El Dorado Of Tax On Service A Mirage

Written by Saumitra Chaudhury | Updated: Jun 28 2004, 05:34am hrs
With Budget Day approaching, matters of government finance come to the fore. Es-pecially when there exists a document, namely the Common Minimum Programme that contains specific numbers relating to the escalation of expenditures on the social sector. We previously highlighted as to how quite impossible it would be to generate the financial resources to fund even a part of the fiscal demands that are made by critical elements of the CMP. Namely doubling government expenditure on education and public health (4.5 percentage points of GDP) and less determinate, but substantial amounts, on fun-ding the proposed Employment Guarantee legislation and bridging the self-evident massive deficit in physical infrastructure. Last week, we noted how it is possible to generate more modest increments to central revenue; that viewing services as a source of massive revenue gain was misplaced optimism. And how it might be better to look for workable and collection-wise efficient solutions to put together any significant increases in tax revenues.

The discourse on tax reform, in the context of a revenue ratio of 20% of GDP (for consolidated government) and an expenditure ratio of 30% of GDP, has often been sought to be infused by the golden halo of the El Dorado that awaits. Services constitute more than half of GDP and while goods are taxed, services are not, so the argument runs. Only if services were to bear the burden of taxation, government revenues would soar, even more expenditure could be financed and the fiscal deficit would fade. While that part of human nature that nurtures hope, in the face of the greatest adversity, shaped the resilience of our species, this hope on occasion transcends into the realm of the merely wishful. As a genre of the miraculous, the legends of cities of gold, where even the dust on the street is of pure gold, predates the Conquistadors and El Dorado. It makes for great fables, but is a terrible guide to policy. However, there remains a sizeable constituency, which believes fable and clings to the provincial idea that there is a magic button out there that is just crying to be pressed for all the problems of governance to simply evaporate.

A part of the problem is the familiarity of many with GDP statistics presented by industry of origin and a corresponding lack of familiarity with the GDP statistics by expenditure. It is of course true that 51% of GDP in India originates from services. Just as it is true that 22% of GDP arises in agriculture and allied services. Does that mean that this mammoth 73% of the nations GDP bear no burden of the taxation regime

Of course it does not. Taxes are of two kinds those on income (and property) and those levied on expenditure (or consumption). Income, corporation, property taxes are levies on the income that arises. All indirect taxes excise, customs and sales taxes are levied on expenditure. It is true that the farmer does not pay taxes on his income or property (land revenue has largely been dispensed with), but he does buy manufactured goods and on that there is tax. In the service sector, taxes are levied not only on the income side, but also on the output side directly or indirectly. Directly, when there is an explicit provision of a services tax (as on telecommunication, insurance etc) and indirectly, when the service is of an intermediate nature and enters into the value of a product which is then taxed.

As a genre of the miraculous, the legends of cities of gold, where even the dust on the street is of pure gold, predates the Conquistadors and El Dorado. It makes for great fables, but is a terrible guide to policy
Economic activity is an inter-linked process which, through the institution of exchange (market) permits agents (you and me) to produce goods and services that then enter into the production of other goods and services by other agents. So your output is someone elses (say B) input and the cost is embedded in the value of what that B person produces. If your output is taxed, then if there are proper setoffs, then B will get the credit for the tax that you have paid and he will pay tax only on the incremental value added. If your output is not taxed, there are no setoffs, B will have to pay on the full value hence your output would be indirectly taxed.

In 2001-02 (for which year all the detailed numbers are available) the GDP (at current market prices) of India was Rs 231 lakh crore (ie, Rs 23 trillion). The value of output in the registered manufacturing sector was Rs 10.8 lakh crore and that in the unregistered sector was between Rs 4 and 5 lakh crore, say a total of Rs 15 lakh crore (trillion) in manufacturing. From mining, quarrying, electricity and gas came over Rs 1 lakh crore and the construction sector added a hefty Rs 3 lakh crore in terms of output value. That is, industry had a value of output of at least Rs 19 lakh crore, maybe Rs 20 lakh crore (trillion). That is about 85% of GDP, which includes the value of agricultural and services sector input into the activity of the industrial sector. And we, of course, know that industry attracts taxes in this country.

Is there any part of the service sector that is not taxed at the output stage (either directly or indirectly), as opposed to being taxed on the income side There indeed is private final consumption expenditure on services and the governments final consumption expenditure on services to the extent that there is no explicit service tax in operation. Private final consumption expenditure on services in 2001-02 was valued at Rs 4 lakh crore and that by government was in the range of Rs 1 lakh crore (net purchases by government is not readily disaggregated between goods and services). There is of course little point in government taxing itself, so we are left with the Rs 4 lakh crore (trillion) of private final consumption expenditure on services. Of this, Rs 1.5 lakh crore was spent on medical care and education. Over Rs 1.1 lakh crore was spent on purchasing transport services and Rs 0.15 lakh crore on communication. These four items account for Rs 2.8 lakh crore, leaving a balance of Rs 1.2 lakh crore (trillion) on personal services etc. Not much of an El Dorado, like always in the cold light of the day tis all a dream.

The author is economic advisor, ICRA