How to Run Public Sector Banks Well Without Privatising Them. And Why That’s Not Going to Happen

As of March 31, 2020, the total bad loans of public sector banks stood at Rs 6,78,318 crore. This is a drop of 24.3% from a peak of Rs 8,95,600 crore as of March 2018. Bad loans are largely loans which haven’t been repaid for a period of 90 days or more.

So how did bad loans of public sector banks come down by nearly a fourth? First and foremost, as of March 31, 2018, IDBI Bank, the worst performing bank when it comes to bad loans, was a public sector bank. From January 21, 2019, the bank was categorised to be a private bank. Accordingly, its bad loans moved to the overall bad loans of private banks. But we need to remember IDBI Bank is owned by the Life Insurance Corporation of India, that makes it as close to being a private bank, as Indian Chinese food is close to the real Chinese food.

As of March 31, 2020, the overall bad loans of IDBI Bank were Rs 47,272 crore. If we add this to the bad loans of public sector banks, the real bad loans of public sector banks work out to Rs 7,25,590 crore (Rs 6,78,318 crore + Rs 47,272 crore). This means that the real fall in bad loans of public sector banks in the two-year period has been around 19% and not 24.3%, as we originally calculated.

So, bad loans worth Rs 47,272 crore came down, simply because IDBI Bank got recategorised as a private bank.

Let’s move to the next point. Take a look at the following chart, which basically plots the bad loans of public sector banks over the years. The bad loans of IDBI Bank are included in this chart.

India’s Manhattan

Source: Centre for Monitoring Indian Economy and Indian Banks’ Association.

As I elaborate in detail in my book Bad Money, the RBI practiced regulatory forbearance between 2011 and 2014 and did not force public sector banks to recognise their bad loans as bad loans, even though they had started to appear by then. In simple English, regulatory forbearance, essentially means the central bank looking the other way from the problem.

An asset quality review (AQR) was launched in mid 2015 and this forced banks to recognise their bad loans as bad loans. As you can see in the chart, the overall bad loans of public sector banks take a huge jump post 2014-15. This was the AQR at work.

Now loans which have been bad loans for four years can be dropped from the balance sheet of banks by way of a write-off. Hence, many loans which had been categorised as bad loans in 2015-16 would have spent four years on the balance sheet by 2019-20.

Accordingly, they got written off from the balance sheet of banks. Of course, before such bad loans are written off, a 100 per cent provision needs to be made for these bad loans. This means that banks need to set aside money to meet the losses arising from these loans. This essentially led to the overall bad loans of banks coming down as well.

And over and above this, the banks would have managed to recover a portion of the bad loans (which includes bad loans that have been written off as well). The overall recovery rate for banks through various recovery channels during 2018-19 was around 15.5% of the amounts involved. (Numbers for 2019-20 aren’t currently available or at least I couldn’t find them anywhere).

In fact, a bulk of the current accumulated bad loans will disappear from the balance sheets of public sector banks over the next two to three years, thanks to the fact that bad loans can be written off after they have spent four years on the balance sheet.

Nevertheless, the question is: even after this can the public sector banks operate in a healthy way where they don’t need to be constantly recapitalised. In fact, once public sector banks get around to identifying post-covid bad loans early next year, their balance sheets are likely to come under stress again.

But the basic problem of public sector banks remains interference by the government. This interference can take several forms. As Viral Acharya and Raghuram Rajan write in a research paper titled Indian Banks: A Time to Reform?: “Interference, including appointing favoured candidates to management, expanding lending just before elections, or directing banks to lend to favoured borrowers is obviously harmful.” (Again, something I discuss in great detail in my book Bad Money).

To ensure that public sector banks do not face this kind of interference it has been suggested that they need to be privatised. Over and above this, there have been news reports which suggest that the government is looking to privatise public sector banks.

This remains a difficult decision politically. Also, in an economic environment like the one prevailing, there will be fairly limited number of firms looking to buy government banks saddled with a huge amount of bad loans and a section of employees not used to the idea of working.

Further, unlike other public sector enterprises, the government has to be even more careful while selling a bank. As Acharya and Rajan write:

“The experience in other countries with allowing corporations to own banks is that it increases the possibility of self-dealing within the group – the bank is used to make risky loans to failing group entities, and the bill is paid by the tax payer when the bank is eventually bailed out.”

