More Than Half of Govt Taxes Will Go Towards Paying Interest on Past Loans

As I keep saying, the union budget at its heart is the presentation of the financial accounts of the government or to put it simply, on what it plans to spend money on, during the course of a year and how does it plan to earn and arrange for that money.

Given this, a lot of analysis happens on the issue of what the government plans to spend money on, during the course of a particular year. A similar thing has happened this time around as well, with journalists, analysts and economists, digging into the budget in trying to figure out where exactly is the government planning to spend money in 2021-22 and where it has spent its money in 2020-21.

The trouble is that like previous years this year as well most analysis has missed out on the biggest expenditure item in the government budget, which is interest payments. Almost every government spends more than what it earns and the difference is referred to as the fiscal deficit. This deficit is largely financed through the government borrowing by issuing bonds. An interest needs to be paid on these bonds every year.

This interest is the largest expenditure in the government’s budget, even though it rarely gets talked about.

Take a look at the following graph, which plots the interest payments on the outstanding borrowing of the union government.

Source: Centre for Monitoring Indian Economy.
2020-21 – Revised estimate.
2021-22 – Budget estimate.

As can be seen from the above chart, the interest payments have been going up over the years and are expected to be at around Rs 8.1 lakh crore in 2021-22 . Now Rs 8.1 lakh crore on its own sounds like a large number, but just looking at the absolute number is not the right way to go about things in this case.

Let’s look at what proportion of overall expenditure of the union government have interest payments formed over the years.

Source: Author calculations on data from Centre for Monitoring Indian Economy.

As per this graph, interest payments in 2020-21 formed a little over one-fifth of total expenditure and this is an improvement on the situation that prevailed before. But this interpretation is wrong, simply because the overall expenditure of the government also includes money that it does not earn.

Hence, a government can always borrow more and spend more in a particular year leading to a higher expenditure number and thus, the interest payments as a proportion of overall expenditure will come down. But that doesn’t mean things have improved.

Let’s look at another chart. This plots the interest payments as a proportion of net tax revenue earned by the union government. Net tax revenue is what remains with the central government after sharing a certain proportion of the gross tax revenue (or to put it simply overall tax collections) with the state governments.

Source: Author calculations on data from Centre for Monitoring Indian Economy.

The above chart gives us a clear picture of the prevailing situation. In 2017-18, the interest payments formed 42.6% of the tax revenues earned by the union government. They have been rising since then and in 2020-21 and 2021-22 are expected to touch 51.5% and 52.4%, respectively.

What does this mean? It means that more than half of the government’s taxes are going towards paying interest on its outstanding loans, leaving very little money for anything else, unless the government earns money through other ways or borrows money or uses other ways to finance the fiscal deficit.

One way for the government to earn more money is through the sale of its stakes in public sector enterprises. In 2020-21, the government had hoped to earn Rs 2.1 lakh crore through this route. This turned out to be a very ambitious target and the government is now hoping to earn Rs 32,000 crore through this route during 2020-21.

The disinvestment target for 2021-22 has been set at Rs 1.75 lakh crore. It is very important for the government to earn this money else it will have to borrow more to meet the expenditure. This will mean higher interest payments in the years to come which will either lead to the government having to cut expenditure or having to borrow even more to meet the expenditure. More borrowing will lead to even more interest on the outstanding debt.

This will have to be paid by implementing higher taxes on the taxpayers and many of these taxpayers will be newer ones, just entering the workforce. This is precisely the way the current generation passes on its liabilities to the next one.

Also, as the outstanding debt matures and needs to be repaid, the government will have to borrow more to repay this debt. Hence, a greater proportion of the borrowing will just go towards repaying debt which is maturing. This will become a debt spiral and needs to be best avoided.

There is another thing that is happening and needs to be brought to notice. The government finances a major part of the fiscal deficit through borrowing. So, let’s take the case of 2020-21. The fiscal deficit for the year is expected to be at Rs 18.49 lakh crore.

