12.5% LTCG is low compared to global standards, says Finance Secretary Somanathan

Somanathan: But you need to look at the actuals of the previous year and see what the spending capacity on those schemes is. So it’s not as if we have not provided for any of the schemes. We have provided what the scheme can absorb, and many of them are centrally sponsored schemes with implementations done by states that require states to actually do the last mile. And the flow of funds depends crucially on their ability to execute that last mile.

Punj: Isn’t there a case for revision of PM Kisan because there have been concerns?

Somanathan: PM Kisan is essentially an income transfer, so that’s a discretionary transfer. Anything can be increased. All extra free transfers are always liked, and all tax increases are disliked. But the point is, is that the best use of the money, or is it better used in some productive fashion? I mean, that’s a question that needs to be addressed, and we think we have got the balance right in terms of what we have done.

Bodhisatva Ganguli: Wouldn’t it be fair to say Dr. Somanathan that you have used the transfer from the RBI and the higher-than-expected tax receipts, which is both the actual so far and projected, largely to reduce the fiscal deficit to come to 4.9 percent?

Somanathan: No. We have used approximately half of it for deficit reduction and half for additional expenditure. That’s the actual way it’s panned out because the total increase that we have got from both sources is about 0.4 percent of GDP. Remember also that the RBI dividend may not necessarily crash next year, but it’s not a recurrent source of income. Building public expenditure programmes on one-off dividends is a very dangerous thing because public expenditure programmes can be switched on easily and not switched off easily. So, we have not chosen to spend the entire dividend on new expenditure programmes, but we have started new expenditure programmes.

You mentioned PM Kisan, but what we have done is to increase Gram Sadak Yojana, Awas Yojana, these are also rural spending but they are not necessarily cash transfers. They are transfers that involve asset creation and rural asset creation. So, there is an increase there, there is an increase in these employment schemes, partly this year, more next year. So, I think we have balanced the use of this extra resource in terms of partly fiscal consolidation and partly new expenditure.

Ganguli: Let’s look at the receipt side for one moment. If I can bring in the DIPAM secretary, there is a Rs 50,000 crore figure mentioned in the budget, but could you give us a broad state of play of the disinvestment programme, specifically with regard to IDBI bank. Some media reports also indicate there has been a fundamental rethink about what the government feels about disinvestment because of the rising values of PSUs - should it go in for strategic privatisation at all?

Tuhin Kanta Pandey: DIPAM stands for the Department of Investment and Public Asset Management and I think that underlies the new approach that we have of public asset management and it’s like the asset you manage on the private side. If you have a house, you don’t always sell it. You also give it on rent and you know the entire REIT structure is about rental housing and so on. Similarly, if you have a public asset, I mean, we are not really only to sell that; we have to actually create value as a part of the economy and manage it efficiently. Being a majority shareholder, the government must manage the public assets profitably, and there should be profitable growth. The government is not alone in this because we have brought in listed players, we have brought in minority shareholders, and their investors have come in, and we have some fiduciary duty for their investments.

Therefore, in this approach where we are value-creating, in which we are bothered about fundamentals, we are bothered about capex, we are bothered about return on capital and return on equity, consistent dividend policy and in the process, when you create a value, you can also do a disinvestment of a different kind. So disinvestment is a continuum from listing to maybe getting rid of control. So, getting rid of control is only one aspect. We have certain transactions where the Cabinet has taken a decision for privatisation, but there are others where there is no management control, which is passed on the listing is done, and value is created.

In this overall scenario, that is why we have got rid of a disinvestment target. We have about Rs 1.06 lakh crore, which is partly dividend and partly miscellaneous capital receipts. Incidentally, Rs 50,000 crore also has two sources, which is a certain amount of asset monetisation accruing to the consolidated fund. Not every asset monetisation accrues to the consolidated fund. It also goes to the concerned company for their own capex, but to that extent, it does, for example, in the case of INVITS or, say, for example, TOT and other projects of the NHAI, would also get in there. Apart from RBI, others give dividends. So, in that strategy, I think we are looking at all different elements of public asset management as not merely disinvestment.

Now, coming to your question on specific transactions, we will continue to see that they are taken to their logical culmination.

Punj: So, what progress have we made in the IDBI disinvestment?

Pandey: We expect that RBI will complete its fit and proper (approval process) soon on the bidders, following which we will do the due diligence because we have to take them to the virtual data room.

