BackState-level trends underline India’s growth imperative
Revenues are better raised by enabling growth than through a zealous pursuit of taxpayers
PremiumA 1% economic growth results in nearly 2% growth in income tax revenues. This is the finding of an analysis of income tax and gross domestic product (GDP) data of Indian states from 2012 to 2018. A second finding is that there is a direct correlation between high economic growth and the ease of doing business. The latter is based on an analysis of the Ease of Doing Business (EDB) rankings of states’ GDP between 2015 and 2020. These findings are not surprising, but they confirm what many have long believed. One, states that focus on growth are quickly rewarded through higher tax revenues. Two, the tax department should not focus on negative things—penalties, prosecution, surveys and other coercive methods to raise revenue. It will be rewarded if it is fair and friendly to the taxpayer. States with a business-friendly environment that allow businesses to function without wasting their time on cumbersome regulations benefit hugely.
The three databases of state-wise GDP, income tax collections, and the ease of doing business present an intricate picture. Together, they seem to show that the Indian economy mirrors Indian society in myriad ways. It is not one homogenous whole, but an amalgam of the economies of different states and regions of the country, all moving along different growth trajectories. This story of plurality is well reflected both in the annual income-tax revenue collections of different states and their EDB rankings.
The GDP of a state in India is referred to as GSDP, or gross state domestic product. This is the value of all goods and services annually produced in a state. For the country as a whole, this stood at 7.1%; after excluding the North-East, it varied from 10% in Gujarat to 5.1% in Puducherry.
Income-tax revenues, on the other hand, grew at an average annual growth rate of 13.19%. After removing some aberrations, the rates in most of the states varied between 18.27% in Jharkhand and 6.16% in Assam.
Some of the newer states have done well. Haryana, carved out of Punjab, and Uttarakhand out of Uttar Pradesh, have recorded impressive annual income-tax growth rates of 14.77% and 15.09% (national average: 13.19%). The GSDP of these two states during 2011-12 to 2017-18 at 8.54% and 7.8% was higher than the national average of 7.1%. Small can be beautiful.
Largely because of the pre-eminence of Mumbai, Maharashtra dominated the ratings throughout the period, with revenue and GSDP growth rates of 13.69% and 7.2%. Currently, it tops the league of highest revenue generators (Maharashtra, Delhi and Karnataka). It speaks volumes of the city that despite its severe shortage of living and office space as well as physical infrastructure, it continues to dominate India’s commercial landscape. In 2017-18, largely because of Mumbai, Maharashtra raised 2.81 times the revenue of Delhi, as compared to 2.59 times in 2011-12.
In sharp contrast stands West Bengal. Throughout the greater part of the 20th century and even earlier, till the early 1960s, Kolkata was the country’s premier centre of business and the main contributor to the revenues collected by the income tax department, comparable to what Mumbai is today. Thirty-five years of Left rule have reduced the state to a shadow of its former self. Today nationally, West Bengal has slid to the 7th position in terms of the revenue it collects. Its GSDP and revenue growth rates, at 5.37% and 11.54%, are both lower than the national average. Karnataka, Tamil Nadu, Delhi and Gujarat have all done much better.
The performance of Punjab, the most prosperous state in the country not so long ago, has again been disappointing. Its economy grew by 5.88% and income tax revenues by 10.85%, both far below the national average. Poorly directed subsidies to farmers by way of free power and water have badly strained the state’s finances and harmed agricultural land, leaving very little money for other development activities.
Four main conclusions emerge from this analysis of the two sets of data when they are read together. Since tax buoyancy across states is generally very high (revenue growth is on an average about twice the rate of economic growth), to raise greater revenue, the state and central governments may in the long run focus mostly on improving economic growth. Revenue growth will follow ipso facto.
Second, the GSDP data used in this study also appears to have a linkage with the EDB rankings of the Department for Promotion of Industry and Internal Trade. Generally, states with high rankings on this table—Madhya Pradesh, Telangana, Andhra Pradesh, Gujarat—reduced discretionary controls and healthy economic and revenue growth followed. The policy implications of this result are obvious.
Third, in the latest rankings, India ranks at a lowly No. 121 on the payment of taxes in the World Bank’s EDB rankings for 2019. This is a major impediment to its breaking into the top 50 club in the overall EDB rankings, where India’s current position is 63rd. To improve on this chart, India’s tax department could show greater zeal in promoting voluntary compliance and less of it in punishing the procedural lapses of ordinary taxpayers.
Finally, in a land of subcontinental proportions, making policies and setting targets top down for the country as a whole is bound to result in distortions. Decision-makers will achieve better results if their targets for officers are sensitive to local conditions.
Hardayal Singh is former chief commissioner of Income tax
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