Despite tax revenues being stagnant relative to the gross domestic product (GDP) for the last five years, the government has chosen to continue using tax breaks to promote investment and consumption. Concerns that the already weak aggregate demand may become more susceptible to external shocks — which are now the norm rather than the exception — are apparently forcing its hand.
After deep cuts in taxes on corporate profits, personal income, and the goods and services tax (GST), the liberal approach has now extended to capital gains tax, which has emerged as a faster-growing source of government revenue in recent years. This amounts to a subtle change from an earlier policy where shifting the tax burden away from companies to individuals was touted as a strategy that is at once pro-growth and pro-equity.
The first instance of this shift was the waiver of capital gains tax as well as the tax on interest income for foreign portfolio investors in G-secs. This was announced in June against the background of a persistent weakness in India’s usually strong capital account.
The latest set of measures, proposed in a Bill, maintains this direction and comprises long-term tax holidays of 15 to 20 years for various entities along with improved clarity on who can avail these tax benefits and how.
The direct and indirect beneficiaries of the largesse include not just global Big Tech firms and offshore funds operating out of India but also Indian companies, domestic data centres, as well as retail and other investors seeking to grab a piece of economic growth and India’s real estate and infrastructure boom.
The government expects these incentives will provide an impetus to job creation and household income. The resultant demand creation is expected to more than offset the fiscal hit from the giveaways in the medium- to long-term.
While the government’s intent is appreciated, it is a fact that any grand bargain between tax concessions and long-term economic growth trajectory is replete with risks.
Structural improvement of the economy and raising its growth potential will require not just reforms and deregulation, but also much larger public investments in physical infrastructure and in improving the lot of the common people.
Such investments play a crucial role in demand creation, bolstering human capital, and increasing economic competitiveness. To be sure, past tax reliefs haven’t yielded the intended results. The revenue foregone from the 2019 corporate tax cut was a massive Rs 5.4 lakh crore in the five years through FY25.
Yet, gross fixed capital formation doesn’t seem to have accelerated. Nor is it proven beyond doubt that the personal income tax reliefs unveiled in Budget FY26 or last year’s GST rate cuts can boost consumption durably.
Rather than the extent of concessions or outright tax holidays, what is more commendable about the current tax Bill is that it accords priority to clear, stable, and predictable tax treatment. This will doubtless reassure investors. But the government should not lose sight of a recommended objective to lift combined tax revenues of the Centre and states from nearly 18% of GDP now to around 25%.
For the Centre, the ratio rose from 10% in FY20 to 11.5% in FY22 thanks to improved tax administration efficiency, but it has since lingered around that level. Benign tax rates are the right policy, but the role of tax as a redistribution tool should not be compromised either.