What Should the Budget do to Taxes with Suranjali Tandon
Explore the various directions the budget could take and how it could impact the economy
In this episode, author and journalist Puja Mehra speaks to Suranjali Tandon, Associate Professor at NIPFP (National Institute of Public Finance and Policy). They talk about India’s tax system, the tax-to-GDP ratio, disparities between salaried and business taxpayers, and the implications of social and economic constraints on tax structures. They also explore the various directions the budget could take and how it could impact the economy.
ABOUT SURANJALI TANDON
Suranjali Tandon is an Associate Professor at the National Institute of Public Finance and Policy. Her research covers Direct and International taxation, Sustainable finance, Corporate Taxation, Financial markets and Climate Finance. She has also written articles on Tax for leading publications like The Indian Express, Bloomberg Quint, Hindu Business Line and The Economic Times to name a few.
NOTE: This transcript is done by a machine. Human eyes have gone through the script but there might still be errors in some of the text, so please refer to the audio in case you need to clarify any part. If you want to get in touch regarding any feedback, you can drop us a message on [email protected].
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TRANSCRIPT
Puja Mehra: Suranjali, we are in the budget season again and there is so much expectation of income tax rate cuts, etc., relief and all that. I wanted to hear from you on what you think of it. But let's start by first discussing how are India's tax rates doing, how have they been?
There was a tax cut for the corporate tax earlier announced. What has been the outcome of that? Has the policy objective been achieved?
And then we'll probably go on to what to expect this time.
Suranjali Tandon: So, whenever you go back and look at how the tax system in general has been transitioning, we see that, you know, over the past few years, there's been a bit of focus on how do you simplify the system. So, even on the personal income tax side, begin with, we've seen that there have been options available where an individual could pick between an old regime and a new regime, where the new regime was basically to say that, you know, you don't have to do all this complicated filing where you have different kinds of incentives and deductions. Here, take a rate which could possibly be lower for incomes at the lower end of the income distribution.
Similarly, in 2019, we saw the reduction in corporate tax rates. So, you had earlier about a 30% statutory rate and now the government said, well, you could again adopt a simpler regime where you do not take these incentives or deductions and just opt for a lower rate at 22%. Of course, there's a surcharge incest on top of that.
So, it comes to about 25.17%. Why is this being done? I think there was a twofold intent. One is to make this tax system, tax compliance easier.
The second was that, you know, the economy since 2018 has been sort of in a situation where there was a palpable need for some kind of a push or a thrust to bolster growth. And I think one of the ways in which it was thought it would work would be through these rationalisations or through a reduction in the rate. Now, you ask a question on whether these worked or not.
And, you know, corporate tax reductions or tax reductions in general can go either way. A lot of time, a lot of hope is placed on them for kick-starting an economy, but it could be that there are other effects in play. So, look at the 2019 cut, many different effects panned out.
So, there was a parliamentary committee, first of all, which estimated the loss in terms of revenue and it was about 1.85 lakh crore. It was said that, you know, this is a cost to the exchequer for bumping up activity in the economy. But did it really bump up activity in the economy?
So, just plain facts, if you look at corporate tax collections, the growth hasn't been stellar, at least at the top level. We see that, you know, companies have been showing higher profits. But what have these profits really resulted in?
So, there was an interesting study or assessment carried out by RBI in its annual report in 2019-20, which was immediately after this change. And what they observe is that actually this resulted in higher cash balances or, you know, companies servicing their debt or investing in current assets, which means that any permanent effect which you would see through fixed asset investments was not palpable in the numbers. And this is what we see across a lot of companies.
In terms of just who opted for this, again, very interestingly, about 15.85% of the companies opted for this new regime. But if you look at the incomes reported under the new regime, it was about 56% for companies with turnovers between 10 to 500 crores and above. So, this basically means that there are large corporations which have a weight of this.
But at the same time, we're still talking about, in terms of macro, we're talking about a push to investment. We're talking about, you know, still some trouble with employment. So, the question really is, we saw that corporates were faring better, but we didn't quite see economic activity commensurately go up, even in terms of investment.
So, it leaves room for doubt on whether this really worked the way it was envisaged.
