Budget 2022-’23: With the economy in a crisis, Centre should consider a Covid tax on the ultra-rich

With the Union Budget set to be presented by Finance Minister Nirmala Sitharaman on February 1, the state of the Indian economy remains grim as the third wave of the Covid-19 pandemic appears to be peaking across cities and towns

In the past two years, the Indian political economy has witnessed three crises: a pandemic, an economic meltdown from the coronavirus-induced restrictions, and a deep erosion in trust between the state and the citizenry. This last current is evident, among other things, from the lengthy protests against the farm laws, which have since been repealed.

The Union Budget presentation is closely observed by economic and political commentators as the government tries to correct some wrongs from the past year, or award a handful of carrots to poll-bound states in the expectation of garnering more votes. In both these scenarios, there remains a divergence between what was promised and what is delivered.

For example, last year’s Budget outlays sought to offer an optimistic “pro-growth” vision to the long-term plan in a bid to kickstart domestic private investment through increased, government-enabled capital spending. This was done in the hope of reviving the “animal spirits” of the economy and prompting recovery across sectors.

The charts below highlight the spending allocations in the Budget last year.

The spending allocation to social welfare and rural development was much lower than expected. There was less money given or transferred directly to those who needed it in a crisis year. The government explained that it aimed to spend more on capital expenditure to boost growth for long-term gains in pursuit of its goal to “make every Indian more atmanirbhar” or self-reliant.

Unfortunately, in the year since then, that pro-growth/atmanirbhar vision of the government has yet to be realised (see Figure 4 below).

In terms of year-to-year growth trends, there were positive signs in the manufacturing and mining activity that recorded a higher relative growth performance last year. But the overall situation still looks grim, particularly in the sectors of agriculture, industrial production and services. Now, with the third Covid-19 wave, the performance of most of these sectors is likely to be hurt more.

Going forward, it is also important to focus more on diagnosing the sequential aspect of growth to be seen across the year than to overemphasise the year-to-year percentage data alone, as done above. India’s growth rate needs to be at least six percentage points higher than the average of 9% to ensure an optimal growth trajectory.

Moreover, the performance of goods vs services, as highlighted recently by JP Morgan’s Chief India Economist Sajjid Chinoy, projected a brief revival of the service sector in the last few months of 2021 before the Omicron variant struck. This even as goods – the metric of industrial production levels – began plateauing after reaching the pre-pandemic scale.

Still, where the government’s fiscal priorities, based on the recent Union Budgets, have continued to miss the mark is on tackling the nation’s challenge of underemployment and underemployment. This is further entrenched by the low social spending in areas that could help create a robust safety net for lower-middle-class workers and failing to put money in the hands of those who need it the most. It is a classical Keynesian solution to almost a (classically) structured labour market problem. Unfortunately, the government fails to even acknowledge the challenge.

The government’s budgetary focus to help the poor, even during the pandemic, was on providing food through a higher subsidy bill. But despite this, most measures (see Figure 2: Ministry-wise expenditure) announced for those affected were stimulus steps to create means for liquidity in the market, in facilitating borrowings for affected small and medium enterprises.

In the charts below, see the breakdown of the Atmanirbhar Bharat package aimed at aiding out of the coronavirus crisis.

An assessment of the outlays announced shows that most spending – almost 55% in the Atmanirbhar Bharat 3.0 package – was aimed solely at industrial infrastructure, manufacturing via the production-linked incentives scheme that yielded little gains in actual growth performance.

At the same time, little was done on the job creation front: the Atmanirbhar Bharat Rozgar Yojana, a scheme to incentivise employment creation, got about 2% of the package.

For farmer-centric allocations, the picture of proposed outlays vs. actual disbursements looks murky. Even before the pandemic, the shortfall between budgeted and actual expenditure claims was roughly 42% for schemes like Pradhan Mantri Krishi Sinchayee Yojana, which focuses on investment in irrigation and improving water-use efficiency, accentuating a further deepening of erosion in trust between farmers and the Centre.

Source: CNES Team InfoSphere Edition Data

Employment challenge

For the Union Budget 2022, the government’s biggest macro-fiscal and economic challenge is to create good jobs. Acknowledging the issue would be the first step for the government, but a correct diagnosis of the matter is equally important.

As Mahesh Vyas, managing director and chief executive officer of the Centre for Monitoring Indian Economy, recently pointed out:

 “The unemployment rate is not India’s most important labour market indicator. The unemployment rate was 7.9% in December 2021. This does not mean that the remaining 92.1% were employed. It does not even mean that 92.1% of all working age people were employed. The unemployment rate merely tells us the proportion of people in the working age population who want to be employed to earn some wages or profits through their work, but in spite of their efforts to find employment are unable to find any. The unemployment rate does not take into account those who do not want to be employed and those who do not try to find work.”

Vyas is right.

Amidst the many concerns in the disjointed labour market within India is how most adults do not clearly express a desire to work to earn wages or profits. That makes traditional metrics less significant in interpreting and studying the problem. The employment-population ratio becomes a more useful indicator, measuring the ratio of the employed to the total working-age population.

At 43%, India’s pre-pandemic employment-population ratio was lower than the global rate of 55% in 2020, as per the World Bank’s data. The employment rate is 53% in Bangladesh and 63% in China. As per the estimate of the Centre for Monitoring Indian Economy, the country’s employment-population rate is below 38%.

This reflects a chronic crisis of “good quality jobs” across India for the working-age population entering the labour force every year, the rate of which has continued to be high even during the pandemic.