Punj: But this has been held up at the RBI level for quite some time now, right? Is there a concern?

Pandey: Well, it has taken some time, yes, but I believe they are in an advanced stage.

Punj: So, Dr. Somanathan if I could ask you about the revenue estimates that you made, there has been no change in the income tax estimates in the budget despite the fact that there’s been a hike in LTCG and STT.

Somanathan: And there has been a reduction in personal income tax rates and a reduction in custom duty on gold.

Punj: So what was the thought process behind the move that has been made on hiking LTCG and STT? It spooked the markets, and a lot of memes are doing the rounds.

Somanathan: Yeah, I think everybody was expecting it but it still spooked them. Because everybody told me before the budget, we want simplification, we want rationalisation, we have too many rates, too many complications, some are indexed, some are not. One is at 15, one is at 10, one’s at 20.

Ganguli: But you simplified upwards, I think.

Somanathan: Yes, and some downwards. So, one should not ask for a simplification if what one is asking for is a reduction. Let’s be clear. Even in GST, let me say when people say rationalisation of GST, if everybody is expecting that all rates will go to 5 percent, I think it’s a wrong expectation. So, this is a pure and simple cleanup of our very complicated rate structure in capital gains, along with an increase. So the earlier structure was something for listed, something else for listed REITs, something else for unlisted, something else for property etc.

Now, we have a simple regime. It’s 12.5 percent without indexation across all asset classes, and the period of retention is one year for all listed assets, including REITs and INREITs, and the period of retention for all other non-listed assets, including gold and property, is two years. So, there is uniformity; it’s a much simpler structure. The return forms will become smaller once we get through this transitional year because this year, there is a difference between gains before the 22nd of July and after.

But in the future, you will see the form becoming much easier because many of these classes will now compress together. It is also a fact that our rate of capital gains tax by global standards on long-term listed equities is low. It is not high. It’s much lower than our marginal income tax rate of 39 percent at the highest end. It is a fact that 88 percent of our capital gains income is earned by people with incomes above 15 lakh rupees and 62 percent by people whose incomes are more than one crore rupees. So, this is not the poor we are talking about. I am talking about capital gains. So capital gains is by no means the preserve of the middle class or something like that. In fact, quite the opposite. I would also say that this is the most elastic item of revenue sources in income tax because this is growing faster than salaries, property income, and income from other sources. We cannot become Viksit Bharat without taxing the fastest-growing element of income at a decent rate. So, we have compared international rates. We are still very low at 12.5 percent. Canada increased its capital gains rate in this budget to 66 percent of the applicable rate, which in India would be 26 percent.

Punj: Fair enough, but that is a developed economy. You look at the per capita income.

Somanathan: No, a developing economy needs more resources than a developed economy. We actually need more resources to be raised.

Punj: But the middle class is constantly feeling…

Somanathan: But the middle class is getting an extra benefit of Rs 25,000 more of tax-free capital gains. So what was Rs 1 lakh has become Rs 1.25 lakh. And our evidence does not show the middle class as the main earner of capital gains tax. It shows the rich piggybacking on the middle class, claiming that it is a middle class issue.

Ganguli: To follow the logic of what you are saying and your reference to Piketty in an earlier interview, wouldn’t it be then logical to assume that the capital gains tax would go up and at the end converge with the marginal rate?

Somanathan: The main aim is rationalisation. We have not attempted to increase rates on any other asset class. We have unified all rates at 12.5 percent. 12.5 percent on property is approximately the low end of where it actually is today – 20 percent with indexation. We have done the calculations, and it works out to, in most cases, approximately 12.5 percent or more. The actual incidence is lower at 12.5 percent in most cases. So, it is a function of how much the property has grown. If it has grown at anything above 10 percent, this is actually better and most properties grow at more than 10 percent.

Ganguli: Your arguments about capital gains going mostly to the rich are well taken. It is obviously true. But another way to think about this could be that let’s say countries like Hong Kong or Singapore or some of the far east Asian countries.

Somanathan: For this let’s compare Hong Kong and not the US or UK and become a Viksit Hong Kong. We don’t want the democratic freedoms of Hong Kong here!

Punj: You have estimated about Rs 1.2 lakh crore revenue from the spectrum auction. But that is not how it has panned out in the past. So what is driving the confidence that you will be able to raise 1.2 lakh crores?

