Any New Tax Could Hit Economic Recovery, Government Warned amid speculation of covid cess

Any new taxes in India’s budget would impede a nascent economic recovery, economists said, amid speculation that Finance Minister Nirmala Sitharaman could impose an additional levy on the wealthy to fund the government’s pandemic-related expenditure.

A so-called Covid cess shouldn’t be announced because the economy is still normalizing after a strict and vast lockdown, Sonal Varma, an economist at Nomura Holdings, said on Thursday in a Q&A with Bloomberg. Abhishek Gupta of Bloomberg Economics warned that such a levy risks hastening capital outflows.

“The trend over the last few years has already raised the total taxes for high income earners to 42.7 per cent, including cess and surcharges, from around 30 per cent,” Mr Gupta said during the Q&A. “A further rise could lower their incentive to invest and earn in India.”

Ms Sitharaman needs to boost spending to dig India out of an unprecedented recession when she presents her budget on February 1, while keeping a watchful eye so that the deficit doesn’t blow out. India’s financial year runs April 1 through March 31.

Here are some condensed excerpts from the interaction with Varma and Gupta:

Budget Deficit

Varma: We are expecting the centre’s fiscal deficit to widen to 6.8 per cent of GDP in FY21, nearly double the original budget target of 3.5 per cent set before the pandemic, but much better than our initial estimate of over 8 per cent in the midst of the pandemic. That’s because a faster-than-expected economic normalization will boost tax revenue and total spending will be lower.

Gupta: While we were earlier expecting central government fiscal deficit to be roughly around 7 per cent or so, we have now estimated it to come in lower at about 6.6 per cent of GDP in fiscal 2021. The recovery has been sharper than anticipated, and we have seen more buoyant tax collections since October.

Budget Credibility

Varma: What will make the roadmap more credible is if there is also a clear strategy on how the government plans to increase India’s tax to GDP ratio over the coming years. Gross tax revenues have been stagnant around 10 per cent of GDP over the last decade. So the roadmap should have a clear revenue enhancement gameplan and not just rely on expenditure compression or expectations of higher nominal GDP growth.

Investment Expectations

Gupta: We expect the government to allocate around Rs 4.8 trillion ($66 billion) for capital expenditures in fiscal 2022, which would amount to a 20 per cent growth over fiscal 2021. We believe that the government focus will remain on increased infrastructure spending on roads, railways, low cost urban and rural housing.

Rating Companies

Varma: While rating companies will watch the budget carefully and growth has recovered faster than expected, the decision regarding whether to change India’s sovereign ratings will ultimately be based on a host of factors. Two rating agencies have India with a negative outlook (Moody’s and Fitch). We believe that Moody’s is likely to move India’s outlook back to stable and so is Fitch, but the latter is a closer call.

Gupta: We don’t expect a sovereign downgrade anytime in the near future, unless things go completely haywire in the budget. In our view, sovereign rating agencies will also focus on tax buoyancy ahead, which is essentially a question about how quickly can the government put the economy back on a pre-Covid potential growth trajectory of 6 per cent-7 per cent and higher.

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