Puja Mehra: I have two follow-up questions here. One is that, at the time of analysing if this tax cut option should be provided, did the budget foresee and announce a revenue loss of 1.8 lakh crore or was their estimate lower? So, basically, I'm asking, did they get their calculations right over there?
And two, I suppose it follows from that question itself, which is that, was it worth the bargain for the budget makers? Did they really get out of this tax cut what they were expecting?
Suranjali Tandon: So, Puja, at the beginning of a new regime, it's very hard to tell what these losses could be. It's important to also forewarn that what you think of as losses are not always losses, because if that incentive had not been given, would activity had stayed at that level? And that question is absolutely important, even when we look at the period, because it was economic setback from COVID.
So, therefore, I would say that, you know, when the government did reach out through this incentive, I don't think there is any preconceived cause. Of course, there are ballpark numbers on what will be lost. I believe there was a reference in the budget to this number.
And these are only, I guess, satirist paribus sort of exercises where you see economy as it is then. So, your follow on question, the response to this would be slightly layered. One is that, of course, as I said, the hard numbers point to the fact that, you know, it hasn't quite pushed activity to the extent it may have been imagined that it would cause because of the level of incentive given.
I think it's also due to look at the numbers in the economic context. So, you're looking at a period when you have the COVID crisis or companies are responding to a situation where demand may be uncertain. And so, therefore, to make investment decisions during such an uncertain time is questionable.
So, companies would still stall and look at where does this ebb and what does the cycle really look like in the new world. And I think when we evaluate this corporate tax cut, it is very important to look at both of these aspects. One is very crudely, how do companies respond?
And second is that, you know, how do they respond given the economic circumstances that the company is facing? So, I would say it's both of these that acted. I think what may be of interest to us would be to look at the numbers here on.
So, I would say the numbers for the years 2023, 2024 and beyond would be more interesting to see what is the longer term impact of this rate reduction.
Puja Mehra: So, you're saying one important factor to be borne in mind when evaluating the success or the payback from this tax cut is that, you know, what the budget makers didn't know is that there would be a COVID-like situation which completely changes investment calculations, etc. for companies. And probably that's why it has resulted in higher cash balances, like you're saying, and improving the quality of the balance sheets, I suppose, of the large companies, which they are yet to leverage for increasing investment activity.
Did I understand that right?
Suranjali Tandon: Yeah, Puja, that's correct. And just to sort of add to that, that, you know, we keep talking about the large corporates, but there was another incentive handed out to smaller firms in manufacturing units. And if you look at the statement of revenue foregone, you also see that there's been quite a bit of increase in the incomes reported under that particular section when you registered units would be able to avail a lower rate, much lower rate of 15%.
So, there are units that are availing of this. Of course, they're only 0.1% of the total number of companies. And this would be, again, a lot of factors playing out in the manufacturing sector, which is keeping this section from being used widely.
But yet again, there has been some update there. And I think, again, the numbers need to be watched over the next few years, because sometimes there are longer term effects, which are not quite palpable or absorbable in immediate cycles.
Puja Mehra: And the exemptions that they were supposed to give up for availing these concession rates or new rates, let's say, did they stick with that? Did they give up the exemptions? Or did they come back and lobby for retaining some of these exemptions along with the lower tax rates?
Suranjali Tandon: I know. So, Puja, once you're into the new system, then these don't matter. But your question is relevant that does the old regime then still look attractive.
And in that sense, I think one of the biggest availed benefit was section 10 AA, which is to SEZ. And there was a hard stop on that. So there was a sunset clause on it.
In that sense, they've taken away one of the biggest incentives that was being availed in the old regime. And so they're stuck by their word on doing away with unnecessary or ineffective incentives and exemptions.
Puja Mehra: We also heard the Chief Economic Advisor say that there are some inherent biases in the tax system, which introduce a bias in favour of capital intensive manufacturing in India. Is that debate linked to what we're talking about?
Suranjali Tandon: It could perhaps, because one of the ways that I could think this would work out is that you have one of the second highest availed exemption is on accelerated depreciation. Now, for any manufacturing unit, it's plant and machinery is quite important. And then when you have these hard physical assets, you can claim a lot of deduction from your profits in a year and your taxes in particular.
