Given there is all round expectation of income tax relief to assuage the demonetisation pains of the people, FM Arun Jaitley may have already decided on lowering of the tax burden through some measures in the Budget to be presented on February 1. While doing so he would be bogged by the same problem that his predecessors have faced, to increase the tax-to-GDP ratio in India. While expectations are that the government would increase public spending to stimulate the economy, this cannot be achieved on a low-tax base, which has been mark of the Indian economy. In fact, India has one of the lowest tax-to-GDP ratios, with emerging market economies’ averaging 21% and OECD’s averaging 34%.
Recent data for the April-December period shows that direct collections have increased 12.1%, while indirect tax mop-up is up by 25%, this may help in achieving the goal of 10.8% this year, but it would still fall short of the 12% level. An analysis of Budget data highlights that the tax-GDP ratio has remained much the same since 1990s. It was just 9.9% in FY15, only 10 bps higher than what it was in FY91. In the case of central taxes, FY08 is the only year the share of taxes increased to 11.9%, but thereafter fell below the 11% threshold again. Now, according to the medium term fiscal statement even the government is projecting it to increase to 11.1% in FY19.
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While a large part of low compliance has to do with high taxes and low reporting, government’s efforts to reduce taxes have not created enough stir to increase India’s tax base. Consider the case of direct taxes, starting off from a low base the ratio increased from 1.88% in FY91 to 3.07 in FY98, when tax rates were reduced to the present 10, 20, 30% category. Then it started to rise again after FY01 with not much change till the government increased its exemption limit in FY07, which led to the highest tax-GDP ratio of 6.26% in FY08. But the ratio has been falling ever since despite the government increasing exemption limits. On the other hand, indirect tax to GDP ratio has fallen for most part since FY91. The ratio fell from 7.94% in FY91 to 5% in FY02, thereafter increasing to 5.79% in FY07. Since then, it has stayed below the 5.8% level.
This means that income tax relief will have to be blended with the additional tax measures, which can also come through extension of the tax base and increased tax compliance if the tax burden is lowered—on the indirect tax side, the implementation of GST will have to do the same for the tax kitty. Although with sluggish growth, the task may not be as easy even with the GST and income-tax push.