Cleaning up taxes

Govt must seize opportunity to reform holes in tax system

In the run-up to the Union Budget, the finance ministry must be wrestling with assumptions about tax collection and other forms of revenue. The problem is not just that the pandemic and associated lockdowns will have wreaked havoc on tax collection but also that there are considerably more calls on its purse than in a normal year. The basic problem is that tax revenue was not robust even before the pandemic hit. The years since the introduction of goods and services tax (GST) have not been good for indirect tax revenue — it is fair to say that GST has underperformed in terms of revenue. It is also true that various changes to direct taxes have not helped as much as they could have. The government must recognise that its constriction for revenue is a reflection of its own failure to increase the tax-to-gross domestic product ratio sufficiently in the past few years.

The fact is that this moment is an excellent opportunity, given the scale of the disruption and the low base, to properly restructure taxation. GST must be one priority, although of course it cannot be tackled through the Union Budget since it is a federal tax and the GST Council is the competent authority. Yet the government could at least give a clear signal of the direction that it intends to take GST in order to repair it. The original promise of the GST— an easy to pay, revenue-neutral, and simple, single tax — has been belied by the introduction of an excessive number of slabs and various forms of paperwork. Lobbying by various industries and sectors has caused this complexity to increase manifold. However, GST is supple enough in form to be easily reformed with the right political will. The priority must be to repair the holes in the tax that have prevented it from living up to its revenue-neutral and growth-enhancing potential.

Direct taxes also have been rendered somewhat threadbare by recent policy actions. For one, the promise to lower and simplify corporate income tax has not been adhered to in spirit. While the headline rate has been lowered, there continue to be exemptions of various sorts on offer, which reduce effective tax rates and narrow the tax base. And individual income tax covers too few Indians. India’s income tax threshold is Rs 5 lakh, which is more than three and a half times India’s per capita income. Few other countries have set their income tax threshold so high. Even for an income of Rs 15 lakh, which is more than 10 times the per capita income, the effective income tax rate is only about 13 per cent. This is far too low. It is hardly surprising, therefore, that the government has been running out of money. As economies develop and become more formalised, they have to increase their reliance on direct taxes, particularly income taxes. Unfortunately, India has not been working on doing so — and, in fact, in recent years has been going in the opposite direction, while attempting to raise cess only on the highest end taxpayers. This approach will consistently fail to raise enough revenue. The government must seize the opportunity provided by the current moment to restructure its approach to taxes.