The overdue release of data on income taxpayers last week by the Narendra Modi government once again throws light on a central but neglected problem in Indian political economy. Too few people pay taxes to fund an effective state that protects national security, administers justice, builds infrastructure and funds a social security net to protect people against sudden shocks to their income.
The numbers are revealing. Around 48 million people filed income tax returns in fiscal year 2015; the effective number is perhaps even less given the fact that many of them had zero tax liabilities. Now, compare the number of taxpayers with the 814 million people eligible to vote in the 2014 Lok Sabha election. This means that there is one taxpayer for every 16 voters—an asymmetry that has profound consequences for national policy.
The result has been a political system that quite naturally cares more about spending to buy votes rather than building a more effective tax system that will spur economic growth. Another way of putting it is that the social contract between the Indian people and the Indian state is seriously flawed. Anybody trying to understand the persistent deficit bias in the Indian fiscal policy should pay attention to this troublesome paradox.
Barely a million Indians admitted to having an annual income of more than Rs.10 lakh a year—a transparently incorrect number. There is massive domestic tax evasion that no political party wants to deal with. Even the current government would rather chase its tail trying to get black money stashed away abroad instead of cracking down on domestic tax evasion. Much of this has to do with the way political parties are funded as well as the cash that needs to be dispensed at every election.
There is some value in the observation that India has a very modest tax ratio because of its low level of income. It is silly to compare our ratio of tax to gross domestic product with what is common in Europe. The Indian numbers are also not comparable with those of smaller countries that are more unitary than us. India is not under-taxed, given the fact that a quarter of its people live on the brink of absolute poverty. Fine. But even that cannot explain away the shockingly low number of people who pay income tax.
Why should all this matter?
There are two issues here. First, the very same middle class that, depending on political preferences, is either calling for a strong state that can deal with threats to national security or for a redistributionist state that will fund lavish social security programmes, gives little thought to the very practical issue of where this money is going to come from. You could either describe such schizophrenic beliefs as hypocrisy or ignora-nce. This newspaper has always supported the mainstream view that tax revenues need to be increased by getting more people into the direct tax net rather than by increasing tax rates.
Second, the paucity of direct taxes means there is a dependence on indirect taxes that are considered to be regressive rather than progressive. They put a higher burden on the poor. One of the central attempts of the 1991 economic reforms was to make the Indian tax system more progressive by increasing the contribution of direct taxes in the total tax kitty. Few care to remember that our tax system was extremely regressive during the high noon of Indian socialism. The 1991 tax reforms have been partly successful in making the tax system more progressive, even though there has been a disturbing dependence on indirect taxes in recent months, as we had commented in these columns earlier (http://goo.gl/NzpfKn).
The Indian state is fiscally constrained thanks to inadequate direct tax collections. The solution is neither a sharp increase in tax rates nor a carefree disregard for fiscal imbalances. The way ahead has to be based on further tax reforms combined with better tax administration, so that more Indians pay income tax.
No nation-state built on tax evasion can be successful.
Should the government raise tax rates or broaden the tax net? Tell us at firstname.lastname@example.org