Rising share of indirect taxes a step back to regressive era

Direct taxes are more equitable as rates are decided on the basis of income, but poor compliance may be affecting collections


Graphic: Ajay Negi/Mint
Graphic: Ajay Negi/Mint

Indirect taxes as a proportion of total taxes have begun to increase since 2009-10, after falling in the years before that, especially post-liberalization. The chart alongside shows that after hitting a low of 39% in 2009-10, the share of indirect taxes has increased to 45% in fiscal year 2016. Ideally, one would like their contribution to trend lower, as these taxes hit the rich and poor alike as they are a tax on consumption.

Direct taxes are more equitable as rates are decided on the basis of income, but poor compliance may be affecting collections, partly explaining why the government is pursuing tax evaders.

Taxes levied on income, property, wealth and capital gains form a part of direct taxes. Indirect taxes refer to excise, sales tax and service tax. Major changes are in the offing which may affect their proportion in the coming years. The introduction of a goods and services tax (GST) in FY18 is a key reform, but its impact on tax revenues is uncertain.

One way of lowering the burden of indirect taxes is to lower the rates itself. Over the years, contribution from service tax has increased both due to higher rates and an increase in coverage of taxable services. Also, FY15 and FY16 have seen a significant increase in the share of the petroleum sector in indirect taxes, due to higher duties on fuels, rising from 21.4% in FY14 to 23.3% in FY15 and 32.4% in FY16.

According to experts, reliance on indirect taxes will continue as long as it remains easier to collect compared to direct taxes. The GST reform’s aim is also to improve collections, after all. There are expectations that the service tax rate could be hiked in the budget, from 15% to 16.5%, in preparation for the GST regime, when it is expected to increase to 18%.

The government is expected to announce a moderation in income-tax rates in the forthcoming budget but with a pruned list of exemptions, hoping to improve compliance and collections on the direct tax front. Meanwhile, it will continue to wield the stick against those with unaccounted income.

Ideally, the government would like both indirect and direct tax revenues to increase but with a greater contribution from direct taxes. The key tax reforms being undertaken now will have a significant influence on the ratio between the two taxes in the coming years.

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