Expect income tax harassment to increase over the next few months

Govt's free food package, brought into effect since Covid outbreak in 2020, and RBI's lesser-than-expected dividend for FY22 might make the govt push the taxman to further augment revenues

Inflation is one of those things where the government is damned if it tries to do anything about it and damned if it does nothing. Between the RBI and the government, the economic policymakers have decided to be damned by doing, by not only hiking interest rates but now also cutting fuel taxes.

The question now is how are they going to navigate the repercussions as Finance Minister’s announcements on Saturday are likely to have a significant impact on government finances. 

It is unlikely that government will be able to meet its fiscal deficit target for the year without some drastic steps. Expenditure cuts seem inevitable because the cut in the excise duty on petrol and diesel, the government said, is expected to result in Rs 1 trillion of revenue foregone over the year. This comes on top of Rs 1.2 trillion of revenue the government is expected to forego due to the cuts on fuel tax made in November 2021. That’s Rs 2.2 trillion of budgeted revenue that will not come.

In addition, the finance minister announced that the fertiliser subsidy would be increased by Rs 1.1 trillion over and above the Rs 1.05 trillion already budgeted. 

And there are a number of smaller decisions, such as the additional LPG subsidy and various import duty reductions, that are sure to have a significant fiscal impact when taken together.

These announcements follow a few announcements and decisions that already were placing stress on government finances. 

The first is a trap of the government’s own making, namely the free food package it had announced in May 2020 and that has continued even now. Then in March 2022, it announced that the scheme would be extended till September 2022, which would take the total cost to Rs 3.4 trillion from the previous Rs 2.6 trillion.

These kinds of welfare schemes are very hard to roll back. Indeed, the BJP has already seen the political benefits of the scheme in the UP elections. It is unlikely to change that formula any time soon.

The second recent development was the RBI’s decision to transfer just Rs 30,307 crore as surplus to the government for the financial year ended March 2022, less than half of the Rs 73,948 crore budgeted by the government. 

Unless the government really squeezes the other state-owned entities for a larger surplus, this too will negatively impact the government’s finances.

There are two mitigating factors here. The first is the government has been pretty conservative in its tax revenue estimates and so is very likely to see actual tax revenues outperform estimates by a significant margin, despite the revenue being foregone due to the fuel tax cuts.

The second is that high inflation has also meant that the GST revenues are and will continue to be record-breaking. It’s a simple thing: With higher prices come higher tax collections. It’s not particularly a legitimate way to grow tax revenues, but it is what it is.

The issue with all these hits to revenue is that government will have to scramble somewhat to keep the fiscal deficit in line with its target for the year. One option is cutting down on expenditure, which it cannot do to any significant extent because government expenditure is the only engine of the economy that is reliably firing. The other option is to borrow more, which is now costlier thanks to the RBI’s actions.

What remains is pushing the taxman to further augment revenues, especially income tax. So expect income tax harassment to increase over the coming months.