Is there a wide gap between India’s political democracy and fiscal democracy? This year’s Economic Survey has a telling graph, a picture that speaks a thousand words. It shows that in Norway, for every 100 voters, there are 100 taxpayers. In India for every 100 voters, we have seven taxpayers. It is as if the voters form the government, and the taxpayers help fund it. Of course, these numbers are only for people who pay income taxes. The burden of indirect taxes is upon all of us. But is this fair?
Indirect taxes are regressive, don’t depend on the income or paying capacity of the payer, and ultimately hurt the poor disproportionately. The goods and services tax (GST) is an indirect tax, and its rates and average burden are expected to be even higher than what prevails now. Indirect taxes in the form of excise taxes have risen by almost 50% for two consecutive years. Tax on petrol itself is up by 150% since July 2014. It is time we confront the curse of the silently escalating indirect taxes in India.
That cannot be done unless we increase direct tax collection, and widen the net to cover more direct tax payers. Why are we so reluctant to take this initiative?
The recent data released on direct taxes pertaining to three years ago, shows taxes foregone on capital gains to be of the order of Rs54,000 crore. A senior official of the Central Board of Direct Taxes is on record as having said that tax loss due to abuse of capital gains tax exemption could be to the tune of Rs80,000 crore this fiscal year. This year’s budget was kind to the real estate sector, making capital gains on sale of real-estate-tax exempt after just two years, instead of three. In most developed economies, capital gains on sale of assets is taxed at 15%. If we want to keep these gains tax exempt, let’s at least have a uniform holding requirement of three years, across all asset classes.
Our generosity extends not just to capital gains, but to income tax payers as well. The minimum threshold below which no income tax is paid is Rs2.5 lakh. This is 250% of India’s per capita gross domestic product (GDP). That makes India one of the most generous exemptors in the world, as shown by Praveen Chakravarty in a recent piece, “Decoding India’s Low Tax Base Conundrum”, in Bloomberg Quint. In most countries, income tax becomes payable when your income is about one-half or one-fourth of the average income in your country. Indeed, in Russia, you pay income tax from the very first rouble that you earn. With such a generous exemption, is it any wonder that only 3% of Indians pay income tax?
This tax-paying class is so vociferous and politically active that the exemption slabs keep creeping up every year. What we probably need is a drastic reduction in the exemption slab; say, down to Rs1 lakh. Of course, the applicable rate in the lower slab should remain low.
Income tax payers have two pet peeves. One is that they say, why are you letting agriculture income go tax-free? Second, they say, when everyone is paying such steep taxes in the form of value-added taxes (VAT), excise and service taxes, why do you want to hike income taxes? Both these are misguided.
First, only 14% of national income is from the agriculture and allied sectors. Almost 95% of the farmers who own land have barely 2-hectare holdings. Even with very high productivity, they can make only a modest income, which if all taxed, will add possibly 1% of gross domestic product (GDP) to tax collections. This won’t even move the needle. Besides, this would need a constitutional amendment. What’s needed, instead, is to catch the crooks who go scot-free misrepresenting their income as coming from agriculture.
The second peeve is like mixing up cause and effect. We have high incidence of indirect taxes because we do so poorly on direct taxes. The former would reduce automatically, if direct tax collection improved substantially. So, arguing that we should simply abolish income taxes altogether, because we collect so little of it, is an absurd proposition which hides our basic failure. The root cause is our inability to shake off the tightening shackle of indirect taxes. Incidentally, indirect taxes also tend to be inefficient, as compared to direct taxes. Until VAT and GST came along, we had cascading taxes, tax on tax, adding to inefficiency. Even the current GST excludes real estate, electricity and petro-products, thus diminishing the offset of credit for tax paid on inputs, and thus retaining inefficiency. Direct taxes in contrast have no such drawback.
One silver lining is in the outcome of demonetisation. Next year, the Union budget expects national (nominal) income to go up by 12% but personal income-tax collection will rise by 25%. Indeed, in the first three quarters of this year, personal tax collection is up 34%. For the past two years, direct taxes have risen by 17% in each year, even though rates have stayed unchanged. That shows a healthy widening of the tax net. Post demonetisation and the surge in bank deposits, about 1.8 million people have received “Hello” letters from tax authorities because of suspiciously high deposits. Most of them will hopefully join the income-tax payers’ club.
India’s ratio of direct to indirect taxes is 1:2, which is exactly the opposite of most advanced economies. We need to urgently correct this skew, for the sake of efficiency, fairness and reducing inequality. Paying direct income tax from your pocket is to be seen as your membership fee for this robustly functioning democracy. That’s the way of reducing the wide gap between our political and fiscal democracy.
Ajit Ranade is chief economist at Aditya Birla Group.