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Income tax rate cut & fiscal math: Will govt's quandary lead to cut its spending?

As per an estimate of Motilal Oswal Financial Services, following a receipt shortfall of Rs 1.5 lakh crore last year.

December 27, 2019 / 11:04 AM IST

There is a strong buzz that the government may announce a cut in the income tax rate in the Budget 2020.

The government is likely to trim personal income tax rates and cut the tax on long-term capital gains from equity investments in its next Budget, in a bid to spur economic growth, reported Reuters on December 17.

However, experts say it will be tough for the government to bite the bullet as it will pose a risk to the country's fiscal mathematics. The government is already struggling to manage the deficit in GST revenue.

"It looks unlikely that the government will go for a cut in income tax rates in the Budget 2020 unless they bring in the direct tax code where exemptions are removed fully. Presently, the government may tweak slabs a bit but will not go beyond this as there will be loss of revenue," said Madan Sabnavis, Chief Economist at CARE Ratings.

Sujan Hajra, Executive Director and Chief Economist at Anand Rathi Securities believes a rejig in income tax is possible.

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"I-T rejig now looks very likely. The deficit would go up temporarily, so we expect a rise in customs duty, more divestment and more GST on ‘sin’ goods to mobilise more fund," Hajra said.

But, what if the government relents to the populist demand which is backed by few economists as well and goes for a cut in income tax even though it does not look prudent? How will the government balance its fiscal maths?

As per an estimate of Motilal Oswal Financial Services, following a receipt shortfall of Rs 1.5 lakh crore last year, the central government is likely to witness a shortfall of nearly 2.1 lakh crore in FY20.

The shortfall for state governments could be even higher at nearly Rs 3.5 lakh crore, as against Rs 3 lakh crore in FY19.

"As against total receipt shortfall of 9.5 percent (Rs 4.5 lakh crore) last year, the shortfall could be about 11 percent (Rs 5.5 lakh crore) this year," said Motilal Oswal.

It is not unlikely that the shortfall of FY20 pushes the government to either relax its fiscal deficit target for FY21 or cut its spending.

One way is that the government may cut taxes marginally, but that may not benefit the economy, say experts.

"If they do go in for a tax cut, I think it will be marginal and not comprehensive which gives people benefits at the lower level, which will not really help to spur the economy," said Sabnavis of CARE Ratings.

"If the tax cut is substantial then it will affect tax collections to a larger extent as we do not expect GDP growth to pick up rapidly next year and this will mean lower collections. Rollovers and capex cuts will be used to manage the deficit," Sabnavis added.

As it looks almost certain that the central government would witness a significant shortfall in receipts this year, market participants believe that the government will have to either cut spending to meet its fiscal deficit target or breach its deficit target by rationalising spending lower than the receipt shortfall.

The bigger challenge for the government, at this juncture, is to revive the demand in the economy. Experts say that the government needs to relax its fiscal deficit targets and raise its capex.

Hajra of Anand Rathi Securities thinks rather than cutting its spending the government's priority would be to improve revenue through measures such as better tax compliance, aggressive and speedy divestment and greater debt mobilisation through T-bill issuance.

Some payment delays are another possibility as cutting either discretionary revenue spending or capex expenses can be counterproductive especially under the current low growth environment, Hajra said.
Nishant Kumar
first published: Dec 27, 2019 11:04 am

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