They further say that the Indian industry is already heavily concentrated. As a recent McKinsey Knowledge Centre report titled India’s turning point An economic agenda to spur growth and jobs points out: “Our analysis shows that just 20 of the country’s roughly 600 large firms contribute 80 percent of the total profit of large firms.” The report defines large firms as firms with an annual revenue of more than $500 million.

If India’s large corporates end up buying its banks, the industry is likely to get even more concentrated. Hence, while privatisation of public sector banks remains a good idea over a long-term, currently, the government can initiate the reform process through the Axis Bank model, wherein the government is an investor in banks rather being a promoter.

The Committee to Review Governance of Boards of Banks in India (better known as the Nayak Committee, after its chairman, PJ Nayak) which presented its report to the RBI in May 2014, suggested the Axis Bank model.

Axis Bank was originally called UTI Bank. It was set up in 1993. It was owned by the Unit Trust of India (UTI) and a clutch of public sector banks. Even though ownership was 100 per cent in the public sector, the bank got a licence to operate as a private sector bank. The bank was listed on the stock exchanges in 1998. UTI Bank was later renamed Axis Bank.

Even at that point of time, the public sector shareholding continued to be the majority shareholding. In early 2000s, when the Unit Trust of India ran into trouble, the government broke it down into two parts. One part became the UTI Mutual Fund and the other was the Specified Undertaking of the Unit Trust of India (SUUTI).

In February 2003, the shareholding of UTI in the bank was transferred to SUUTI. UTI Bank was later renamed Axis Bank.

As the Nayak Committee Report pointed out:

“The Government-as-Investor stance has characterised the control of the Bank, with SUUTI acting as a special purpose vehicle holding the investment on behalf of the Government. The CEO is appointed by the bank’s board, and because the bank was licensed in the private sector, it sets its own employee compensation, ensures its own vigilance enforcement (rather than being under the jurisdiction of the Central Vigilance Commission), and is not subject to the Right to Information Act. SUUTI appoints the non-executive Chairman and up to two directors on the Board, and there is no direct intervention by the Finance Ministry.”

This means that the bank has been run as a proper banking business, without much intervention from the government. Between March 2003 and March 2014, the share price of Axis Bank rose thirty-two times. Over the years, the government has been able to sell its stake in the bank to raise a decent amount of money.

The point being that even though, as per its shareholding, Axis Bank ‘was for many years a public sector bank’, but ‘fortuitously, the bank was licensed at the commencement of its business as a private sector bank’.

The Nayak Committee Report suggests that the government should look at public sector banks as an investment and not as a business it has to run, and follow the Axis Bank model. This essentially means the government reducing the stake in these banks to less than 50 per cent, and letting the bank’s management and its board do their job, like in the case with private sector banks.

But then as the oft-repeated cliche goes, public sector banks are not just about making money. They also need to keep the social objectives of the government in mind. This is something that even Prime Minister Narendra Modi had suggested at the First Gyan Sangam in 2015 (a meeting of bureaucrats, bankers and insurers). As Modi had said on that occasion, while “government interference was inappropriate, but government intervention was needed to further public objectives”.

It’s this line of thought has driven India’s public sector enterprises for seven decades now and gotten them nowhere in the process.

R C Bhargava, the current Chairman of Maruti Suzuki, who was also an IAS officer for a very long time, writes the following in his book Getting Competitive: A Practitioner’s Guide for India:

“The USSR was the pioneer in attempting industrialization along with creating a communist society. It did not succeed. On the other hand, Japan became a highly competitive and industrialized nation and has a high degree of equality and social justice. The policies for regulating and promoting industrial growth do not have any social content in them [emphasis added]. Social equality was a result of the political and industrial leadership understanding that manufacturing competitiveness would be enhanced if there was greater equality and the bulk of the people were enabled to become consumers of manufactured goods.”

What Bhargava, who has worked for long periods of time, both for the government and the private sector, is basically saying is that social objectives of the government shouldn’t become objectives of its enterprises.

This does not mean that the government should do away with meeting its social objectives. Not at all. But what it should do instead is incentivise banks on this front.

