The tax slabs can be suitably adjusted for inflation to alleviate the economic hardships of the common man
In a few days’ time, Finance Minister Nirmala Sitharaman will be presenting her fifth budget, the last full budget before the 2024 elections. Despite pressure for increasing populist expenditure, one hopes that she will stick to the pragmatism that marked her earlier budgets and focus instead on consolidating the fiscal path further.
Given the present state of the economy with seven per cent growth looking achievable, revenues showing healthy growth, the GST stabilising at around Rs 1.5 lakh crore a month and the continuing bull run in the stock markets, the factors are favourable for the government for projecting a fiscal deficit target less than the last year’s budget estimate of 6.4 per cent.
However, there are some aberrations in our taxation structure which must be corrected. These were flagged after the last year’s budget and it is time the government acts. Chief among these is the complex structure of our capital gains taxation that is arbitrary, ad-hoc and distorts the market, and this must be rationalised for efficient allocation of resources.
There is not only a multiplicity of rates and holding periods for different types of investments, but some have benefits for inflation indexation which others do not have. Capital gains tax is levied on profits made on capital investments on real estate, gold, stocks, mutual funds, and various other financial and non-financial assets. It can be either a long-term capital gains tax (LTCG) or short-term capital gains tax (STCG) depending on the holding period of the investments.
Unlike income tax, for the LTCG, the tax rate does not change in a progressive manner. Thus, the same rate of tax applies for all capital gains whether in lakh or crore rupees. There is also a separate set of exemptions that apply to LTCG, and they come with arbitrary conditions. For example, one can get exemption for buying a house after selling another, provided the new house is bought within two years or constructed within three years of the sale. On LTCG on stocks and equity mutual funds, there is an exemption limit of Rs 1 lakh.
On others, the benefit of indexation is available.
The last time the government tinkered with the capital gains tax regime was in the Budget for FY19, when the LTCG was reintroduced on listed shares. The surge in capital market transactions combined with the booming stock market since then has led to healthy growth in collections, and these can be further streamlined and increased by rationalising and simplifying the structure of capital gains taxation.
There should be one uniform rate for LTCG and all LTCGs should be given the benefits of indexation. There is no rationale for treating listed and unlisted stocks differently and applying different rates in respect of them. Different tax rates in respect of tax assets move resources from one to another, and the same happens with different holding periods.
Real estate sector is the biggest absorber of black money, which is why its prices are way above its intrinsic value. If we want to cleanse the system, special incentives for investing in real estate or holding onto it must be removed and the sector must be brought under the GST regime.
Over 100 million demat accounts were opened in India during the pandemic years (March 2020 to Dec 2022), hugely expanding the base of retail investors in the stock market who are willing to take additional risks to generate wealth. Given an estimated 10-fold increase in our direct tax collections from the increased stock market activity and the future potential for further increases, rationalisation of the capital gains structure is urgently called for. The threshold limit for LTCG also needs to be raised substantially from the present limit of Rs 1 lakh to encourage more retail participation in equity investing.
This can only increase the direct tax collections further. Even if all these changes cannot be introduced in this budget, the FM must make her intent of rationalising the structure of capital gains taxation absolutely clear with a specific roadmap.
Secondly, there is also an urgent need to rationalise the centrally sponsored schemes to increase the allocative efficiency in the budget. But there are many schemes which have inherent populist biases and are economically inefficient; they consume scarce resources that have an opportunity cost.
These schemes also tend to proliferate. There is an urgent need to take a hard look at some of these schemes and rationalise them, not through bundling together under some umbrella schemes as the government had done in the past, but through convergence and merger, and substantial reduction of redundancies.
The previous finance commissions have all red-flagged this issue and the latest, the 15th Finance Commission has said, “We have noted the proliferation of centrally sponsored schemes and central sector schemes and the tendency to continue with them without an evaluation of their outcomes. It is our expectation that the Union Government will utilise the year 2020-21 to complete the review of such schemes and thereafter prune and rationalise the list to focus on certain key sectors and interventions with nation-wide externalities. The objective in our view should be to ensure that there is a minimum level of expenditure on certain desired sectors to improve human development and infrastructure. This will also reduce pressure on the revenue account of the Union to enable higher capital expenditure within the available fiscal space.” Government is yet to review and rationalise these schemes which will release lot of taxpayer funds for capital purposes and curtail unproductive expenditure.
Lastly, the dual system of income tax assessment that was introduced in the FY20 budget under section 115BAC of the Income Tax Act is making no sense. For one thing, it is again too complex with six rates — 5, 10, 15, 20, 25 and 30 per cent - without exemptions, as against three in the pre- existing tax regime with exemptions. With or without exemptions, there should be only a single tax regime. The alternate tax regime has failed to enthuse people, and if the FM is serious about it, she should simplify it to the extent that a taxpayer can prepare and file her tax return under the new regime without the help of chartered accountants.
The alternative is to raise the existing exemptions suitably keeping in mind the fact that high inflation which has become the new permanent normal now will not slow anytime soon, especially with the Russia-Ukraine War showing no sign of ending.
The tax slabs can be suitably adjusted for inflation to alleviate the economic hardships of the common man.
(The author is a former Director General at the Office of the Comptroller & Auditor General of India)
