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Tax reforms, not coercion, will boost revenues

In the first four years of UPA-I, the direct tax-to-GDP ratio improved from 3.8%. Photo: iStockPremium
In the first four years of UPA-I, the direct tax-to-GDP ratio improved from 3.8%. Photo: iStock

  • First four years of UPA-I saw faster growth in direct tax-to-GDP ratio than the first four years of the Modi regime, despite the absence of comparable aggressive measures
  • Only around 7.4% of adults (aged 15 years and above) in India file or pay income tax

About 73% of India’s startups have received ‘angel tax’ notices, reported Quartz, citing a survey of more than 2,500 startups and entrepreneurs. While the government has indicated that it is working to resolve the issue, the taxman’s efforts to tax investments by ‘angel’ or early-stage investors has already dented sentiment.

Perhaps, the government’s enthusiasm to serve angel-tax notices is influenced by its need to plug the shortfall in goods and services tax (GST) collections.

Despite aggressive measures such as demonetization and GST, the Modi government is not faring much better than its predecessors when it comes to raising tax revenues.

India’s recent economic history offers enough evidence to show that tax revenues can be raised even without a rampaging tax bureaucracy or ad-hoc measures such as demonetization.

India’s tax-to-GDP (gross domestic product) ratio improved significantly in the period between 2003-04 and 2007-08 simply because of higher growth and tax reforms.

The creation of the tax information network, raising the service tax base, and replacing states’ service tax with value-added tax (VAT) helped boost tax revenues, wrote M. Govinda Rao, an economist and a public finance expert, in a 2015 paper.

Many of these reforms had beginnings under the Vajpayee government, which were subsequently undertaken by the United Progressive Alliance (UPA) government that succeeded it.

In the first four years of UPA-I (2004-05 to 2007-08), the direct tax-to-GDP ratio improved from 3.8% in 2003-04 to 6.3% in 2007-08. This was led by an improvement in both personal income tax and corporate income tax collections. In contrast, the improvement in the direct tax-to-GDP ratio in the first four years of Modi government has been modest: it has increased from 5.6% in 2013-14 to 6.0% of GDP in 2017-18.

In fact, India’s experience since 1991-92 shows that a steady increase in direct tax revenue has been achieved without any aggressive tax-related measures, and despite a decline in marginal tax rates.

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Rise in corporate income tax revenues over the years has also been fuelled by the emergence of capital markets as an important source of funds, which induced corporates to truthfully declare their profits.

So far, there is little evidence to suggest that measures such as demonetization have led to any sustained increase in either the tax base or tax collections although demonetization and the income disclosure scheme launched prior to that may have contributed to a one-time spurt in direct tax collections.

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The obsession with raising taxes has often been justified by the fact that India collects less taxes as a share of its national income compared to several other large economies. However, compared to other economies at a similar stage of development, India’s tax-GDP ratio appears respectable, as a previous Plain Facts column had highlighted.

India’s corporate tax collections seem quite in line with other large emerging markets. However, India does seem to fare relatively worse when it comes to personal income taxes and property taxes.


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India’s personal income tax base also seems to be relatively smaller compared to developing economies at a similar stage of development as India, suggesting that the tax structure is relatively more skewed in the country, with the burden of taxes being imposed on a small minority.

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Only around 7.4% of adults (aged 15 years and above) in India file or pay income tax. This is much lower than comparable countries with similar per capita income, such as the Philippines (26%) and Vietnam (58%). However, as a percentage of GDP, India’s personal income tax collections exceed both these countries. Thus, a small share of population continues to pay a large part of personal income tax in India.

And this skewness has not changed much in recent years, despite claims by policymakers that the tax base has been widened.

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Thus, efforts need to be directed towards widening the tax base in a systematic manner rather than trying to extract more from existing taxpayers. Creating a stable tax regime, encouraging entrepreneurial activity—which would raise incomes and tax revenues—and simplifying India’s complicated tax system are likely to be more effective in widening and deepening the tax base than ad-hoc policy measures.

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