So I think that's one way to say that it is favourable to capital intensive units. The other, of course, is not related to hard capital. But I think what we also don't talk about is that there are still a lot of incentives that exist in terms of preferential rates of taxes to certain kinds of incomes.
And whether we look at this in terms of capital gains, which has been talked about quite a bit, we earlier had a larger wedge between how equity was treated as opposed to debt-based instruments. And I think over the years, what we've seen is that there's been some interest to close that gap, but it still remains. And in that sense, it favours certain kinds of capital and investments as well.
So I think that's also to be remembered when you look at tax structures. It's not just what the corporates are paying and what kind of incentives they're receiving.
Puja Mehra: Thank you actually for bringing this up, because I hear two different kinds of views on this. Some people say that it's good that the gap is being closed and some people say that no, they should be treated differently. What's your view?
Suranjali Tandon: I think, Puja, it's a good question for an economist to ponder over for years, because I think if you look at budgets and if you look at tax policy reports over the last many decades for India, they've all mulled over this. If you go back in the 1960s and see the kind of taxes we had on even things like bonus issue, on dividends of different kinds, it was mind-boggling. And we've traversed a long path to come to this point.
I think the fundamental question, which most economists have tried to ask and answer, but we still don't have conclusive answers on this, whether you should encourage debt or you should encourage equity. And one of the main arguments is that, well, debt is already deductible from profits as a cost, and so therefore should be then taxed higher when these incomes are received, whereas equity is treated quite differently. So I think what it requires is a proper analysis.
Now, just to give you an instance of what tax changes do, in 2020 again, we had a shift in distribution tax. We've had a lot of vacillating on this as well. So sometimes it's taxable in the hands of the individual receiving the dividend, that it's back to the company.
And what we saw is that right after this is introduced, the dividend distributions decline from companies as a percentage of their profit after taxes. And so there is this behavioural shift even from such taxes, right? And so I think the impacts could unfold in so many ways.
It requires an economic analysis. I think usually when you look at an investment market, what is usually argued is that parity is always great because you're not trying to show that you prefer one over the other. But in principle, if you're trying to create long-term effects through, let's say, higher investment, then the question is to ask is that, is that lack of parity really serving your purpose?
Or the lack of parity, is it actually bringing parity in taxation, as I said, in terms of debt being treated differently in the books of accounts of companies and then distributed out as incomes as opposed to equity income. So what does this lack of parity really mean and what does it do? I think that needs to be answered before saying whether it's good or bad in general.
Puja Mehra: So let me say what you're saying differently. In terms of the policy objective, what is it that we want to strive for? Do we want to strive for, like sometimes the officials say that we want to treat different kinds of incomes from the tax point of view similarly.
Is that the policy objective or is it that we want to encourage investments? And we're seeing that for more than 10 years now, the investment rate in the economy is not picking up to go back to the high levels that it was. Does this play a role there?
Is the tax policy also one of the factors that we need to address if we really want to bring the investment level back to there?
Suranjali Tandon: So Puja, I think you ask a very interesting question again, which I've been trying to pose to myself for years now, is what is it that tax policy is trying to do, right? So what's the spirit of the law that we see? I think there are times when simplification is the goal and you want to create parity to just make it easier that, you know, you go to a particular section, you know, if this is a capital gains applicable, it's applicable to everyone and then you work with it.
There are other times, which again, very interestingly, if you read budget documents over a period of time, like for example, in the 1990s when we liberalised and, you know, the long-term capital gains on equity were made preferential, there was a clear-cut stated objective that, you know, we want more foreign institutional investors in the market, we want to open it up, we want to open up the capital market and I think it was tuned to that. So I think over a period of time, we see change in objective and I think India's tax system and economy has matured a bit since then and so therefore now there is this effort to create some parity to simplify.
Now, what does this system really look like and how does it play out for just investment purposes? I think there are two kinds of investments again. One is your new fresh investments that you see in terms of physical assets, in terms of capacity in the economy and the second is the secondary market investment.
