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Finance Minister Nirmala Sitharaman (Photo: Pradeep Gaur/Mint)
Finance Minister Nirmala Sitharaman (Photo: Pradeep Gaur/Mint)

Taxing times for the economy

Weak compliance, unresolved tax disputes and unrealistic tax targets threaten to hollow out India’s tax system

“When lots of people don’t pay tax or find ways not to pay tax, the burden comes on those who pay their taxes honestly. I want every Indian to introspect – do you accept this situation?" said Narendra Modi earlier this month. The Prime Minister’s appeal is a consequence of India’s slowing tax collections. In recent years, partly because of economic slowdown and partly because of changes to the tax system, India has struggled to raise taxes -- and this has severely constrained the government’s ability to reignite the economy.

India’s tax-to-GDP ratio, the universal measure for a state’s revenue-raising ability, for centre and states combined was 17.1% in 2018-19, lower than the average of its emerging market peers (20.9%). Crucially, India is more reliant on indirect taxes (taxes on spending) instead of direct taxes (taxes on income) compared to its peers. Since direct taxes are taxed on income, they are more progressive and hurt the poor less. But the direct tax share in India's tax collections has shrunk as overall tax revenues have fallen. The central government’s gross tax revenues, as a share of GDP, declined for the second successive year in fiscal 2020, according to revised budget estimates. This was also the biggest shortfall from budget estimates in the last 18 years.

Part of this shortfall is self-inflicted: the government’s cuts to the corporate tax rates meant that tax revenues estimates had to be revised down. But there is a chance that the government may miss even this revised tax collection estimate of 21.6 trillion rupees. Historical trends suggest that the government collects about 68% of the annual total collections by December. If this holds for the current fiscal, then tax collections this year are likely to be closer to 20 trillion, about 6% short of estimates. This would make it the 12th time in the last 19 years that the government’s actual tax collections fell short of its budget estimates.

Such overestimation of tax collections has not only compromised the credibility of the budget exercise but it is also straining the tax system. Tax officials, whose performance is linked to the realization of the revenue targets, are under pressure and this could be forcing them to demand more from taxpayers. One natural consequence of this is frequent tax disputes. Data from budget documents shows that total amount under tax disputes, as a percent of gross tax revenue, more than quadrupled from 11% in 2007-08 to 46% in 2018-19. Within this, the bulk of the disputes (39%) centre around personal income and corporate income tax issues.

To address this, the government has announced a new amnesty scheme “Vivad se Vishwas" , seeking to dispose of nearly 480,000 cases, involving disputed tax amounts of 9.32 trillion. But its impact is likely to be limited.

“Wherever people don’t have a very strong case, they would like to come forward and settle. But in genuine cases, where assessees typically have a higher chance of winning, people would not go for the amnesty scheme," said Amit Maheshwari, partner at Ashok Maheshwari and Associates, a tax consultancy firm. And statistics are not in favour of the government. According to a 2019 CAG audit report, an overwhelming majority of the cases in tribunals and courts are decided in favour of the assessees.“Also even if you settle for the pending cases, in future you may have the same issue being disputed by the tax authorities and again you may get into litigation. It is better to finish the litigation right now to set better precedence for next time", said Maheshwari.

Resolving these tax disputes, ultimately, is a stop-gap arrangement that will not address the structural issues within India’s tax system. For one, its tax base for direct taxes is too small. In his speech earlier this month, the Prime Minister claimed that only 1.5 crores Indians pay income tax. And though there has been sharp growth in the number of taxpayers in recent years (the annual growth in number of taxpayers doubled to 14% in fiscal 2018 from 7% in fiscal 2017), this is largely a reflection of a low base.

Not only does India have a narrow tax base, but its base is skewed towards the top income earners in both the personal income tax and corporate tax categories. Despite very few taxpayers falling in the top income brackets, nearly two-third of personal income taxes in the country were paid by the richest 5% in the assessment year 2018-19 (fiscal 2018), while about half of the total corporate taxes were paid by just the top 1% of companies. The overwhelming majority of tax filers fall under the zero tax liability bracket.


Rather than initiate systemic reforms to revamp the tax system, the government has largely resorted to aggressive tax demands and stop-gap measures. The introduction of Goods and Services Tax was meant to be one structural reform but even that has been plagued by implementation issues. Until all this is addressed, India’s ability to raise much-needed revenues will remain constrained.

This is the third of a 10-part series on the 2020 Budget.

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