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Photo: Mint

Tap stock market wealth for a stimulus programme

A one-off tax on windfall gains from the current equity rally could help the government spend more

The current stock market rally is making a lot of people scratch their heads. Its exuberance contrasts sharply with the woeful state of the economy. Howard Silverblatt, senior index analyst at Standard and Poor’s Dow Jones Indices, said: “This market is nuts." The S&P 500 has risen by more than 50% from its March lows. The Nasdaq, which is dominated by technology stocks, is up 68%. Apple just crossed a market value of $2 trillion. A hedge fund called Universa secured a return of 4,331% in one quarter. This was presumably thanks to some clever bets on the steep market fall in March.The same giddy story is repeated in stock markets of London, Frankfurt, Tokyo and Mumbai. The BSE Sensex is up almost 50% in five and a half months. The governor of the Reserve Bank of India (RBI) has cautioned that the market is due for a correction, a rare comment by a governor. It was not meant to be a stock market tip, but an assurance to the financial system that RBI would stand by with liquidity support if the bubble burst. The irony may not have escaped him that it was probably the huge liquidity infusions carried out by central banks that were fuelling this incredible rally. Globally, central bank balance sheets have fattened themselves, much like in the aftermath of the 2008 financial crisis. Even RBI has pumped in more than 10 trillion since February to spur credit creation. However, much of this liquidity returns to it every night as surplus funds through its reverse repo window.

We don’t know if this rally will come to a halt or continue unabated. Monetary easing will continue, supporting asset price rallies. The liquidity seems to have spilled over to commodity markets too. Gold prices had touched an all-time high recently, before receding somewhat. Ordinarily, zooming gold prices imply risk aversion, as investors choose the yellow metal as a safe haven. But the high tide across the world is lifting all boats at the same time.

Meanwhile, news from the economy is dismal: a contraction in output and incomes, a steep rise in unemployment, and fiscal management under stress. Most governments around the world have unhesitatingly opened their fiscal taps to fund programmes like unemployment insurance, job furloughs, assistance to small businesses and even direct cash transfers to households. India too has injected the equivalent of 1% of its gross domestic product as fiscal stimulus, which has mostly helped the rural economy. This took the form of increased food and rations, direct cash transfers, high grain procurement at support prices, and a doubling of funds for India’s rural employment guarantee scheme, which acts as a form of unemployment insurance. More stimulus is expected, especially for industry, small businesses and the urban economy.

The challenge for finance minister Nirmala Sitharaman is to find the resources needed to fund the increased outlay. Short of monetizing the deficit (i.e. printing currency notes), there are only two options. Increase either taxes or borrowings (which is nothing but deferred taxes). There are suggestions like floating a special covid bond outside of the budgetary process, or selling sovereign bonds to foreigners. Both would raise the indebtedness of the government, which can trigger a rating downgrade. Another idea, described in this column (4 May, Mint) is to pledge government shares in public sector companies to RBI. Such a loan against shares can be structured as a five-year repo transaction, thus bypassing markets and averting a disruptive impact on interest rates. The loan-to-value ratio can be a full 100% and the rate of interest a modest 3%. Since a stimulus thus financed would help India’s growth prospects, it would also presumably prop up prices of the pledged stocks themselves. Hence, the resultant capital gains could help partially redeem the repo loan. It will be mutually beneficial to both the government and RBI. Indeed, the Centre should have pledged its shares before the current rally began, and helped itself perhaps to an extra 1 or 2 trillion.

The bigger question is how to tap the huge wealth being created in stock markets. Is it fair to eye this wealth as a way to fund the fiscal needs of the government? After all, the government needs resources for redistribution to those who have lost incomes and livelihoods, help small businesses tide over the crisis, and prevent destitution and starvation. Additionally, it’s now accepted that an ultra-loose monetary policy itself is causing equity wealth to zoom. In turn, it has worsened income inequality. That’s because the rewards of stock rallies tend to accrue to those in higher income brackets. The equity rally has been helped along by practices such as stock buybacks, which pump up price-to-earning ratios. In the past five years, American companies have used up $1 trillion every year to buy back their own shares.

Would a small tax on this windfall wealth be acceptable? Say, as an exceptional measure to help cope with a pandemic-stricken economy? One parallel to this is former US President Barack Obama’s 2008 suggestion of taxing the windfall profits of oil companies. This idea goes back to a tax imposed by the Jimmy Carter administration in the 1970s. Of course, that was a tax on windfall income, whereas the present idea is to tax windfall wealth. Operationalizing such a wealth tax may be tricky, but it is an idea worth pursuing. At the very least, we need to protect the current regime of capital gains tax, which was hard fought and won back after nearly 20 years.

Ajit Ranade is an economist and a senior fellow at The Takshashila Institution, an independent centre for research and education in public policy.

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