Despite the move to lower FY25 fiscal deficit target to 5.1% of GDP, concerns arise as reducing fiscal deficit often involves increased tax collections
With the Union Finance Minister Nirmala Sitharaman having announced that the taxation rates for both direct and indirect taxes will remain unchanged.
Her exact words, ahead of 2024 General Elections, were: “I do not propose to make any changes related to taxation. Tax rates to be retained for direct and indirect taxes including import duties,” she said while presenting the interim budget in Parliament.
While it is has been touted that the Interim Budget 2024 lays focus on youth and women empowerment, while maintaining fiscal consolidation and continuing capex, the unusual budget move of lowering down the FY25 fiscal deficit target to 5.1% of the GDP appears to be a step in the backward direction.
Especially since the ways to reduce fiscal deficit involve increasing tax collections, by borrowing, or by other means every year to bridge the gap between its income and expenditure.
In fact, the admission by Finance Secretary TV Somanathan would be of relevance since the target to reduce the Centre’s debt-to-GDP ratio to 40% was set before COVID-19 period and would now be examined.
According to Hodge et al. (2020) in their Research Article titled: Tax Policy After Coronavirus: Clearing a Path to Economic Recovery - “Short-term policies to “stimulate” economic growth after COVID-19 run the risk of producing short-term results and would likely prove insufficient and ineffective for sparking a long-term recovery.”
Similarly, Wesbury and Stein (2010) in a Forbes’ Article titled: Government Austerity: The Good, Bad And Ugly, enunciated: “Lawmakers at all levels of government should focus on deliberate and comprehensive strategies to clear a path of the most economically harmful taxes that will prevent businesses and individuals from investing, creating jobs, and lifting the economy out of its slumber.”
In economic policy, austerity is a set of political-economic policies that aim to reduce government budget deficits through spending cuts, tax increases, or a combination of both (Wesbury & Stein, 2010).
Tejvan Pettinger in the article entitled: Austerity – Pros and Cons dated: 20 July, 2017 observed: “In most macroeconomic models, austerity policies which reduce government spending lead to increased unemployment in the short term.”
Similarly, Storm Servaas (2019) while studying a closely related phenomenon, postulated: “These reductions in employment usually occur directly in the public sector and indirectly in the private sector. Where austerity policies are enacted using tax increases, these can reduce consumption by cutting household disposable income.
Reduced government spending can reduce gross domestic product (GDP) growth in the short term as government expenditure is itself a component of GDP.”
According to Annapoorna (2024) of ClearTax.in: “The concept of austerity is controversial and according to many economic experts, the national outcomes that are gained from the austerity measures can cause more damage than good.”
“Whenever a government experiences financial instability it is as a result of their debts outweighing the amount of revenue received by them. This results in large budget deficits. The debt level of the government generally increases with an increase in the spendings by the government. As a result, the chances of default and inability to pay off the debt increase. This is why the lenders or creditors start to demand higher returns on any future loans in order to avoid the risk of default. The government faces the responsibility of paying off the debt and satisfying the obligations towards the creditors. In an effort to do so the government needs to implement certain measures.” (ClearTax, 2024)
Annapoorna surmise that: “This is when austerity measures are introduced.”
Therefore, although the goal of austerity measures would be to bring down government debt, the effectiveness thereof still remains debatable.
According to the Big Four Accounting Firm Deloitte in the report titled: Tax policy and recovery from the COVID-19 crisis, the authors have commented:
During the economic recovery phase, tax policy will likely play a key role.
While different countries will make different choices on a short-to-medium-term basis, tax incentive regimes providing stimulus to certain sectors will be an option to encourage investment and spending and to create jobs.
Measures introduced during this gradual recovery period are likely to be more targeted than those that were deployed during the initial emergency response phase.
However, this will not be an easy task to calibrate as certain regions within a country may be able to ease the containment restrictions more quickly than others.
Longer term, though, ever-increasing amounts of government debt would appear to be unsustainable, as would the continued reliance on monetary policy to keep interest rates at historically low levels.
Tax policy therefore will be one of the longer-term levers that governments can use to generate revenue to manage increased levels of national debt.
The memory of the COVID-19 crisis will not fade quickly.
Governments will want to be better prepared for the next ‘black swan’ event. However, a balanced response is necessary to avoid further global economic disruption.
Local sourcing of essential supplies during the crisis has been problematic for many nations.
Applying an overly nationalistic approach across the board should be weighed against the impact on cross-border trade and the global economy.
There may also be an impact on the role to be played in promoting investment, innovation, and growth.
The principles governing international tax have displayed a long track record of supporting international trade through bilateral and multilateral approaches to income tax and customs duties.
Summarising:
In conclusion, while tax policy is not the only lever that governments have in addressing issues that have been brought to the foreground as a result of the COVID-19 crisis, it is an important one.
It is essential to understand the associated role of tax policy in the decision-making process as governments and their advisors plot a path toward economic recovery.
