January 31, 2022
Tax when you want too spend
By Nitin Desai
TAX WHEN YOU WANT TO SPEND
Raise the tax-GDP ratio to finance rising revenue expenditure
The principal fiscal challenge that India faces is the stagnation in the tax GDP ratio for several decades. The tax revenue of the Union Government, after netting out the share of the States in collected taxes, was an average 7 percent in the five years ending in 1978–79 and also, four decades later, in the five years beginning in 2019-20. There were two periods when the ratio went up by about one percent—in the latter half of the eighties and during the boom years in the first decade of the new millennium. But basically the Union Government’s Net Tax Revenue to GDP ratio is stuck at around 7 percent. Adding the share of states to this net revenue number raises the Union Governments Tax/GDP ratio by 3-4 percent but does not alter the assessment about stagnation.
This stagnation in the net tax GDP ration of the Union Government has to be compared with the rise in the revenue expenditure to GDP ratio which went up from an average of 8.5 percent to 11 percent in the same two five year periods. This gap led to rising market borrowings and a doubling of Union Government’s interest burden as a percentage of GDP from 1.5 percent to 3 percent of GDP between these two five year periods. The burden was even higher at 4 percent during the nineties and the first decade of the first decade of this century and rose during the the two recent covid years to 3.5 percent of GDP.
At the same time the ratio of the Union Government’s capital expenditure to GDP declined from 6 percent to 1.7 percent. This meant that market borrowings were used to finance current expenditures. This is why the ratio of assets to the liabilities of the Union Government fell sharply from over 70 percent till the early nineties to an average of 44 percent in the five year period ending in 2019-20. One must also note that since the early nineties the Union Government has resorted to disinvestment of assets as a source of budgetary finance and the amount so mobilised amounted to 12 percent of the assets shown in the budget in 2020-21.
The shift in the Union Government’s spending towards current expenditure is partly a product of the fact that public enterprises now finance their investment not through budgetary support but through their own savings and direct access to the capital market. Besides this the public-private partnership strategy for infrastructure has raised the share of the private sector in this area of investment. That is why some reduction in the share of capital expenditure in public spending was inevitable. In addition there is a also a shift in development strategy to direct benefit schemes like MGNREGA that involve revenue expenditure.
The real issue for fiscal policy is not the shift of spending to the revenue account but how this spending is financed. For some three decades now the Union Government has financed a substantial part of revenue expenditure by increasing its liabilities and selling its assets. That is what fiscal policy needs to correct.
A fair degree of progress has been made in widening the reach of the income tax system. In 2018-19 55 million salaried individuals filed returns which seems a fair proportion of the 70 million non agricultural workers who are regular wage and salary earners. In the same year around 25 million non-corporate assessees declared a business income which should be compared to the figure of 63 million MSME enterprises, the vast majority being micro enterprises. Though there could be some room for identifying evaders, judging by the increase in the number of non-corporate assessees from 40 million in 2015-16 to 64 million in 2019-20 it seems some progress has been made in extending the reach of the income tax system. The focus now should perhaps be on linking the income tax data base and the 13 million who are in the GST data base to identify evaders.
The real issue is not the number of assessees but the coverage of the actual income received by the people liable to tax. Applying the available inequality data to non-agricultural income one can infer that in 2018-19 about 75 percent of this income accrued to one third of the earners in the non-agricultural sector and this one-third must have had per earner income exceeding Rs.4 lakhs, which would put them all in the taxable bracket. Even allowing for various concessions and toning down the very high estimate of high income group shares, it would appear that personal income tax collections as a percentage of non-agricultural income should be around 10 percent. In practice, the income tax collection in 2018-19 amounted to just 3.3 percent of non-agricultural income. This blatant underreporting of income is what needs to be addressed.
We also need to reexamine the plethora of tax-relief concessions to companies and individuals that are offered today. In 2018-19 the revenue foregone by these concessions amounted to Rs 2.1 trillion on corporate and income tax collections of Rs. 11.4 trillion. The Finance Minister moved on this route when the alternative of foregoing concessions and benefiting from lower rates was offered both for corporate and personal tax. But the choice was left to each assessee who would clearly opt for the option that led to lower tax liability. Hence offering a choice does not help. It simply reduces tax collection. The FM should now move towards the removal of tax-relief concessions and lower rates for all assessees, if necessary phased over a few years.
The tax rates should be rationalised across different categories of income. One glaring anomaly is in the different rates applicable to dividend income and capital gains on equity holdings, even though both come from the same source which is corporate also profits. Realised capital gains, suitably corrected for inflation and the costs of realisation, are as much a form of current income as salaries, business profits, interest and dividend earnings and should be treated as such.
Rationalisation and simplification of the direct tax system and a determined drive to double the income tax-GDP ratio over a few years should be a clearly articulated goal for fiscal policy. Let us hope we see a move in this direction in this year’s budget.