A bulk of this deficit will be financed by borrowing Rs 12.74 lakh crore from the market. Where does the remaining money to fill the gap come from? A bulk of it comes from the small savings schemes.

The small savings schemes currently in force are: Post Office Savings Account, National Savings Time Deposits ( 1,2,3 & 5 years), National Savings Recurring Deposits, National Savings Monthly Income Scheme Account, Senior Citizens Savings Scheme, National Savings Certificate, Public Provident Fund, KisanVikas Patra and Sukanya Samriddhi Account.

The money coming into these schemes net of disbursements that happen during the course of the year, is used to finance the fiscal deficit of the union government.

This has been rising at an astonishing pace over the years, as can be seen from the following chart.

Source: Centre for Monitoring Indian Economy.

In 2012-13, the amount had stood at Rs 8,626 crore and it has since risen to more than Rs 4.80 lakh crore. While this amount does not end up as a debt of the government, it is a liability that the government does need to repay over the years.

Also, this is money that is coming from the public savings at the end of the day. In order to ensure that money keeps coming into these schemes, the government will have to continue offering a higher rate of interest on these schemes in comparison to bank fixed deposits.

Hence, the perpetual complaint of the bankers is likely to stay, given that the government needs this money to continue financing its high fiscal deficit. The other option is to borrow directly from the market and increase its outstanding debt figure, which the government wants to avoid beyond a point.

What this tells us is that all hasn’t been well on the government finances front over the last few years, and covid has only made it worse. One reason for this lies in the constant fall in the taxes collected by the government as a proportion of the gross domestic product (GDP), over the years.

The net tax revenue of the union government stood at 8.97% of the GDP in 2007-08. It has since fallen and was at 6.67% of the GDP in 2019-20. In 2020-21, it is expected to be at 6.90% of the GDP. The figure is higher in 2020-21 simply because of the size of the Indian economy, as represented by the GDP, is expected to contract more than the taxes collected by the government during the year.

This fall in tax collections and the dependence of the government on other ways of financing its fiscal deficit, also leads to the question whether the size of the Indian economy or its GDP, is being properly measured. Over the years, the informal part of the Indian economy has seen huge destruction and the question is, does this destruction reflect properly in the GDP figures being published over the years. This is a question well worth asking given that if the GDP is growing why have tax collections been falling?

To conclude, it does seem the government understands the financial situation it is headed towards. Hence, an ambitious target for disinvestment has been set. Over and above this, it also has plans of monetising physical assets including surplus land. Hopefully, this will take off soon. .

PS: Of course, you will not find this kind of analysis anywhere in the mainstream media or even digital publications which charge a fee. Hence, it is important that you support my work. You can do it here. 

Why Govt Loves Income Tax and Isn’t Going to Scrap It

One suggestion that I see people constantly make on the social media, particularly on Twitter, is that the government should do away with personal/individual income tax. They often say this with a lot of confidence, giving the impression that they have thought through the argument. Over the last one week, since the presentation of the annual budget of the union government, such  suggestions seem to have made a comeback.

But the confidence of the people making these suggestions largely comes comes from two things. One is that they haven’t had a look at the government data on taxes, which leads them to believe that barely anyone pays income tax and hence, it should be scrapped. Two, they have no idea as to how most governments operate.

Let’s take a look at a few charts to understand why this logic is all wrong. The following chart plots the individual income tax collected by the government as a proportion of the Indian gross domestic product (GDP), a measure of the size of the economy.

Source: Centre for Monitoring Indian Economy.
Revised estimate for 2020-21.
Budget estimate for 2021-22.

As can be seen from the above chart, income tax as a proportion of GDP has only gone up over the years. In 2019-20, it peaked at 2.68% of the GDP. In 2020-21, thanks to the economic contraction due to the spread of the covid pandemic and falling incomes, the income tax to GDP ratio is expected to be at 2.36% of the GDP. It is expected to rise again to 2.52% of the GDP in 2021-22.