As Acharya and Rajan write:

“Perhaps a better approach would be to pay for the mandates (such as reimbursing costs for maintaining branches in remote areas or opening bank accounts for all) so that both private banks and public sector banks compete to deliver on them. This will distance the public sector banks a little from the government. While public sector banks may be given a slightly different set of objectives than private banks (for example, they may put more weight on financial inclusion), their boards should have operational independence on how to achieve the objectives.”

Competition and incentivisation goes a much longer way in delivering services than a government diktat.

The question is, where will the money for all this come from? Allow me to throw a few numbers at you, before I answer this question.

The market capitalisation of the State Bank of India, India’s biggest bank and the biggest public sector bank, is Rs 1.67 lakh crore. The total assets of the bank as of March 2020 were at Rs 41.97 lakh crore. Now compare this to Kotak Mahindra Bank. Its market capitalisation is at Rs 2.53 lakh crore. The total assets of the bank as of March 2020 stood at Rs 4.43 lakh crore.

Hence, in comparison to the State Bank of India, the Kotak Mahindra Bank is a very small bank. But its market capitalisation is almost Rs 86,000 crore more. Why? Simply because Kotak Mahindra Bank is run like a proper bank and the stock market gives it a proper valuation for the same.

Or take the case of HDFC Bank, which has a market capitalisation of Rs 5.80 lakh crore, which is more than all public sector banks put together. Both these well-run banks have much lower bad loans than public sector banks. The overall bad loans of private banks, Yes Bank notwithstanding, are significantly lower than public sector banks even after adjusting for their size.

The point I am trying to make here is that if public sector banks end up being much better run than they currently are, the stock market will give them a higher market capitalisation. And the government can then finance its social objectives by gradually selling the shares it owns in these banks.

Of course for anything like that to happen, the Department of Financial Services in the Finance Ministry which controls the public sector banks, needs to take a backseat. As Rajan writes in I Do What I Do: “Unless PSBs are run like normal corporations, they will not be competitive in the medium term. I have a simple metric of progress here: We will have moved significantly towards limiting interference in PSBs when the Department of Financial Services (which oversees public sector financial firms) is finally closed down, and its banking functions taken over by bank boards.”

But as we all know, bureaucrats don’t take backseats.

Oh and politicians. Let’s not forget them here. Back in 2000, the Atal Bihari Vajpayee government tried to push through the move and dilute the government stake in PSBs to 33 per cent. And it failed. Why?

Vajpayee’s finance minister, Yashwant Sinha, had introduced a bill to reduce the government’s stake in PSBs to 33 per cent. It never saw the light of day. In a 2018 interview, Sinha said: “The parliament and the people were not prepared for such [a] kind of step”.

In fact, all these years down the line, we are still grappling with the same issue.

The more things change…

And I sincerely hope, I am proven wrong on this.

Modi government refuses to acknowledge India’s jobs crisis

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Indian Railways, India’s largest public sector employer, recently received more than 28 million applications for 90,000 jobs posts, it had advertised for. As of March 31, 2017, the Indian Railways employed around 1.31 million individuals.

The ratio of the number of applicants to the number of jobs stood at a whopping 311:1.
The number of applicants was more than the population of Australia, which was a little over 24 million in 2016. It was around 6 times the population of New Zealand, which in 2016, was around 4.6 million.

Using data provided by the Central Statistics Office of the government of India, we can estimate that the number of Indians between the ages of 15 and 29, who are most likely to apply for these jobs on offer, are at 360 million (189 million males and 171 million females).

This basically means that close to 7.8% of the population in the age group that can be categorised as India’s youth has applied for the 90,000 jobs on offer at the Indian Railways. What this calculation does not take into account is the fact that everybody in the age group 15-29 is not looking for a job.

Many individuals in this age group are studying. In case of females, many are married at a young age and take care of the family. In some other cases, females have been pulled out of school or college, and are waiting at home to get married.

We need to adjust for this i.e. take the labour force participation rate of this age group of the population into account, and then recalculate the numbers.

The labour force participation rate for males in the age group 15-29 is 63.1% (as per NSSO June 2012). These are the proportion of people who are actually looking for jobs. For women it is 18.3%.

There are two explanations for the low female labour participation rate. One lies in the fact that many individuals in this age group are still studying. Further, the overall labour force participation rate for females is also very low at 18.1%, and this reflects in this age-group as well.

