The government’s budget math faces a tax challenge

Invoking the analogy of an elephant that is satisfied with a small offering of rice and doesn’t trample upon the paddy fields, India’s new finance minister, Nirmala Sitharaman sought to allay fears of firms and investors who have increasingly complained of ‘tax terrorism’ in recent years.

“What the people will give in the form of tax, the government thinks that is enough; but if they don’t get that, then the government is not going to make the mistake of being the elephant and hurting the public; and the government also won’t get anything,” said Sitharaman in a post-budget interview. “We will do with what we have been able to collect as tax from the public.”

However, the assumptions underlying the revenue projections for the ongoing fiscal year have raised fears that the era of a rampaging tax bureaucracy may not be over yet.

Notwithstanding downward revisions to its tax estimates in the recent budget, the government continues to project an impressive 18% growth in tax revenue in 2019-20. If realized, it would be the fastest growth in tax revenue in a year since 2010-11. In other words, the government expects the gross tax-to-GDP ratio to climb to its highest level since the 2008 global financial crisis at a time when concerns of economic slowdown have intensified.

Given that last year’s (2018-19) gross tax revenue fell short by 8.4% of budget estimates, and the economy is not expected to recover sharply, meeting the tax targets will be a tough ask, raising fears that taxmen may put undue pressure on firms and businessmen to meet the stretched revenue targets.

The main reason for the tax shortfall last year was the shortfall in Centre’s GST collections, which was 22 percent lower than budgeted.

Given the track record till now, it remains uncertain if this year’s GST target would be met. The gross monthly GST collections (before refunds) fell just below the 1 trillion rupee-level in June. The April-June average for GST mop up has been Rs. 1.05 trillion, below the Rs. 1.12 trillion average estimated to be required to meet this year’s target.

For GST collections to improve, the government needs to fix the loopholes which have been often used for tax evasion. ‘Briefcase’ firms or fake companies have often been floated to issue fake invoices and fraudulently claim input tax credit. The multiple slabs and complicated rules also seem to be raising the scope for evasions.

The slowdown in economic activity and lacklustre investment spending pose further risks to the GST revenue target.

Despite aggressive tax mobilisation efforts, direct tax collections also grew slower than in earlier years mainly owing to the slowdown in personal income tax collections.

Thus, we might see a repeat of 2018-19, i.e., government resorting to expenditure cuts on the one hand and aggressive measures on the other hand to offset the revenue shortfall. The last quarter of 2018-19 witnessed increased incidents of the income tax department pursuing start-ups in relation to the much criticized ‘angel tax’. Nevertheless, the government’s efforts did lead to a rise in corporate tax revenues in 2018-19, which were 7 percent higher than budget estimates. The pattern could be repeated this year should GST collections falter. It would then dampen the positive sentiment generated by budget’s announcement to reduce the corporate tax rate from 30 percent to 25 percent for companies with turnover of up to ₹400 crore.

Another way for the government to compensate for inadequate GST has been to raise more money from cesses and surcharges. In the latest budget, the government has already increased the cess on petrol and diesel, while levying surcharge on top income earners.

However, increased reliance on cesses and surcharges is at odds with the spirit of fiscal federalism since the funds collected are not shared with states. Earlier governments also resorted to this method but the reliance on cesses and surcharges has grown sharply in recent years. There have also been attempts to rejig tax rates and corner more funds under such cesses. To illustrate, the 2018 budget had reduced the basic excise duty on petrol and diesel by ₹2 per litre and instead raised the road cess levied on petrol and diesel by the same amount. This year, the special additional excise duty and road cess on petrol and diesel have been raised by Re 1 per litre each, both of which will accrue exclusively to the Centre. The rising surcharges on the ‘super-rich’ may also tempt capital flight, a factor the government seems to have discounted.

Sitharaman’s reference to the elephant (which accepts a small offering) in her budget speech was promising. But the overambitious revenue projections and the ‘desperate’ proposals to meet those projections have raised serious concerns about India’s tax management once again.