FE Editorial: Taxing tangle

Written by The Financial Express | Updated: May 31 2011, 08:47am hrs
With three think tanksNIPFP, NCAER and NIFM (National Institute of Financial Management)in the race to estimate the size of Indias black economy, various figures are once again doing the rounds. Theres NIPFPs original 21% of GDP estimate of 1985, Arun Kumars 35% in 1991 and Global Financial Integritys (GFI) 50% in 2008as compared to this estimated annual generation of black economy, GFI estimated the total stash of illicit assets held abroad is $462 billion. Its a bit like the estimates of the 2G scam, three or four by the CAG itself in one report and another by the CBI!

You need to be careful about the estimates, it is natural to confuse tax exemptions with tax evasion. Indias tax-to-GDP ratio hasnt gone up as dramatically as it should have after the 1991 reforms; as compared to 15.4% in 1990-91, it was just 16% in 2009-10, after rising to 17.6% in 2007-08. That is poor, but doesnt necessarily mean tax evasionadd the tax-exemptions of 7.2% of GDP that the budget papers give, and thats a tax-GDP ratio of 23.2%. Many think the tax-exemption number is overestimated. If you assume a figure of half, thats still a tax-GDP ratio of 19.6%. Keeping in mind agriculture income (16% of GDP) is not taxed, nor is the small scale sector (10% of GDP), thats an effective tax-GDP rate of 26.5%. Once you take into account the exemptions given for various services, railways and so on, the effective tax is much higherthis would suggest the 50% black economy estimates include large parts of the tax-exempt economy as well. The average tax-GDP ratio for China is 17% and 35% for OECDgenerally, the richer a country, the greater the formal sector, and the easier it is to tax it.

If you look at the individual components of taxation, corporate tax-GDP is up dramatically, from 1.7% of GDP in 2000-01 to an estimated 4% in 2011-12; excise duties are down from 3.3% to 1.8; service tax levies are just 0.9% of GDP, suggesting good potential, given that the sector accounts for 60% of GDP.

Amnesty schemes, the usual way to catch black money, are never quite the silver bullet they appear. The most successful amnesty, VDIS 1997, unearthed R33,697 crore (2.2% of that years GDP) of black money and gathered R9,729 crore of tax but the tax-GDP ratio fell after that year. The rise in corporate tax-GDP ratio suggests the way to tackle black money is to encourage formalisation of the economy (organised retail and radio-cabs, for instance, to replace kiranas and black-and-yellow taxicabs that dont pay taxes) as this is how tax-GDP ratios riseraising the tax-GDP ratio by just 0.1, from 16 right now, will fetch the R10,000 crore got from VDIS 1997, underscoring the point that raising tax-GDP ratios is a lot more critical in the fight against black money.