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Budget 2022 may not bring in any tax reforms, expected to be fiscally prudent, says Ambit

Budget 2022 | "We expect the Centre to keep the fiscal deficit target around 6.4 percent of the GDP in FY23. This will have two major implications – the Centre's debt-GDP ratio, which increased by 1,000 bps to 64 percent in FY21, would reduce to 60 percent by the end of FY23."

January 30, 2022 / 07:34 PM IST
Budget 2022

Budget 2022

Sumit Shekhar, Senior Economist and Eashaan Nair, Economist at Ambit Institutional Equities

At 17.4 percent, India's overall tax to GDP ratio in FY20 was comparable with that of many other emerging markets. Like these countries, India, too, witnessed significant growth in the tax-GDP ratio in the last 20 years due to the increasing formalisation of the economy. India's tax structure has come a long way – from 80 percent of taxes being contributed by indirect taxes in the 1980s to 46 percent between FY10 and FY19. This could be attributed to a steady rise in corporate and income tax between FY00 and FY20. But we note three recent shocks to the tax structure which would strain the Centre and states' potential tax receipts: 1) reduction of corporate tax rates, 2) constant reduction in GST rates, and 3) Centre's increased dependence on cess. While the FY23 budget may not bring in any tax reforms, we expect it to be fiscally prudent to contain the high level of government debt which increased to 91 percent in FY21.

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In FY20, the government announced a cut in corporate tax rates from 30 percent to 22 percent for existing firms and 25 percent to 15 percent for new manufacturing firms with the aim of attracting foreign investments and increasing manufacturing competitiveness in India. An immediate impact of this decision was the fall in corporate tax to GDP ratio, from 3.5 percent of GDP in FY19 to 2.7 percent in FY20. Our estimates suggest the Government lost corporate income tax worth Rs 1.5 trillion and Rs 2.23 trillion in FY20 and FY21 respectively. Despite impressive corporate tax collections in FY22YTD (Centre achieved 64 percent of budgeted target in 8 months), we expect the government to lose up to Rs 1.5 trillion (0.6 percent of GDP) of potential corporate tax collections.

In the last 4 years, GST has become the largest tax component in India as it streamlined the indirect tax mechanism and brought in greater transparency. GST contributes 35 percent of Gross Tax Revenue (GTR) of the Union and 44 percent of the State's own tax revenues. Before the pandemic began, the government was in the habit of reducing GST rates of commodities in frequent intervals which has led to revenue neutral GST rate to be 11.8 percent as opposed to the promised 15.5 percent as 40 percent of commodities attract 5 percent or less tax.

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Though the Centre is required to transfer 42 percent of the divisible tax pool with the States, the Centre uses cess, a non-shareable tax item, to protect its revenues. In FY11, cess charged by the Centre was only Rs 0.5 trillion, which dramatically increased to Rs 3.7 trillion in FY22BE. From less than 5 percent contribution to gross taxes in FY11, it now contributes almost 17 percent of GTR. If the States are to receive a share of the cess pool on the basis of the Finance Commission's recommended proportion, States on average would have had an additional Rs 50,000 crore in FY21 and Rs 1.5 trillion in FY22 based on FY22BE. Due to such huge losses in revenue through imposition of cess, the States have raised concerns.

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While cess to an extent has compensated for loss in tax revenues for the Centre, the above-mentioned shocks have put considerable strain on State revenues. An analysis of finances of 19 major States has revealed that they have only achieved 51 percent of their budgeted revenue up to December 2021 as tax collections, which have been 8 percent higher than FY20YTD, have only been 55 percent of the budgeted target. The immediate impact has been on capex, which although 15 percent higher than FY20YTD levels, has only been 39 percent of the budgeted target. This is unpleasant for overall Government capex since States contribute more than 2/3rd of it.

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The pandemic-induced fall in revenue coupled with a rise in income support scheme spending increased the overall government debt-GDP ratio to 90.6 percent in FY21 compared to 74.1 percent in FY20. To bring down this high level of debt, the Government presented a fiscally prudent budget in FY22. Despite the additional expenditure caused by the second wave of the pandemic and the uncertainty over achievement of current year disinvestment targets, we expect the Centre to achieve a fiscal deficit of 7 percent (just 20bps higher than budgeted). This marginal miss in deficit is primarily due to (a) impressive revenue collections – the Centre has already achieved 76 percent of the budgeted revenue in just 9 months; and (b) fiscal prudence – by keeping a check on the spending of a majority of the ministries; the Centre has only achieved 46 percent of its fiscal deficit target in the first 8 months, the lowest in the last 5 years.

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We look at the FY23 budget as a continuation of the FY22 budget – focus on containing the fiscal deficit. Keeping fiscal deficit in mind, total expenditure is estimated to rise by just 8.5 percent YoY in FY23 as revenue expenditure is expected to rise by 6.6 percent over FY22. While the budget may not involve any significant reforms as the government would focus on rural and agro-oriented welfare spending such as food subsidy, MGNREGA (Mahatma Gandhi National Rural Employment Guarantee Act), PM-Kisan and fertilizer subsidy, all of which, though expected to be reduced as compared to FY22, will remain elevated. While capex growth is expected to moderate in FY23, push from the Road & Railway Ministry would result in 19 percent YoY growth in capex allocation, which is 2.5 percent of GDP.

We see the current impressive gross tax revenue growth moderating in FY23 in line with a moderation in nominal GDP growth which we expect to grow at 13 percent YoY in FY23 compared to expected growth of 17 percent YoY in FY22. Political compulsions and high inflation are likely to prompt further cuts in fuel excise duty, which remains very high.

We expect the Centre to keep the fiscal deficit target around 6.4 percent of the GDP in FY23. This will have two major implications – the Centre's debt-GDP ratio, which increased by 1,000 bps to 64 percent in FY21, would reduce to 60 percent by the end of FY23. Secondly, fiscal prudence in FY23 would also allow the current government to have more firepower for the decisive pre-election budget of FY24.

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Sumit Shekhar is the Economist at Ambit Institutional Equities.