Instead of taking ad-hoc measures, the first budget of the Modi 3.0 should develop a medium-term quantitative plan to raise additional tax resources over the next five years with a year-wise and government-level breakup to bridge the tax gap of 7% of GDP, said Arbind Modi, former CBDT Member and Senior Economist at the IMF. India should have a single GST rate of 12%, Modi told FE’s Prasanta Sahu. Edited excerpts.
How do you see the performance of the Indian tax system in the last decade or so?
The combined tax to GDP ratio in 2023-24 was around 18% compared with 16.7% in 2013-14. So, in the last 10 years, India’s tax to GDP has progressed by 1.3%. However, compared with the peak of 18.4% of GDP achieved in 2007-08, we have still not recovered from the revenue shock in the aftermath of the Global Financial Crisis in 2008-09.
Similarly, oil-linked tax revenues have increased marginally by 0.15% of GDP only during the last decade. But at 2.2%, it remains well below the peak of 2.9% in 2007-08. India needs to make greater progress on carbon tax while appropriately compensating the poor and the vulnerable through direct cash transfers.
Therefore, the quantitative outcome of our domestic resource mobilization effort has been modest despite significant tax policy and administration reforms. This is not adequate given our resource requirement and our potential.
What are the other areas of concern?
A worrying feature of our tax performance is the increase in the tax gap over the years since our tax potential has increased faster than the tax effort measured by the tax-GDP ratio. With an estimated tax potential of 25% of GDP for 2023-24 and tax-GDP ratio of 18%, the tax gap is around 7% of GDP as against 5.4% in 2017-18.
Another worrying feature is that the tax-GDP ratio for developed and manufacturing states like Andhra Pradesh, West Bengal, Punjab, Kerala, Telangana, Maharashtra, Tamil Nadu, Karnataka, Haryana and Gujarat, is significantly below the critical minimum of 15% of GDP required to provide necessary public services.
What do you look forward to in the upcoming budget?
The first year of the new political cycle is an opportunity for initiating tax reforms. There is no point in undertaking ad-hoc measures in the ensuing budget when another budget is due after six months. Such measures are generally not sustainable in terms of revenue productivity. The Central Government, in consultation with the States, should develop a medium-term quantitative plan to raise additional tax resources over the next five years with year-wise and Government-level breakup. This will substantially reduce the political risk of tax reforms and smoothen the process.
You were one of the key architects of the 2009 Direct Tax Code (DTC) and later Convenor of the Committee to rewrite the Income Tax Act in 2017-18. Both works have been implemented to some extent in recent years. Do we need a new Code now?
The present Income-tax law has become a complex piece of legislation losing its original character due to more than 3000 amendments over the last 60 years and thousands of court judgements. Today, the law is incomprehensible to any ordinary citizen and inconducive to voluntary and self-compliance. It is also extremely difficult for tax officers to keep abreast with frequent and large-scale changes. Therefore, there is a greater need for a new Code to codify the relevant judge-made laws and remove the redundant provisions imparting transparency and lowering compliance cost. It will also obviate the need for ad-hoc changes in the future.
The existing profit-based business tax regime is origin-based, favours debt, results in implicit taxation of investment and encourages cross-border profit-shifting. We cannot continue with this distorted regime and need to replace this with a destination-based cash flow tax (DBCFT) which will address the existing problems and improve India’s international competitiveness. This is essential to eliminate implicit taxation of investment and bias against exports.
What are the changes you would suggest on the personal income tax regime?
Tax reforms involve creating “winners” and “losers” with the former overwhelming the latter. The present policy of giving the option of a new tax regime sans deductions and an old tax regime with deductions is designed to create only “winners” resulting in significant revenue loss. The government should stick to the new tax regime which I think is the right way to go.
The PIT rate schedule should be reviewed to reduce the number of tax brackets to preferably two, but not more than three. Since the basic exemption is very high compared to international practice, the lowest rate may be increased from 5% to 15%.
Secondly, we should rationalize the tax treatment of savings by moving to an exempt-exempt-tax (EET) regime for new savings but grandfather existing savings.
You were part of the Arvind Subramanian Committee which suggested GST revenue neutral rate at 15.5%. Currently, the weighted average rate is 11.6%. Should GST rates be raised to boost revenues?
The current level of GST collections at 5.6% of GDP is at par with the collections in the pre-GST regime from the taxes subsumed in it. Therefore, the weighted average rate of 11.6% is the RNR rate. This vindicates the revenue-neutral rate of 12% recommended by the Task Force on GST set-up by the Thirteenth Finance Commission in 2009. It is obvious that the revenue neutral rate of 15.5% for collecting 5.6% of GDP in revenues, was an overestimate.
Ideally, if a 12% rate was applied to the entire consumption base without exemptions, the revenue yield would be 8.4% of GDP under full compliance. Since there is a gap of 2.8% of GDP, the focus should be on bridging this by eliminating the exemptions, converging to a single rate of 12% and reducing non-compliance. Therefore, I would not pitch for a rate higher than a single rate (or, weighted average rate) of 12%.
Will India benefit from the proposed OECD/G20 global tax agreement?
India is not expected to gain in terms of additional revenues from the new international tax architecture. Given the complexity, I would not give more than five years to this agreement before it collapses. We should see this as a Treaty of Versailles and prepare ourselves for the Bretton Woods! India should have pitched for a DBCFT regime instead.