At the same time, the demand for work under the Mahatma Gandhi National Rural Employment Guarantee Act – seen as a fallback option or a safety net – remains high despite the resurgence of some economic activity since the second half of 2021. Inadequate rural employment budgets have made it difficult for states to provide adequate work to those who have little or no alternative employment opportunity.

Where the Centre needs to get its act straight is in defining allocative spending priority in two areas this upcoming Budget: one, focus the design of fiscal policy on creating good quality jobs through incentives across sectors and do so over a three-to-five year plan.

Second, create well-financed job-based social security nets by supporting increased outlays to the rural employment guarantee scheme, and formulate an urban version of it in cities for temporary relief.

At the macro level, if only 38% of the working age population in India is employed and only another 3% wants to work but cannot find work (unemployed as a percentage of the population), then implicitly, as Vyas of CMIE points out, 59% of the working-age population does not want to work.

For 2022, the government’s “pro-growth” outlook and “atmanirbharta vision” – as enshrined in the Union Budgets of 2020 and 2021 – lies in actualising that by finding employment for not only the 3% who are unemployed, but also a significant chunk of the remaining 59% of the population.

To reach global employment standards, India needs to create jobs for an additional 187.5 million people every year.

Funding the changes

The tax-to-gross domestic product numbers look good for this year. Even if the ambitious disinvestment targets are not met, the proceeds from a more buoyant tax-to-gross domestic product ratio should encourage the Centre to enhance reallocation of resources towards social development areas.

Over past three to four years, the Centre has found it increasingly difficult to accrue the revenue it estimates to collect over a given fiscal and to spend what it says it would. This is especially true across the heads of essential social, public expenditure schemes such as crop insurance, child nutrition plans, rural employment guarantee and the Ujjwala Yojana, which provides access to cooking gas cylinders to poor families.

Despite this, the composition of India’s weak growth performance was being largely sourced from higher government spending, which was still less than what was promised in the annual estimates as fiscal deficit has continued to expand.

Given the widening inequalities in income and wealth, and the surging profits accrued by corporations during the pandemic year, an unsolicited proposition to the finance minister would be to use this year’s opportunity to do the following:

a) Consider generating greater fiscal spending capacity by taxing the ultra-rich through a Covid consumption tax.

b) Use these additional resources to spend more on nutrition, health and social schemes, and more importantly, on public work programmes that can help create more jobs in the public sector in urban and rural areas.

c) Borrow wherever possible only for crowding in private investment possibilities.

d) Establish clarity in economic vision through a medium-to-long term fiscal plan.

A Covid consumption cess

Imposing a “Covid consumption tax or cess” on the ultra-rich has been discussed at length before. It could be introduced first for the top income class, perhaps the top 5%. Under more normal circumstances, getting the political capital to do this might have been difficult, but not under the current circumstances.

How would this work?

A consumption tax, or cess, is a tax imposed on consumption, as opposed to some other measure of ability to pay, most notably income. As mentioned earlier: “In India, our data on consumption-based surveys (even at household levels) and trends seen within them has been observed as a principal method for understanding and analysing various kinds of inequities, and therefore, can allow policymakers to have a good idea on considering a ‘consumption tax’ that progressively accrues income from higher consumers-producers.”

In practice too, consumption is much easier to measure than income, and the dynamic efficiency gained from encouraging savings and investment could be large. The transitional difficulties, often associated in implementing such a system, are more likely in nations where consumption-based data and its sources are weak.

In India, a relatively more robust consumption-based household data allows any such transitional costs to be minimised. For a start, in a graded implementation cycle, one can at least consider imposing a marginal consumption or spending tax alongside existing income taxes, which – if it were to be me – can be phased out over time.

Create a multiplier effect

In a recent field study undertaken by the Centre for New Economics Studies, the team spoke to a number of daily-wage workers who have seen a 50%-60% dip in days of work during a given month, and a 70% drop on average in their daily incomes. This is even as their household expenses, especially transport and conveyance, have increased.

It is imperative for this Budget to urgently put money in the hands of those who need it the most. Increasing the volume and frequency of cash transfers for the lower classes through existing plans is step one. For step two, there is a strong case to reduce the rates of personal income taxes for a two- to three-year fiscal window, especially for the lower-and-middle income class, those under the tax base.

Why this increased focus on fiscal spending or multiplying spending amongst the lower-income classes? The answer lies in India’s structural demand problem. Consumption demand has been increasingly weak across income classes in India, even before the pandemic led to catastrophe during the devastating second wave in April and May 2021.

The source of an asymmetric growth trend for the nation has remained, for far too long, on what economic agents – households, firms, banks, government, and the external sector – in the top 10% income class produce and consume.

For a structural problem like this to be addressed, which is correspondingly linked to addressing the wide inequality of wealth and income, a more comprehensive fiscal action plan is needed. However, the Centre’s fiscal actions and responses over the past seven to eight years have remained more ad-hoc, guided by political, rhetorical reasons, which are not grounded in principles of “markets” or in any sound economic theory or logic.

The vitality of this Union Budget in tackling India’s jobs problem hinges upon the Centre’s ability to establish clarity in its macro-fiscal and economic action plan through a comprehensive three-to-five point agenda. An agenda, which must be coherent in its vision and blueprint, ensuring India’s economic recovery not to be just centred on the well-being of the top 10% but be consequentially more inclusive, equitable and sustainable in its nature.

Deepanshu Mohan is an Associate Professor of Economics and Director at the Centre for New Economics Studies, Jindal School of Liberal Arts and Humanities, OP Jindal Global University.