Pandey: I have gone by the figure given to me by the Department of Telecom, so I wouldn’t be able to answer that question. The auctions have been completed, and they have to collect the money in instalments. It is not a one-time thing.

Punj: And this Rs 10,000 crore has been allocated for a price stabilisation fund, which is a huge quantum jump from the last. So, what is the rationale behind that?

Somanathan: It is to keep prices of pulses and oilseeds under a decent.. I mean, we want to increase MSP procurement of these and give farmers an assured price. It has succeeded in wheat and rice. We now need it to succeed in pulses and oilseeds, for which a corpus is needed. This is not necessarily an annual feature because, unlike wheat or rice, there is not necessarily going to be a huge subsidisation. So we buy it, and we sell it. We buy it so that farmers have an assured price, for which we will need to maintain some buffer stocks. This is basically an infusion into the price stabilisation fund, mainly for the products that are not currently fully procured under MSP. It does not mean we will necessarily procure all the products. We will give a guarantee of procurement, and whatever is not absorbed at MSP can come to us. So, it will be a fallback arrangement.

Pandey: It was always there, except that it is being expanded.

Punj: The earlier allocations were to the tune of maybe like a few hundred crores.

Somanathan: No, earlier, the proportion that was being bought was small.

Pandey: We are going to be more ambitious. Three years back also it was a much larger amount.

Punj: Thousand crores from what I remember reading. So I have never seen it at Rs 10,000 crore number.

Somanathan: The intent is to be much more serious with the buffer stocks of these commodities. Now that food inflation is becoming more difficult with the Ukraine (situation), international prices of food have become a problem. So, we need to do a better job on the domestic side, which is the only thing we can control.

Ganguli: To come back to the capital gains tax, I do not want to commit you to finance secretaries who might come after you. Nonetheless, are these the terminal points, at least for now?

Somanathan: I would certainly say that there is no intention at this point in time to go anywhere else. This is not an intermediate station; this is the destination. I want to repeat, and this is a serious point. We did intend to unify and simplify. Otherwise, frankly, I do not think 12.5 (percent) is necessarily the right rate for capital gains on long-term equities. It could be higher. But I do not think it is right to bring everything to that rate.

We have attempted basically a rationalisation but not on the side of lowering the tax take because this is a sector which we think is a future elastic source of revenue and must be tapped because we will need income from this revenue. It is already very significant. We get over a lakh of crores on this. So it is not small anymore and it is also marginal.

Ganguli: The increase is also marginal.

Somanathan: Very marginal. From 10 to 12.5 percent, Canada increased it from 50 percent of the applicable rate to 66 percent of applicable rate this April. President Biden had proposed an increase.

Ganguli: His successor is unlikely to implement higher rates on capital gains.

Somanathan: We are looking at what is good for India. India does need tax revenue. Earners of capital gains are not poor and we will continue to tax capital gains. We need to tax capital gains and we need to tax it at a decent rate, not so concessional. And inequality is rising globally. Let us also understand we keep talking about rising inequality. The biggest source is listed equity valuations. So, this is not an immoderate step. It is a very moderate change in taxes on a very large source of wealth in the country.

Ganguli: On fiscal deficit, next year is 4.5 percent. Then I think the 3 percent number which was a relic of the Maastricht Treaty, has been abandoned if I am not mistaken. And instead, you move towards reducing the public debt as a percentage of GDP.

Somanathan: Our aim, as stated in the speech and as a formal and important statement, is to move towards targeting a reduction in the public debt and fixing a deficit target that aligns with that. So, it is not that we are not going to have a deficit.

Ganguli: Not necessarily a fixed ratio?

Somanathan: But the deficit may not be a fixed number.

Ganguli: But the debt, is there a number?

Somanathan: There will be a goal for the debt, but it will be a declining goal. And this means the key difference is that growth rates, interest rates, and inflation rates all affect what is a sustainable fiscal deficit. A single numerical target, irrespective of growth rates, is not the way we would like to manage this because that involves perhaps too much of a growth sacrifice in a country like India, which has a long way to go in terms of growth and where investment is also going to be important. Growth is always going to be as important as other parameters. So this will give us the flexibility to ensure that, on the one hand, we are not incurring debts that we cannot sustain. On the other hand, we are not completely hamstrung by some number that is fixed theoretically on some basis.

Ganguli: And rich countries who have been lecturing us about fiscal deficits have been quite cavalier, particularly in the wake of COVID.

Somanathan: Yes.