THE MIDDLE INCOME TRAP

As February approaches, the Finance Minister suddenly starts looming large everywhere. From social media chatter to cocktail party conversations, the focus turns to what he will or will not do. This trend started during the early years of economic reforms, when the government began to slip in significant policy changes into the Budget, which, being a Money Bill, ensured that legislative assent for key reforms was not held prisoner to the shifting numbers game in Parliament.

This trend was reinforced by saturation media coverage before, during, and immediately after the Budget, ensuring that India’s annual presentation of accounts and spending plans became something else altogether — an annual statement of policy intent and direction which is watched and analysed by millions at home and abroad.

🔹The last full Budget

Amongst the most avid Budget-trackers will be the great Indian middle class — largely salaried taxpayers in whose hearts, despite a long history of having hopes dashed Budget after Budget, hope appears to spring eternal. This year is no different. There is excited anticipation around the Budget, what with this being the last ‘full’ Budget before the 2019 Lok Sabha elections, which means that the Finance Minister will surely try to reach out and reward all those sections of society which are likely to affect the poll outcome.

And, of course, all those feel-good stories about India being one of the fastest-growing economies in the world, and global bodies like the International Monetary Fund and the World Bank revising India’s growth forecast further upward, have added to this air of expectation. Surely we’re out of the woods now? Surely a $2-trillion economy will be generating enough money to drive this growth without one having to shell out more by way of taxes?

Indeed, so buoyant is the mood that most taxpayers have already prepared a longish list of things they want to see in the Budget come February 1. This includes, of course, raising the basic deduction limit to at least Rs. 2 lakh (currently, it’s Rs. 1.5 lakh). They would like the tax rate itself to be reduced across various slabs, and the slabs themselves raised, to take into account the erosion caused by inflation.

It’s not as if they don’t have a case. After all, the last time taxpayers got a break — increases in tax exemption and deductions under Section 80C — came in 2014, soon after the Modi government came to power. So, will the Finance Minister oblige this time around? Will this be the ‘Dream Budget’ that the middle class has been waiting for so eagerly all these years?

🔹Little fiscal room

I doubt it. That is because the Finance Minister has little fiscal room for manoeuvre. Despite many economists saying that the fiscal deficit target of 3% of GDP is “just a number” and the actual number should be based on current circumstances rather than a rigid target, the Finance Minister is bound by the mandate of the Fiscal Responsibility and Budget Management Act, which lays down both the deficit target and the glide path. And unless Parliament amends it, or gives him special exemption, he will have to stick to it.

The second is that the “oil bonanza”, which caused the government’s coffers over the past year or so to grow exponentially, has dried up. Global crude oil prices are on the rebound, and with petrol and diesel prices fully decontrolled, fuel prices have started shooting up again. The price of petrol crossed Rs. 70 per litre in many cities last week, even touching Rs. 80. This may well force him to cut duties on fuel.

The other problem the Finance Minister has is that all the increase in GDP growth is not really reflecting in tax collection figures, particularly on the income tax front. Data relating to tax collections for the assessment year of 2015-16 (fiscal 2014-15) were made public just last month, and makes for very discouraging reading, if you are Arun Jaitley. In fact, asBusiness Line’s Tina Edwin reported, “nearly half of those who file returns do not pay taxes. Of those who paid taxes, nearly 90% paid less than Rs. 1.50 lakh.”

The ‘middle class burden’ is starkly exposed by another set of numbers. The bulk of income tax paid by individuals (not counting corporates) comes from those with an annual income of more than Rs. 24 lakh. This group forms just over one per cent of the taxpayer base, but over half the tax collected is from this group. The next group of people — those with taxable incomes between Rs. 10 lakh and Rs. 24 lakh — who actually constitute the core ‘middle’ middle class, accounted for another 23% of taxes. Together, these two groups accounted for just 5% of tax payers, but 76% of taxes paid.

This means that this group is too small numerically to count politically come election time, but is too important financially for the Finance Minister to be doling out too many tax breaks. Prepare to grin and bear it, one more time.