Taking the labour force participation rates into account, the total number of people actively looking for jobs in the 15-29 age group works out to 150 million (119 million males and 31 million females).

This means close to 18.7% (28 million expressed as a percentage of 150 million) of the population in the 15-29 age group, has applied for the 90,000 jobs on offer at Indian Railways. Or to put it a little simplistically, one in five individuals in the 15-29 age-group has applied for the jobs on offer in the Indian Railways.

This tells us the sad state of affairs for the one million youth who are joining the Indian workforce every month. Another factor at work here is that the government pays much better at lower levels than the private sector in India does, which obviously gets many people to apply.

The above figures clearly show the lack of formal jobs in India. This is a problem that the Indian government is not willing to acknowledge. Recently, Jayant Sinha, a junior minister in the Modi government, called India’s jobs crisis more of a data crisis, in a column he wrote for The Times of India, India’s largest selling English newspaper.

In his column he stated that 6.5 million new jobs were created in the retail sector between 2014 and 2017. While he didn’t state the source of this data, some digging around suggests that he borrowed this number from Human Resources and Skill Requirement in the Retail Sector, authored by KPMG, for the NITI Aayog, a government run think tank.

The 6.5 million jobs that Sinha talked about was basically a forecast, which Sinha passed off as the actual number of jobs created.

As far as the lack of data is concerned, the Labour Bureau carried out six household based Annual Employment-Unemployment Surveys (EUS) between 2010 and 2016. Of this, reports of five rounds have been released till date. (Makes us wonder why has the report on the sixth round been held back up until now).

The report of the fifth round was released in September 2016. One the major findings of the report was that only 60% of the Indians who were looking for a job all through the year, found one. This figure showed the bad state of jobs in India, very clearly. This finding was consistent with a similar finding reported in the report on the fourth round of the survey as well.

Recently, in an answer to a question raised in the Parliament, the government said, “On the recommendations of Task Force on Employment, however, this survey has been discontinued”. Basically, a survey which brought bad news has been discontinued and then the government goes around talking about lack of data.

There is enough data that suggests that India is facing a huge jobs problem. The so called demographic dividend is collapsing. The Modi government refuses to even acknowledge this problem. The first step towards solving any problem is to acknowledge it. If you don’t acknowledge a problem, how do you solve it?

The column was originally published on April 13, 2018, on AsiaTimes.

PM Modi, Nehruvian Economic Policies Aren’t Going to Get Us Anywhere

narendra_modi
This is something that we should have written on a while back, but as they say it is better late than never.

In the annual budget of the government of India, presented earlier this month, the finance minister Arun Jaitley raised custom duties on a whole host of products. In his speech, Jaitley made it clear that this wasn’t a one-off thing, but a change in policy direction.

As he said: “In this budget, I am making a calibrated departure from the underlying policy in the last two decades, wherein the trend largely was to reduce the customs duty. There is substantial potential for domestic value addition in certain sectors, like food processing, electronics, auto components, footwear and furniture. To further incentivise the domestic value addition and Make in India in some such sectors, I propose to increase customs duty on certain items. I propose to increase customs duty on mobile phones from 15% to 20%, on some of their parts and accessories to 15% and on certain parts of TVs to 15%. This measure will promote creation of more jobs in the country.”

The customs duty has been raised on around 45 products. The maximum increase was in case of cranberry juice from 10% to 50%. (All you cranberry juice drinkers out there, maybe it is time to start appreciating the taste of chilled filtered water with a dash of lemon in it).

The idea as Jaitley explained is to create jobs within the country. With increased custom duties, imported goods will become expensive. This will make domestic goods competitive. As people buy more and more of domestic goods, the companies producing goods in India will do well. Once they do well, they will expand and create jobs in the process. Alternatively, because imports will become uncompetitive, the domestic companies can continue operating, and jobs can thus be saved. QED.

The problem with this argument is that it stinks of Nehruvian era economic policies, in particular import substitution, which was the norm in independent India, up until the economic reforms of 1991. Import substitution as a policy was introduced by Jawahar Lal Nehru and carried forward by Indira Gandhi, two individuals, the Bhartiya Janata Party keeps blaming for everything that is wrong in this country (even though we are four years into the term). At its simplest level, import substitution is basically an economic policy which promotes domestic production at the cost of imports. And it is an economic policy, which doesn’t work.