Now, we see a bit of, I would say, you know, disconnect between the two. We've seen a roaring stock market over the last few years but we've seen a very slow investment cycle on the corporate side and I think this is perhaps because there are some kinds of investments still that exist for the secondary market for certain kinds of investors and then there is all other factors that play in to determine the cycle for real investments. So for example, you know, the real investments would be a function of the demand in the economy, it would be the general level of interest rates, it would also be what the global markets are looking like.
So I think the two are being driven by other macro factors as well. Then there is also this flight effect of taxes. Now, whether we should change taxes to raise investment, I think we have our answer.
If we gave the corporate tax cuts and we didn't see that jump, irrespective of the fact that, you know, I mean, it's been a short duration, we can evaluate it but in periods of crisis, if this hasn't worked, it's a question to be asked whether this will work in the next few years. So I think corporate taxes are sometimes overstated as a way to achieve the investment objective. I think, in fact, there are questions being raised on whether monetary policy should do this job at all and if you can't do this through interest rates, then the question is can you do this through corporate taxes and I think there's a big question mark there.
Puja Mehra: In fact, I've been reading similar questions being asked around the world in many other countries and everybody seems to be saying that corporate tax cuts don't always work as we think they would. In fact, the same is also being said for interest rates. There are so many other things that go into a company's decision on whether to invest or not and these are just part of the factors taken on board when making those calculations and decisions.
Let's now talk about income tax. I know from your and my earlier discussions that as it is the threshold for income tax in India is quite high when compared to the per capita income and when compared to the amount of tax you're going to raise per rupee spent on collecting that tax, given the bigger levels of incomes. But still, there is this whole discussion that has now started because there is need for giving consumption a push.
Should there be some sort of relief on income tax? There hasn't been relief for a long time. There's been inflation, etc, etc, etc.
So, what do you think? Again, I suppose, just like we said for investments and the relationship of that with corporate taxes, do you want to, for this particular point in time, tweak your taxation policy on income, not keeping in mind the longer term policy objective? So many things here.
What are your thoughts?
Suranjali Tandon: So, I think one is that corporate taxes are popularly believed to be the easiest thing to change and I think we're seeing that in the US as well, right? So, Trump's been going on about how he's going to again create some kind of an incentive. He did that earlier in 2017 with the Tax Cuts and Jobs Act and even if you look at the reports, I think there are question marks on whether any GDP gains were enough to compensate for the revenue losses and what it did for the US economy.
So, that's a big question, I think, across the world. It remains an unanswered question. I think the broad answer to this is that it really depends on the sector.
It depends on your growth cycle and so your taxes will feed into that overall impact. Now, you raise the question of consumption, which I think is absolutely important because what we've been noticing again on consumption is that there has been a shift there, right? So, if you look at the annual reports of large F&CG companies and they are sort of reflecting on what we're seeing in the economy.
So, we're seeing that urban demand is slipping, rural demand stays buoyant. Now, you don't have a tax system which works differently for different regions and so what this basically says is that if I reduce my taxes, I assume people will consume and that is a question to ask. Well, if you were looking at broad data, you would say, well, credit card spend is up.
So, we would see more spending maybe because people would then not want to take debt. But on the other hand, we're also seeing that, you know, rural demand might be buoyant but urban may not and then you may see certain products seeing more demand because what we've also seen is that GST collections have been up, which means that there are certain kinds of products that are contributing to this. I think that there needs to be a more tailor-made policy which you don't really achieve through direct taxes in the context that we're seeing.
I think what has been observed is that a lot is being done on the GST side. There's been a lot of thought on which products, well, of course, there again there is a lot of discussion on kinds of products and variants within that but more broadly, I think there needs to be an understanding of what we want to do on the indirect side for specific kind of consumption to be bolstered rather than, you know, rely on the direct taxes side.
Puja Mehra: Okay, so that leads into three questions then. So, you're saying that you don't think now is the time for any kind of income tax relief and then the second thing that you're saying is that the way to address the consumption push requirement is GST but then on GST everybody says that we need a stable predictable system and we shouldn't keep tinkering with the rates and I know you don't mean that popcorn should have different kind of rates. I know you're talking about slightly different tax treatment for different categories of goods but even then I thought that the economists want that there should be a very simple predictable stable GST rate system that shouldn't keep changing every few years.