The typical argument suggesting that the government should do away with income tax, goes somewhat like this. Oh, but very few people pay income tax. Now that is true, but that hardly means that the government will stop collecting income tax.

A slightly more sophisticated argument (at least the person making it, feels it is a sophisticated argument) goes somewhat like this. Oh, but income tax collected forms just a couple of percentage points of the GDP. That’s nothing.

Honestly, I find both these arguments hilarious. Guys making these arguments have no idea about how the data looks and as I said, which is where their confidence comes from.

Let’s look at the following chart, which basically plots corporation tax (income tax paid by corporates on their profits) and personal income tax as a proportion of gross tax revenue, over the years. Gross tax revenue is basically the sum of different taxes (corporation tax, income tax, union excise duty, customs duty, central goods and services tax etc.), earned by the union government.


Source: Centre for Monitoring Indian Economy.

What does the above chart tell us?

1) The corporation tax collected as a proportion of the total taxes collected by the government, has been falling over the years. In 2009-10, corporate taxes formed around two-fifth of the total taxes collected by the government. In 2021-22, the tax is expected to be at around one-fourth of total taxes. There are multiple reasons for this. Corporate revenue growth has slowed down over the years. Along with that corporate tax rates have also come down.

2) The importance of income tax in the overall taxes earned by the government has gone up in the last decade. In 2009-10, they formed around one fifth of total taxes and in 2021-22, they are expected to form around one fourth of the gross tax revenue earned by the union government. In 2019-20, income tax formed around 23.9% of overall taxes.

Hence, all taxes may appear small as a proportion of the GDP, but that does not mean that they are not important for the government. The government isn’t the entire economy as represented by the GDP but only a part of it and the taxes earned are a part of that part.

Now tell me which government in its right mind is going to drop a tax which is likely to bring in one-fourth of the total taxes earned by it. This especially in an environment where corporation tax collections as a proportion of the GDP have been falling over the years.

Another argument that is made is that income taxes should be eliminated and indirect taxes should be raised. So, with no income tax, people will earn more and hence, spend more, and the government will end up collecting more indirect taxes, and these taxes will more than make up for a loss of income tax.

While this sounds good in theory, the trouble is that unlike the physical sciences, in economics you cannot carry out real life experiments. So, no government is going to risk one-fourth of its revenue just because in theory they could do something else. Nah, not going to happen. The whole argument rests on the idea that if income tax is done away with people are likely to spend more. What if they don’t and decide to save more? There is no way of knowing in advance about how people are going to behave.

Actually, a more refined argument can be made here. People who pay a bulk of India’s income taxes already have most things that they need in life. Hence, their marginal propensity to consume will be low. This means that the extra money they earn thanks to lower taxes, they are more likely to save/invest it than spend it.

Hence, the argument that people are likely to spend more because they will earn more thanks to no income tax, doesn’t really hold. One thing that can be said for sure here is that if income tax is done away with, the stock market will go through the roof (not that it isn’t already).

A better way to increase consumption and hence, indirect tax collections is to reduce goods and services tax on mass produced goods. The impact is going to be much greater in this case.

There are other reasons here as well. There is a huge income tax bureaucracy in place. What happens to those people with no income tax? Income tax is also used by politicians in power to harass those in opposition or other people opposing them. Why let go of such an option?

All in all, income taxes are not going anywhere, even though when the BJP was in the opposition, it was pretty vocal on the issue of doing away with them.

But now they need to run the country and the gross tax revenue collected by the government, has come down over the years. The gross tax revenue as a proportion of the GDP peaked at 12.11% in 2007-08. In 2019-20, it was at 10.61%. It is expected to fall to 9.75% of the GDP this year and rise to 9.95% of the GDP next year, still significantly lower than the all-time peak level.

So, next time you want to go shouting on Twitter asking the government to do away with personal income tax, please do remember these points.