As the French economist Jean Tirole writes in Economics for the Common Good: “In economic matters too, first impressions can mislead us. We look at the direct effect of an economic policy, which is easy to understand, and we stop there. Most of the time we are not aware of the indirect effects. We do not understand the problem in its entirety. Yet secondary or indirect effects can easily make a well-intentioned policy toxic.”

What does Tirole mean here? Another French economist Frédéric Bastiat explains what secondary or indirect effects are, through the broken window fallacy.

Bastiat basically talks about a shopkeeper’s careless son breaking a pane of a glass window. He then goes on to say that those present would say: “It is an ill wind that blows nobody good. Everybody must live, and what would become of glaziers if panes of glass were never broken.

The point being that if windows weren’t broken, how would those repairing windows, the glaziers that is, ever make a living. This seems like a fair question to ask, but things aren’t as simple as that.

As Bastiat writes in Essays on Political Economy: “This form of condolence contains an entire theory, which it will be well to show up in this simple case, seeing that it is precisely the same as that which, unhappily, regulates the greater part of our economical institutions.”

Bastiat then goes on to explain what exactly he means by this. Let’s say replacing the pane of the broken window costs 6 francs. This is the amount that the shopkeeper pays the glazier. If the shopkeeper’s son would not have broken the window there was no way that the glazier could have earned these six francs.

As Bastiat puts it: “The glazier comes, performs his task, receives his six francs, rubs his hands, and, in his heart, blesses the careless child. All this is that which is seen.” This leads us to conclude that breaking windows is a good thing because it leads to money circulating and those who repair broken windows doing well in the process.

Nevertheless, this is just one side of the argument. As Bastiat writes: “It is not seen that our shopkeeper has spent six francs upon one thing, he cannot spend them upon another. It is not seen that if he had not had a window to replace, he would, perhaps have replaced his old shoes, or added a book to his library. In short, he would have employed his six francs in some way which this accident prevented.”

How does this apply in the case of the Narendra Modi government increasing custom duties on a whole host of products? The seen effect of this, as already explained above, is that domestic Indian companies can compete with cheaper imports because of the custom duties being increased. This is likely to create jobs and if not, it is at least likely to save jobs. This is the first order effect or the seen effect.

What is the second order effect or the unseen effect? It is well worth remembering here that consumers only have so much money to spend. If cheaper imports no longer remain cheaper because of an increase in custom duties, the consumers have to pay a higher price for the goods made by domestic companies. Once this happens, they are likely to cut their spending on some other front.

The trouble is that this some other front on which consumers cut their spending, is not easily identifiable. Once consumers cut their spending on other fronts, some domestic businesses are not going to do well, and jobs will be lost there. The trouble is this is not something which is very obvious. It is an unseen effect.

If the consumers keep spending the same amount of money as before, they will end up cutting down on their savings, which isn’t necessarily a good thing. As Henry Hazlitt writes in Economics in One Lesson: “The fallacy… comes from noticing only the results that are immediately seen, and neglecting the results that are not seen.”

Another point that needs to be made here is that the domestic companies are organised well enough to lobby with the government. The end consumer never is.

Increasing customs duties is not a solution to creating jobs. For jobs to be created Indian firms need to be globally competitive. When companies produce for the global market, they need to compete with the best in the world. This automatically leads to a situation wherein the products which a company produces need to be globally competitive. On the other hand, when import substitution is the norm and companies need to produce just for the internal market, almost anything goes. This explains why the Indian corporate sector on the whole, has not been able to be competitive on the global front. It has still not been able to come out of the import substitution era. (We hope people do remember the Ambassador Car which had the same engine between 1944 and 1982.)

In order to be globally competitive, India needs to introduce a whole host of reforms, from labour law reforms to land reforms. It needs to start pricing electricity correctly. The governments need to control their fiscal deficits to ensure that they don’t push up interest rates in the long-term. Our education system needs a paradigm shift (We find this phrase absolutely cringeworthy, but nothing explains the situation better). The corporate bond market needs to function much better than it currently is. The number of inspectors that an average business needs to deal with has to come down. The paper work needs to be simplified. All these distortions in the system need to go.

