Home / Economy / What drove income tax collections growth in the pandemic year

NEW DELHI: India’s total tax revenues in the financial year that ended on 31 March touched an estimated 27.17 trillion, surpassing the revised estimates for that year presented in the 1 February budget by 3.1 trillion. The overall collections are about 17% higher than in 2020-2021, driven by a 22% growth in direct taxes comprising corporate and income tax.  What has driven direct tax collections, and is the pace of growth durable or a flash in the pan?

One, the base effect has helped, as the pandemic had sharply dented tax revenues in the previous year. The direct tax to GDP ratio fell to its lowest in 14 years, at 4.8% in 2020-21. To support consumption, which suffered during the first-wave covid-19 lockdowns in 2020, the tax department had swiftly processed and released tax refunds, in many cases within days. Therefore, the net direct tax collections for the previous year were depressed on that account too. Refunds aggregating 2.5 trillion were paid.

Two, the financial performance of companies has improved. Sales and profitability picked up on account of pent-up demand and cost-cutting during the pandemic, which resulted in a higher tax payout. And so, marquee companies, oil PSUs (public sector units) and banks paid more in the fourth instalment of advance taxes that were due on 15 March. Cumulative advance tax collections stood at over 6.82 trillion, up 38% from the 4.94 trillion collected in the corresponding period of 2020-21.

The Reserve Bank of India’s (RBI) surveys on business expectations also forecast an improvement in profit margins for companies; It noted that manufacturers perceive sequential improvements in production volume, order books, capacity utilization, employment and overall business situation till the first quarter of FY23. However, the surveys also showed strain from rising input costs. The Russia-Ukraine conflict will further add to this strain. While sectors such as IT, pharma and metals have fared well, others like hospitality, capital goods and automobiles are not out of the woods yet. This may reflect in the collections going forward.

Three, the acceleration in digital payments resulted in business and trade shifting away from cash to channels, such as banks, that are more easily traceable by tax collectors, leading to reduced tax evasion, helping collections in both direct and indirect taxes grow. With the goods and services tax (GST) compliance improving, tracking how much GST a company has paid, and for how much actual value added by it has become easier. Using the tax system’s data analytics, this data can now be correlated with what the company claims as its expenses. The department can thus check whether a company has declared its income correctly and assess its tax liability more accurately. A chunk of the increase in collections is likely to have come out of tax evasion getting plugged this way.

Finally, a pick-up in hiring by tech companies on higher salaries is also reported to be shoring up personal income tax collections.

The tax to GDP ratio touched 11.7%, the highest since 1999 when the tax to GDP ratio was 10.3%. The gross tax revenue buoyancy is a measure of the responsiveness of tax revenues to growth in nominal GDP. It was 1.9 in FY22, with direct tax buoyancy at 2.8 and indirect tax buoyancy at 1.1. What this improvement tells us is that per rupee of GDP more tax was paid.

Is this growth sustainable? The government has budgeted gross tax revenues to grow by 10% in FY23 over the revised estimates for the previous year. It has budgeted for a 13.6% increase in collections from direct taxes and 5.6% from indirect taxes. The gross tax revenue buoyancy is at 0.9 – direct and indirect tax buoyancies have been budgeted at 1.2 and 0.5. Further, the budget estimate of the tax to GDP ratio in FY23 is 10.7%. That is way too low for a country as large as India and more conservative than the actual FY22 figure. The excessively optimistic budget estimates in the recent past drawing criticism have made the government conservative probably. Or, perhaps, it does not see the momentum in collections sustaining, with the base effect no longer favourable and the one-time gains of digitalization not durable. Revenue secretary Tarun Bajaj has said while talking about the collections, that getting such high figures of buoyancy will not be easy for now.

Given India’s pressing developmental expenditure needs, and the fact that the tax-GDP ratio is much more modest than the OECD average, the goal should be to double it. Ultimately, the only durable way tax collections can improve is when more and more Indians need to spend more, while companies invest more to expand production and sales. For that, the economy will have to recover from the shock of the pandemic and the weakness preceding it. In the meanwhile, mining of GST data is beginning to look like a promising way to track so-far undeclared incomes and reduce tax evasion. If the audit trail thrown up by the GST in the income and production chain is diligently mined to tap into both the indirect and direct tax potential, the tax GDP ratio will improve considerably.

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