Fiscal constraints

Govt must generate more tax revenue

The state of government finances is extremely vital in a developing country like India. If government finances are stretched, as is often the case, the state will be neither in a position to provide basic public goods nor able to make enough investment in capacity-enhancing infrastructure. Higher levels of deficit and debt can not only crowd out private investment but also create potential risks to financial stability. It is thus important that the state collect enough revenue to discharge its functions. While these broad issues are well known, governments, both at the Union and state levels, have not been able to respond effectively. Thus, against the given backdrop, remarks made at a recent event by Bibek Debroy, chairman of the Economic Advisory Council to the Prime Minister, need attention.

The implementation of goods and services tax (GST) was expected to give a boost to tax collection by reducing evasion and improving efficiency in the system. Although collection has improved in the recent period, the GST system has not performed as expected. As Dr Debroy noted, the government is losing revenue because of GST. He further said the ideal GST system was one with a single rate and it was meant to be revenue-neutral. According to the calculations made at the time of the introduction, the average rate should have been about 17 per cent, which is about 11.4 per cent today. GST rates were also reduced prematurely, largely owing to political reasons. Notably, the general government taxes subsumed in GST amounted to 6.3 per cent of gross domestic product (GDP) in 2016-17. Collection in 2022-23 was estimated at 6.6 per cent of GDP. It would have been lower if the compensation cess had not been extended under exceptional circumstances.

It is thus critical that the rate and slabs are rationalised at the earliest to at least take the average rate to the revenue-neutral level. Members of the GST Council, as Dr Debroy underscored, are willing to reduce the highest rate of 28 per cent, but they don’t want the lower rates to go up. Till these basic structural issues are addressed, the GST system will not perform to its potential, with implications for India’s fiscal position, which has become challenging after the pandemic. India’s general government debt, according to the International Monetary Fund’s projections, is expected to remain above 80 per cent of GDP at least till 2028. The general government Budget deficit is also expected to remain elevated. However, the overall fiscal condition will not improve quickly by fixing GST alone, though it must be a priority, and reforms would also be required in the area of direct taxes.

The government has done well to introduce an exemption-free income tax regime. The objective should be to bring as many taxpayers under it as possible. This will not only simplify the tax system but also increase compliance. Although the government has been working in this area, it must broaden the tax base. The Fifteenth Finance Commission, for instance, noted the difference between India’s potential and actual tax collection was worth 5 per cent of GDP. Policymakers must target closing this gap. That can significantly increase the government’s capacity to spend. Reforming the GST system thus can be an important part of the efforts to increase tax collection.