Long story short—going back to Nehruvian economics is not going to do any good to the country. The sooner Narendra Modi understands this, the better it will be for India. India has suffered enough because of the mess initiated by the economic policies of Nehru and Indira Gandhi. And there is no point, going back to it.

The column originally appeared in Equitymaster on February 19, 2018.

Why Pakodanomics is Not the Answer to Creating Employment

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India gave the world zero, and helped Mathematics, which until then was dependent on Roman numerals, leapfrog.

Last week we also gave the world, what I would like to call pakodanomics (I guess even bondanomics would work fine).

In a television interview, prime minister Narendra Modi, said: “If someone opens a ‘pakoda’ shop in front of your office, does that not count at employment? The person’s daily earning of Rs 200 will never come into any books or accounts. The truth is massive people are being employed.”

Thus, prime minister Modi, helped found a new discipline in economics, pakodanomics.

What was prime minister Modi really trying to say here? This entire jobs crisis is being overblown. What is important is employment and not jobs. This, I think, is a fair point, which most people in India do not get, given our fascination for sarkari (i.e. government) jobs. Of course, expecting the government to create employment for one million Indians entering the workforce every month and the 8.4 crore Indians who need to be moved from agriculture to make it economically feasible, is unfair. That point is well taken.

Employment can come in various forms. Even selling pakodas and making Rs 200 per day is employment. Selling pakodas on the street is incidental here. What is more important is that the prime minister of India is saying that people can sell stuff on the street, make money and employment can thus be generated.

There is a basic problem with this argument. Before I get into explaining that problem, a couple of clarifications: a) I didn’t come up with the example of the selling pakodas, the prime minister did. b) The piece is not about the unit economics of pakodawallahs and how much money they make on a given day (I know, dear reader, you know a pakodawallah who is a millionaire). But it is about selling any product on the street to earn Rs 200 per day and the prime minister of our country offering this as an employment opportunity.

At Rs 200 per day, the annual income of an individual selling pakodas (Again, let me repeat here, pakodas are incidental to the entire example. It is about making money by selling stuff on the street) would be Rs 73,000 (Rs 200 x 365 days). This is assuming that he sells 365 days a year. This is an unrealistic assumption, but we will let it be.

The per capita income of an average Indian was Rs 1.03 lakh in 2016-2017. Hence, the individual selling pakodas earns 29 per cent less than the average Indian. If I were to flip this point, an average Indian makes 41 per cent more than the individual selling pakodas. So, clearly there is a problem.

Of course, someone has to earn lower than the average income. But the difference between the average income and the income of the individual selling pakodas is significant. PM Modi’s pakoda seller is not earning much simply because there are too many people out there selling pakodas. At a broader level there are too many Indians selling stuff on streets. This is primarily because there aren’t proper jobs going around. And if there are, people are unskilled to carry them out.

Let’s get into a little more detail by looking at some data. Take a look at Table 1, which deals with the self-employed people in India.

Table 1: Self Employed / Regular wage salaried / Contract/ Casual Workers
according to Average Monthly Earnings 

What does Table 1 tell us? It tells us that nearly half of India’s workforce (46.6 per cent to be exact) is self-employed. Further, 67.5 per cent of India’s self employed make up to Rs 90,000 a year. A little over 41 per cent make only up to Rs 60,000 a year. What does this tell us? It tells us very clearly that self-employment (selling pakodas for example) does not pay well.

Most of India’s self-employed workers make lesser money per year than the average per capita income of the country, which in 2015-2016 (for which the self-employed data is), was Rs 94,130. So, there is a clearly a problem with being self-employed. (The good part is, it is better than being a casual labourer, which is by far worse. But to be self-employed you need some basic capital to start, which many Indians, who end up as casual labourers, don’t).

People in India are self-employed because they do not have a choice. Currently, the government is busy trying to pass of self-employment in India as entrepreneurship, which are two very different things. People in India become self-employed because there are no jobs going around for them. Entrepreneurship, on the other hand, is by choice.

Further, as can be seen from Table 1, getting a job is more monetarily rewarding than being self-employed. Hence, selling pakodas or being self-employed, is not the solution to the problem. It is a symptom of the problem, an indication of the problem and the fact that barely anything is being done about it.