So, that's number two and number three, since we are talking about rural consumption versus urban consumption, we know it's difficult to do because there is a constitutional clause etc but is it time again to talk about taxes on agriculture incomes?
Suranjali Tandon: So, just to say first that, you know, I think we've been complaining in India a lot about the tax to GDP ratio and if we are to at least see a stable one and we want to move further from that, I think thinking about, you know, tax cuts as a way to go, I think it's a pause on that. I don't think that's an immediate solution to a problem that we're seeing. If it is a macroeconomic problem, it needs resolution at so many levels and you can't keep handing out tax cuts every time to solve that problem.
This leads to the consumption question. Well, you know, I do say that we can think about some sort of a change in the GST rates or structure at the moment but of course then there is the question of stability. So, then I think worth evaluating is that, you know, is the current system stable?
Is it working well the way it is? And then that leads us again back to the macroeconomic questions on do we want an easy monetary policy? Is this something that, you know, we want to do immediately and swiftly to be able to pull the economy out or raise demand which of course on the flip side could have questions about asset quality in the banking sector.
But I think we have to think about new tools to do this. Do we want more fiscal policy on the expenditure side to think about how to deal with consumption because that is more targeted in terms of sectors and segments and regions. And moving from there to say what can we do next?
Can we tax agriculture? And I think that's a favourite question before budget and I think it's a perennial question on whether this will bring a new tax base. It will raise revenue substantially.
I think its potential is overstated because even if you do imagine that you do implement an agricultural tax and that may be politically quite upsetting, what you may actually see is that the revenues may not go up as substantially. It's not going to change the world. So, I see the problem is, okay, so we could raise revenue but is this going to be politically feasible and how long before we actually achieve the target?
And then what this means is that we can't give away on other taxes because once you introduce this, it does not mean that it gives you enough fiscal space to be giving away incentives on others. So, what I would imagine is that instead of putting all the pressure on the tax structure in the system, I think it may be more important to think about more targeted expenditure and I think better expenditure than just sort of giveaways. I understand that perfectly.
Puja Mehra: So, these were sort of the set of questions I wanted to discuss from a very immediate budget is coming up point of view. These questions tend to be on the minds of listeners but I also want to now get into a discussion on more conceptual and sort of long-term kind of issues which you and I have been talking about quite a bit over the years which is things like, you know, most Indian people tend to think that we are really taxed a lot and we don't get anything much governance in return compared to say the Nordic countries or the more developed advanced world where why would I not pay even a 50% tax on income because quality of life is so good. How far is India from that kind of status and what do we need to do to get there?
Is it just that we need to raise per capita income?
Suranjali Tandon: Yeah Puja, so this is again a perennial question I think on what can we do on the personal income tax and people perceiving the tax system is unfair. To be honest, it's not just Indian. I think it's a psychological thing that people prefer others to pay more taxes.
So, even the discussion in the US interestingly about, you know, the rich and the wealthy to pay more taxes I think stems from the fact that if there is someone else who looks like they can bear it, must bear it and I think it plays out in different ways in systems that are more tight or more strict. There the option of escaping it is lower but in systems where there is possibility to avoid and evade the tax compliances is lower. Then we ask the question of can we be the Nordics?
I think this is aspirational for so many economies. I think it's important to look at the context in which these economies have evolved. They have a social security contribution, you know, they have a different sort of tax system where they have fewer taxpayers and so therefore monitoring compliance may not be as difficult.
They have different sort of tax morale and so I think the comparability is a bit of a problem. It's always aspirational to be like the Nordics but I think it's a complex combination of economic factors, social factors and political factors and I think this whole issue of whether we should raise the tax to GDP because we don't have enough public goods and saying, you know, because we don't have enough public goods we don't want to pay enough taxes. It's like the chicken or the egg problem.
I think what you need is a calibrated approach to bolster incomes in jurisdictions like India. You need to have a protracted period of growth with stability which we've seen in the last few years but I think faster on the growth side with more taxpayers entering the system. That's when you can begin to think of elevating our tax rates to the level that these countries implement and also having a social security system which is comparable.
