a portrayal of the real world.

The Budget has announced three Employment-Linked Incentive (ELI) Schemes. How effective are these schemes to address India’s unemployment problem?

The success of the ELI scheme depends on whether the subsidies the government is giving is used to fill the demand gap. For example, India is short of plumbers and nurses, but the scheme does not speak of them. Our net exports of nurses to foreign nations are greater than number of nurses trained in India in a given year. We need more nurses; we need to give them jobs. A number of places have a demand scarcity and that scarcity is not being met because there is a skill gap. Now, if someone wanted to hire a skilled worker to increase their productivity but cannot hire that worker because of cost issues then this sort of scheme would work because they would pay that skilled worker more to enable them to get hired by this company. But, if the scheme only addresses unskilled or semi-skilled labourers then it will not work, and would tantamount to a design flaw. If the subsidies attract scarce skills to improve productivity, then it will work.

The Economic Survey 2023-24 pitched for an inflation targeting framework that targets an inflation rate excluding food. What is your view on this?

This is a silly time to have this conversation. When I was a member of the PMEAC, I wrote a note to the Prime Minister's Office (PMO) saying that the first phase of the inflation targeting framework is coming to an end, therefore this is the time to review it. I implored the government to do it then. After five years, why bring it up in the middle of an inflation targeting regime?

However, at some point, the RBI has to consider, what their theory of inflation transmission is. As per the creative reflections of the monetary policy committee, the repo rate goes up or down or stays the same, and underlining that is the presumption or assumption that infra marginal changes in the repo rate bring about a response in inflation expectations. That is a theory used in advanced economies, that has a formal sector that accounts for 95 percent of their economy, robust credit mechanisms, and a private sector that aligns its investments along with inflation expectations. How does this sort of infra marginal changes by the RBI impact a large country like India, where the service sector is over 60 percent, informal sector is 90 percent, that is a question the central bank needs to answer. I agree that we should revise the inflation targeting framework, but first, we have to be clear what is the analytical framework underlining this targeting that the RBI is using. I do not know of a governor since Raghuram Rajan who has given any clarity on this.

Second, on what basis have we kept the inflation target at 4 percent? Is it a good number? Is it a politically acceptable number? They need to first talk about what their framework is and what their analytical model is and then we can talk about whether to target core instead of headline inflation. For example, why in a country like India where the informal sector accounts for 90 percent of the economy, do we target CPI and not WPI or a combination of the two?

The one crucial element that the Budget was missing, according to you.

The Budget was missing a plan. There isn’t a plan. There are schemes. There are no plans to become a Viksit Bharat in the Budget, which was promised. So, what I am missing in the Budget is a broken promise that they will present a plan to become Viksit Bharat, and that has not been delivered.