To conclude, zero was a useful invention, pakodanomics isn’t. It’s better to get rid of it as soon as possible and concentrate on the real problem of creating the right environment which will help the real entrepreneurs create genuine employment opportunities for India’s youth.

As I keep saying, the first step towards solving a problem is recognising that it exists.

The column originally appeared in Equitymaster on January 24, 2018.

Personal income tax comes to Narendra Modi govt’s rescue as corporate tax falls

Earlier this week, the government released some interesting data on direct taxes which essentially are composed of corporate taxes, personal income tax. They also include tax collected through the income tax amnesty schemes launched by the governments over the years.

How have these taxes done over the years? Has the Narendra Modi government managed to collect more direct taxes than the earlier government’s (as is often said)? The recently released data provides the answers.

Take a look at Figure 1. It basically plots the direct taxes to the GDP ratio over the years.

Figure 1:

Tax to GDP

Source: http://www.incometaxindia.gov.in/Documents/Direct%20Tax%20Data/Time-Series-Data-2016-17.pdf

 

What does Figure 1 tell us? It tells us very clearly that the direct taxes collection as a proportion of the GDP, has remained flat over the last few years, including the three years of the Modi government. It also tells us very clearly that whenever a politician talks about the collection of direct taxes (or for that matter any other tax) going up, it should be in the context of the size of the economy (i.e. the GDP).

If that is not the case, then he or she is clearly bluffing or does not understand how taxes are reported. As I said earlier, the direct taxes are comprised of personal income tax, corporate tax and other direct taxes. First and foremost, let’s take a look at how things look if we ignore the other direct taxes. This is important for the year 2016-2017, when the government managed to collect a significant amount of tax, through two income-tax amnesty schemes, one launched before demonetisation, and one after it.

Figure 2:

Net direct tax

Source: Author calculations based on data taken from http://www.incometaxindia.gov.in/Documents/Direct%20Tax%20Data/Time-Series-Data-2016-17.pdf

Unlike Figure 1, which curves up at the end, Figure 2 is more flattish, once we adjust for the other direct tax. This matters in a year like 2016-2017, when the government collected Rs 15,624 crore as other direct tax, much of which was collected from income tax amnesty schemes. Once adjusted for this, the direct taxes to GDP ratio in 2016-2017 falls to 5.49 percent. In 2015-2016, it was at 5.46 percent of the GDP. This is much lower than the 6.30 percent achieved in 2007-2008. Hence, the direct taxes to GDP ratio has fallen over the years.

It is important to take a look at how does the situation look for corporate tax and personal income tax, as a proportion of the GDP, the two most important constituents of direct taxes. Let’s take a look at Figure 3, which plots the corporate income tax as a proportion of GDP.

Figure 3:

Corp tax

Source: Author calculations based on data taken from http://www.incometaxindia.gov.in/Documents/Direct%20Tax%20Data/Time-Series-Data-2016-17.pdf

Figure 3 tell us very clearly that corporate income tax to GDP ratio has been falling over the years. It has fallen from a peak of 3.88 percent of the GDP in 2007-2008 to 3.19 percent in 2016-2017. One reason for this has been the slow growth in corporate earnings over the last few years. Finance Minister Arun Jaitley has talked about lowering corporate income tax rates, but that hasn’t really happened. Whether lower taxes lead to higher collections remains to be seen.

Now let’s take a look at Figure 4, which plots to the personal income tax to GDP ratio.

Figure 4:

personal tax

Source: Author Calculations based on data taken from http://www.incometaxindia.gov.in/Documents/Direct%20Tax%20Data/Time-Series-Data-2016-17.pdf

Figure 4 makes for an interesting reading. While, personal income tax to GDP ratio like the corporate tax to GDP ratio also fell, it has managed to recover over the years. Basically, the loss of income tax from the corporates has been covered by getting individuals to pay more income tax, on the whole. One reason for this lies in the fact that the number of individual assessees have risen at a much faster rate over the years, than the number of corporate assessees. And this jump has basically ensured that the tax collections of the Narendra Modi government have continued to remain flat. They would have fallen otherwise.

The column originally appeared on Firstpost on December 21, 2017.