So I think it's a long road to say that you can be like the Nordics is an imperfect comparison. I would say that it's a mix of so many things and just to reiterate that the tax to GDP in any country is a function of so many economic factors and social and political factors that when we say that, you know, a certain tax to GDP is appropriate for an economy it is an inaccurate comparison. So we should look at what is the maximum attainable given the constraints of the economy itself.
Puja Mehra: So while the salaried class in India feel is that they are the biggest contributors to the tax collections, those who are in business they feel it is them. Just to clear the air on this, who is really sort of the most taxed and the biggest contributor to the tax to GDP ratio?
Suranjali Tandon: In most of my interactions I hear this that, you know, salary people are very upset about them being the massive contributors to the exchequer. I think what the grievance is that tax paid by salaried individuals may look very different because of the deductions and the potential expenses that they can bill to reach a certain effective rate. Just in terms of if you look at the numbers in terms of contribution to the overall incomes reported under tax you would see that actually business incomes are the highest.
It could be on account of corporates but there's an even mix there. So again if there is the grievance of salary class being treated differently, I think tax structures can again evolve slightly. So for example there are individuals who report business can we top or cap their expenses that they can claim to bring them power with salary incomes so that their effective rates look similar or can deductions to salary income which are already available be stepped up to bring them at par with effective rates of business income.
I think that is a thing worth exploring but just to say that you know they're feeling particularly isolated as agreed in the tax system is a bit of an overstatement based on just the fact that the tax system or tax compliance looks very different for both.
Puja Mehra: It's interesting what you say because you know let's take the example for instance of two families. One family where there's a couple both of them are earning but they do not have any dependence in terms of children or elderly parents etc and another family where there's let's say a working mother who has to provide for school education etc but she's single or looking after an elderly parent etc are dependent. Should the tax treatment of these two families be different?
We don't look at tax treatment of families we look at individual incomes but do you think it would make sense and if we begin to build those kind of exemptions then the whole grievance of the salary would be addressed to some extent?
Suranjali Tandon: So for example there are some systems which have tax credit for children there are possibilities of creating such differences based on family choice but I would say that again for anyone who's looking at the tax system the question is do you want simplicity or do you want parity? It goes back to the original question that we were talking about. Now insofar as creating parity between different kinds of families which is again a space of choice and circumstances it would become complicated in a sense that the tax system would then begin to look very different for each of these kind.
Puja Mehra: Now I appreciate that point I appreciate that point but I was not saying this from the point of view of parity but also from the point of view of human resource development. I mean human capital when we talk of it's killing a whole lot of other things a lot of it takes place at home and a lot of it is an outcome of the kind of incomes your family has access to. So from that point of view but the point on complexity is well taken.
Suranjali Tandon: Yeah no so Puja again you know question in my mind is that do we want to treat a person with phenomenal income but with a larger family differently than a person with phenomenal income and single and these become very complicated questions which if we begin to answer through just tax policy it creates outcomes which may not be the target of that policy which is why I say that you know in a circumstance where you believe that the family needs to be supported more because of dependence either we need to figure out what we do on the social security side and on the contributions or we think about the expenditure system better managed and more efficient than to say that we're going to start pulling at the tax system to do the job for us.
Puja Mehra: So that seems to be in fact my biggest takeaway from our conversation today which is that you know a lot of times we think that the solution to something is in the way taxes are designed but actually it's not that it's just that once you've collected that tax revenue how you spend it and perhaps even when we were originally discussing the question of investment boost and consumption boost though entry into these problems is not through the tax system but perhaps how you're spending or maybe policy reforms that may have a bigger role to play, policy certainty that may have a bigger role to play in pushing investments and perhaps an overall jobs policy that creates the environment for companies to expand and create more jobs and that is slightly long term but that is a more lasting solution to the consumption problem.
Suranjali Tandon: Yes, I agree.
Puja Mehra: So I don't know if that makes the job of economist looking at taxes easier or more difficult but on that note thank you so much.
Suranjali Tandon: Thank you Puja.
