A case for widening the tax base

As India awaits a vote-on-account Budget, there is a possibility that it may end up being a full-fledged one. T

he ruling party’s loss in the recent State elections stokes concerns that the gap between the targets set for FY19 and the final tally could widen.

In May 2016, the government set up a Committee to review the FRBM Act. The Committee recommended that the government should target a fiscal deficit of 3 per cent of the GDP by 2020, cut it to 2.8 per cent in 2021 and to 2.5 per cent by 2023.

While the expenditure largely remained on course till November 2018, subdued tax receipts would be inflating the fiscal deficit for FY19. With populist measures on cards, the expenditure in the remaining months is anticipated to go beyond the Budget estimates.

The latest available data show that the government has touched a fiscal deficit of 114.8 per cent of the full-year estimates by the first eight months of the financial year. India’s fiscal deficit was ₹5.9 lakh crore, or 3.5 per cent of the GDP, in 2017-18.

In the last 10 years, while the absolute volume of Central tax collection increased by 3 per cent, the share of direct tax collection declined by 3 per cent, which has been compensated by the rise in indirect taxes.

Direct taxes are seen as a more equitable form of garnering revenue than the indirect taxes which are considered regressive.

GST which has been falling short of target would perhaps mitigate this anomaly over a period of time. It may be noted that within the indirect taxes, excise duty collections surged at the fastest pace by 80 per cent. This is partly because of excise on crude, which saw multiple increases since 2014 to shore up the revenue at a time when international crude oil prices were falling.

The average direct tax collection since FY09 has been around 55 per cent of the total tax collections — FY10 showing the highest at 61 per cent. In FY18 it stood at 52 per cent.

The corporate tax collection has taken a beating — its share in direct tax fell from 63 per cent in FY09 to 56 per cent in FY18. However, the personal income tax which is considered as a secured source has seen a healthy rise from 35 per cent to 41 per cent during the same period as the number of taxpayers under the direct tax net increased in the last 10 years.

Tax-GDP ratio

The tax-to-GDP ratio has not been impressive for India. Ideally with increase in GDP, the tax collection should also increase. If the economy is growing and business is doing well, naturally, profits will be better and therefore taxes should also be higher.

In India’s case while the overall tax-to-GDP (Centre and State) increased from 17.45 per cent in FY08 to 17.82 per cent in FY17, the GDP and per capita income have doubled during this period.

Interestingly, India’s rate of growth of tax revenues was not in sync with its GDP growth in the post-reforms period.

In fact South Africa’s tax-GDP figures are much better despite its lower GDP per capita and GDP in absolute terms compared with India since 1991.

India’s GDP per capita in terms of purchasing power parity and GDP in absolute terms have both increased by six times during 1991 and 2017, whereas in the case of South Africa they have just doubled in the same period.

However, the overall tax-to-GDP as it stands for India it is 17.82 per cent and South Africa it is 27.11 per cent.

India must aim to double its tax-to-GDP ratio to achieve the OECD average of about 34 per cent.

The tax-to-GDP for some of the other emerging market economies like Namibia, Mozambique, and Chile stands at 28.53 per cent, 20.1 per cent, and 28.53 per cent respectively. In fact the tax-to-GDP of neighbouring Nepal is also an impressive 21.3 per cent.

The way ahead

India has had a comparatively low tax-to-GDP ratio largely due to low direct tax base and an unorganised sector. Direct tax which is easier to consolidate upon in the entire tax collection given that it primarily involves personal income tax and corporation tax, is more sensitive to GDP growth rate.

While the direct tax-to-GDP ratio has grown at an average of 5.67 per cent in the last 10 years, real GDP has grown by 7.78 per cent during the same period — this anomaly needs to be corrected. While the direct tax-to-GDP touched its highest at 6 per cent in FY18, the need is to push this ratio up to create more fiscal space. More people need to be brought into the tax bracket.

The Kelkar Committee report mentions the ‘missing middle’, which includes professionals (like CAs, lawyers, and doctors), which manages a leeway to report actual income.

Also tax exemptions to agricultural income need to be plugged smartly. If the efforts to widen the tax base succeed, it could also open up the possibility of lowering tax rates and cesses imposed. Today, that burden is disproportionately shared by honest tax payers.

With increasing fiscal pressures, the scope for reducing corporate tax is limited. Also the trend in GST collections is unclear for now.

With rise in income levels amongst the salaried classes, the tax slab requires a revision. It is a fact that many qualified individuals today directly start their career at the highest 30 per cent tax bracket, that is, at ₹10 lakh. However, their growth in consequent years may not be substantial.

The government can widen the 20 per cent tax slab beyond ₹10 lakh to give relief to such tax-payers and increase their disposable income, or possibly slice the 30 per cent tax slab into two categories.

Considering the rising cost of living, the government could consider doubling the cap of permissible deductions to around ₹4 lakh, to encourage individuals to save more towards their retirement.

Simultaneously the limits on government saving instruments like PPF, NSC, etc. under section 80 (c) could be increased. Additional deposits into these schemes could help the government garner more resources for long-term projects.

The author is an Economist with EXIM Bank, India. Views expressed are personal.

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