Out of the fiscal deficit slippage of 0.5% points of GDP in FY20 and FY21, only 0.1% point in each year has been used for augmenting capital expenditure indicating a marginal fiscal stimulus.
Economic slowdown: real and nominal dimensions
By the time the FY21 budget was presented, it had become clear that both real and nominal GDP growth rates had significantly fallen. As per the Central Statistical Organization’s (CSO) advance estimates for FY20 and the first revised estimate (RE) for FY19, the real GDP growth for FY20 was estimated at 5.7% and the nominal GDP growth at 7.8%. In fact, both these growth rates have been falling over successive quarters since FY17, when the real growth rate was at 8.3% and the nominal growth rate was at 11.8%. Such a low nominal GDP growth translates into a low tax revenue growth, which has also suffered from a low tax buoyancy both for direct and indirect taxes in FY20.
The FY21 budget proposals need to be assessed in terms of four major considerations namely: (1) whether the FY20 RE of tax revenues are likely to be realized since these constitute the base year numbers for FY21 budget estimates (BE), (2) what is the true extent and quality of fiscal deficit in FY20 RE and FY21 BE, (3) what is the credible quantum of fiscal stimulus inherent in the budget proposals for FY20 and FY21 and (4) to what extent the proposed National Infrastructure Pipeline (NIP) is dependent on center’s budgetary support. These issues are discussed in detail in the February 2020 issue of the Economy Watch.
Budget FY21: starting with downward tax revenues projection
Considering the ongoing economic slowdown as also discretionary policy initiatives of the government, the union budget for FY21 kept the annual growth in center’s gross tax revenues in FY20 (RE) at 4% against a projected growth of 18.3% in the budget estimates of the budget presented in July 2019.
Center’s gross tax revenues for FY20 (RE) were lowered to INR21.6 lakh crore from the corresponding BE at INR24.6 lakh crore. The corporate income tax (CIT) revenues were revised down by INR1.55 lakh crore in FY20 incorporating the effects of the CIT rate reforms undertaken in September 2019 and the economic slowdown. Similarly, personal income tax (PIT) revenues in FY20 were revised down by INR9,500 crores while the indirect tax revenues were revised down by INR1.3 lakh crore. However, the actual tax revenues may fall short of even these lowered targets. As per the CGA data covering the first three quarters of FY20, there is a contraction in the center’s gross tax revenues of (-) 2.9%. This implies that in the last quarter of FY20, a growth rate of 19% over the corresponding period of FY19 is required to achieve the full year growth of 4% as envisaged in the RE. Such a high growth in the last quarter has not been achieved in recent years. Considering individual categories of taxes, this task appears uphill. In the case of PIT, to meet the full year RE, a growth of 51.6% is required in the last quarter of FY20 and for indirect taxes, a growth of 18% is required against an actual growth performance of only 0.1% in the first three quarters. If FY20 actual revenues, which would serve as the base for FY21, are lower than the RE, it would upset the FY21 BE projections. This revenue uncertainty might also affect the fiscal deficit projections.
Growth stimulating policy initiatives: pre-budget and budget
One of the most important policy reforms aimed at attracting investment particularly investment in the manufacturing sector was rolled out between the FY20 and FY21 union budgets in the form of an overhaul of the CIT structure as also the structure of the related exemptions and deductions. Although this reform offered a major concessionality to domestic companies, the related cost in terms of foregone revenues was borne by the government. According to the government’s estimates, the revenue cost could be as much as INR145,000 crores for FY20. In the October 2019 issue of the Economy Watch, we had estimated this cost for FY20 to be somewhat lower at close to INR1 lakh crore. The revenue impact of the CIT reform is immediate and would continue in successive years until CIT revenues pick up as a result of an increase in the corporate tax base, which depends on additional investment by current or new companies and their profitability. The base widening effect is expected to progressively neutralize the revenue eroding effect of the CIT rate reduction. However, its impact may only be felt after a few years.
In order to push up demand, the union budget FY21 relaxed the fiscal deficit targets from 3.3% of GDP to 3.8% in FY20 and from 3% to 3.5% in FY21. Additional stimulus was also introduced by providing an optional PIT rate structure and by abolishing the dividend distribution tax (DDT). The estimated revenue costs of these reforms amount to INR40,000 crores and INR25,000 crores respectively limiting the extent budgetary fiscal stimulus at a maximum of INR65,000 crores.