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 of 7 per cent in the five years ending in 1978–79 and also, four decades later, in the five years ending in 2019-20(1). There were two periods when the ratio went up by about 1 per cent — 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 per cent. Adding the share of the states to this net revenue number raises the Union government’s tax-GDP ratio by 3-4 per cent, but does not alter the assessment about stagnation.

This stagnation in the net tax-GDP ratio 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 per cent to 11 per cent in the same two five-year periods. This gap led to rising market borrowings and a doubling of the Union government’s interest burden as a percentage of GDP from 1.5 per cent to 3 per cent between these two five-year periods. The burden was even higher, at 4 per cent, during the nineties and the first decade of this century, and rose during the two recent Covid years to 3.5 per cent of GDP.

At the same time, the ratio of the Union government’s capital expenditure-to-GDP ratio declined from 6 per cent to 1.7 per cent. This meant that market borrowings were used to finance current expenditures. This is why the ratio of assets-to-liabilities of the Union government fell sharply from over 70 per cent till the early nineties to an average of 44 per cent 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 per cent 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 also a shift in development strategy to direct benefit schemes like the Mahatma Gandhi National Rural Employment Guarantee Act that involve revenue expenditure. 

Illustration: Ajay Mohanty

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 micro, small and medium 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 database and the 13 million who are in the goods and services tax database 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 per cent of this income was accrued to one-third of the earners in the non-agricultural sector, and this one-third must have had per earner income exceeding Rs 5 lakh, 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 per cent. In practice, the income tax collection in 2018-19 amounted to just 3.3 per cent 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 (FM) 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 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.

(1) Data for the Covid year 2020-21 has not been used in these calculations

nitin-desai@hotmail.com