Fiscal numbers for 2021 first quarter do not inspire confidence about economy

While headline growth in tax collections has generated a lot of enthusiasm, a careful analysis of these numbers shows that large parts of the Indian economy might still be in a precarious situation

GDP numbers for the first quarter of 2021-22 (April-June) will be released on August 31. In its June meeting, the Monetary Policy Committee (MPC) of RBI projected a GDP growth rate of 18.5% for the quarter ending June. The quarter ending June 2020 saw a GDP contraction of 24.4%.

Re (AP)

What we have now are the fiscal numbers for the central government for the quarter ending June. These numbers are released by the Controller General of Accounts (CGA), which works under

Does a growth in gross tax revenue mean robust recovery?

The answer to this question is slightly complicated. The relation between taxes and GDP is determined by two factors: tax buoyancy and inflation.

Tax buoyancy refers to the increase in taxes per unit change in GDP. As is obvious, tax buoyancy can go up if tax rates go up or tax coverage improves in the economy.

Because, taxes are levied on nominal and not real incomes, tax growth tends to be closer to nominal GDP growth than real GDP growth. When we discuss GDP growth rate, it is the real numbers which matter.

There have been significant developments on both the tax buoyancy and inflation fronts. The union government increased tax rates on petrol and diesel when crude oil prices crashed last year, keeping retail prices the same, and adding to government revenues in a pandemic year. These tax rates have not been brought down despite a significant recovery in crude prices, which is why prices of petrol-diesel are at a record high today. To be sure, the fact that corporation tax rates were reduced in September 2019, also means that tax buoyancy of direct taxes in June would have fallen compared to what it was in June 2019.

The June quarter also saw very high inflation, with the wholesale price index (WPI) growing at 11.91% on a year-on-year basis. This means that a large part of increase in tax collections in the quarter could be just inflationary noise.

To be sure, the GDP deflator, which is the difference between nominal and real GDP growth, is not the same as WPI or Consumer Price Index (CPI). However, the GDP deflator has a stronger correlation with the WPI than CPI. This is to be expected. CPI is meant to capture household budgets, while WPI is the proxy for producer prices in the economy.

Tax collections in June also corroborate the story of economic recovery being profit-led and confined to the organised sector

Modern economies levy various kinds of taxes. An examination of trends in growth of collections of various kinds of taxes can give us an idea into the nature of economic recovery.

Statistics speak for themselves. If union excise duties are taken out from gross tax revenue, the growth between the June 21 and June 2019 quarters comes down from 32.8% to 27.6%. A large part of the union excise duty tailwinds to taxes would be on account of higher duties on petroleum products.

The data also shows that indirect taxes such as Goods and Services Tax (GST) and customs have grown at a much slower pace than direct taxes such as corporation tax and income tax.

The growth in corporation taxes, which have increased from ₹70640 crore in June 2019 to ₹1.23 lakh crore in June 2021 is especially noteworthy. This is because the June collections are significantly higher despite a reduction in corporation tax rates. The union government announced a reduction in corporation tax rates in September 2019. It slashed corporate tax rates for domestic manufacturers from 30% to 22%, while for new manufacturing companies, the rate was reduced from 25% to 15% provided they do not claim any exemptions.

The disproportionate increase in corporation tax and incomes taxes shows that corporate profits and white-collar professional incomes have seen a much faster recovery than normal economic activity. The latter will be reflected in things such as GST and customs duty collections. According to income tax data for assessment year 2018-19, just 2% of income tax returns accounted for more than 80% of income tax payments in India.

The pro-cyclical turn in fiscal policy

The most worrying statistic in tax collection numbers for the June quarter is the fact that the Centre transferred less money to the states as part of the constitutionally mandated tax devolutions than it had in both the June 2020 and June 2019 quarters. The shortfall will be even greater if inflation adjustments were to be made. This is bound to have created a fiscal squeeze on state governments.

The Centre’s own expenditure rose by just 0.7% in the June quarter over the year-ago period. An inflation adjustment would entail a decline in real terms. This means that fiscal policy was actually pro-cyclical at a time when the economy was dealing with the second wave of Covid-19 infections.