The mega Air India order which sent ripples across the globe is quite significant on many fronts. But most important is that it marks the entry of India as the world’s most significant consumer. This has been made possible by the demographic advantage we enjoy.

India has overtaken China as the most populous country recently. According to OECD, quarter of our population is less than 15 years old which makes us a very youthful nation indeed. Share of elderly population is among the lowest and fertility rates are high. The steady upward trend in working age population is particularly noteworthy as it gives us a definitive edge over our peers and can help drive growth in the coming years.  

India is in a sweet spot in this parameter with this age cohort steadily increasing its share from 55 per cent in 1970 to 67.5 per cent by 2021. The trend line for this metric is however sloping down for most countries including China, over the last decade.

There are many broader policy implications that arise – harnessing this workforce effectively to contribute to GDP, providing them the right skill training, providing jobs, social security etc. But growing work force should also result in increase in income tax revenue. Why is that not happening? Why is the income tax base so narrow and what can be done to remedy this.?

A large portion of workforce employed in the unorganised or informal sector is one of the reasons why fewer people are filing tax returns. Drive towards formalisation of economy and identifying high income earners in the informal sector can perhaps help increase the number of income tax payers.

Why the low tax base

The low base of income tax payers has been debated and discussed about quite often in the past. Recently, in a reply to a question posted in the Lok Sabha by Mahua Moitra, the Finance Ministry had revealed that the number of people who filed income tax returns stood at 6.8 crore in 2020-21.

This means that only 4.8 per cent of the total population filed IT returns in 2021. Of these, only 1.69 crore paid tax since 65 per cent of the taxpayers earned less than ₹5 lakh. So effectively, only 1.2 per cent of the population pays income tax as of now.

But there are reasons why the number of taxpayers is low in the country. Of the total population of 140.76 crore in 2021 according to World Bank, only 95 crore people were in the working age group of 18 to 64 years. Now, not all those in the working age are employed. Many women, for instance are home-makers or care-givers and may not be in the working cohort. The worker population ratio in India is 44.5 per cent, which means that only 42 crore people could be employed in some way or the other in India.

Further, a dominant portion of India’s workforce in employed in agriculture and agri income is exempt under income tax. This results in 45.6 per cent of agri-workers not filing tax returns. So, only 23 crore of the workers in the non-agri segment are liable to pay tax.

Besides these, the tax incidence arises only if the income is above a certain threshold. If we account for people earning under ₹5 lakh per annum, that is likely to whittle down the tax payer base further. According to Statista, 67 per cent of Indian households had annual income under ₹6 lakh in 2021. This reduces potential income taxpayers to 7.6 crore.

Given these factors, the current run-rate of IT return filing between 6.5 and 7.5 crore is not low. But how to harness the increasing working age population and take this number higher?

Increasing the tax base

A low-hanging fruit is the agricultural income and many have also been advising the government to bring it in to the tax net. But this happens to be a political hot potato and action on that front is unlikely. There are however two other means through which the number of income tax return filers can be increased.

One, through increasing the formalisation of the economy.  According to a paper, ‘Measuring Informal Economy in India_ Indian experience’, by SV Ramana Murthy, of the total workforce in 2017-18, 90.7 per cent was employed by the informal sector. The report says that besides agriculture, some sectors such as construction, trade, restaurants, communication and other services too have over three-fourth of the entities operating in the informal sector. Bringing such businesses in to the formal sector could help direct tax collections.  

This can be done with some help from the GST system. One of the objectives of the GST regime in its original form was to nudge those in the unorganised sector to shift to the formal sector and file GST returns in order to avail input tax credits or to continue supplying to larger buyers.

But leeway provided in the initial phase, such as doing away with invoice matching, dropping reverse charge mechanism etc have diluted this objective. With the GST system now having settled down, implementation of these self-policing mechanisms rigorously could help increase the formal economy.

Collecting tax at source for purchase of certain goods and services is another way to identify those who earn a tidy sum every year but are not paying any taxes. As of now, TCS is collected for high value goods such as expensive motor vehicles, gold jewellery or overseas remittances. The ambit of TCS can be expanded to consumer durables, domestic luxury travel, stays in expensive hotels etc. This can help identify those operating in the informal sector and earning high income, yet evading tax. While this could hit honest taxpayers, they can reclaim the tax in their annual return based on the form 26AS.