‘Forced formalisation behind the surge in tax collections’

September 20, 2021 4:50 AM

India’s informal sector accounts for about a half of its GDP but employs as much as 80% of its workforce, according to an HSBC estimate.

Similarly, a shift in wealth distribution away from the poor and the lower-middle class to the upper-middle class or the rich boosts income tax mop-up because the tax regime is usually progressive.Similarly, a shift in wealth distribution away from the poor and the lower-middle class to the upper-middle class or the rich boosts income tax mop-up because the tax regime is usually progressive.

By Banikinkar Pattanayak, Rajesh Ravi & Nayan Dave

A robust tax collection in recent months has lent some credence to the notion that the expansion of the formal sector of the economy, which got a leg-up from demonetisation and the GST rollout, has gathered steam with the Covid-19 outbreak.

Gross tax revenue in the first quarter of this fiscal shot up by an impressive 33% even over the same period in FY20 (before the pandemic struck). In stark contrast, nominal GDP in the June quarter grew only 2.4% from the pre-pandemic level.

Industry executives in some of the labour-intensive sectors FE spoke to lamented that the formalisation may have been a “forced” process, driven mostly by the Covid-induced extinction of several unorganised sector entities, rather than an organic one. This has led to greater consumer reliance on the formal sector, even though overall consumption demand remains sticky due to large-scale income losses.

This seemingly-accelerated shift towards formalisation, coupled with cost-cutting by India Inc, have boosted the profitability of large companies, leading to strong growth in the corporation tax collection. The GST mop-up, too, has remained robust in recent months, barring the aberration in June (for business transactions in May) when the second wave peaked.

India’s informal sector accounts for about a half of its GDP but employs as much as 80% of its workforce, according to an HSBC estimate. Unsurprisingly, private final consumption expenditure shrank 11.9% in real and 2.7% in nominal terms in the June quarter from the pre-pandemic levels.

Pronab Sen, noted economist and former chairman of the National Statistical Commission, said the spurt in tax collection has been driven by both “forced” formalisation and a change in the composition of consumption in the aftermath of the pandemic. When income inequality grows and wealth gets redistributed in favour of the more privileged, the broader private consumption gets a jolt. But the consumption pattern gravitates more towards discretionary items, including luxury goods (which attract higher GST rates) than the essentials, Sen explained.

Similarly, a shift in wealth distribution away from the poor and the lower-middle class to the upper-middle class or the rich boosts income tax mop-up because the tax regime is usually progressive.

So, this phenomenon tends to drive up both the GST and income tax collections, Sen said. But ultimately, it weighs down economic growth, given the informal sector’s overwhelmingly large share in employment, he cautioned.

Aditi Nayar, chief economist at Icra, said while direct tax collection jumped 47% in the June quarter from the pre-pandemic level, the non-agriculture GVA in the Q1 of FY22 shrank relative to the Q1 of FY20 — both in real (-10.3%) and nominal (-2.3%) terms. “The formal/tax-paying portion of the non-agriculture economy has gained market share at the cost of the balance, benefiting from the structural shifts generated by demonetisation, GST as well as the Covid shock,” Nayar said.

While hardcore data on the recent performance of the entire informal sector remain elusive, industry executives said the Covid crisis has ravaged non-agricultural entities in the unorganised sector more than the rest.

M Rafeeque Ahmed, founder of Farida Group, a major leather footwear exporter, said there were instances of independent entrepreneurs shutting shop. “I would not like to say this kind of trend has added to the real formalisation because I believe it is not a healthy thing.”

J Rajmohan Pillai, chairman at Beta Group, a dry fruit trading firm in Kerala, said, “Out of 834 registered cashew factories, more than 700 are closed now due to a combination of factors. Demonetisation, followed by the GST launch, had its impact.” Of course, most of the GST-related issues, including refunds, have been settled now, he added.

In the tourism sector, informal units have suffered the most lethal blows of the pandemic. “We have reports that nearly 15,000 of our members have applied to cancel their GST registration,” said G Jayapal, general secretary at Kerala Hotel and Restaurant Association.

However, given the surge in export orders, some players see a silver lining. “Most large companies are flooded with orders, so much so that they have started taking the help of the ancillary units (in the informal sector) to fulfil their commitments. While some of the smaller units did suffer initially, things are improving now,” said RK Jalan, vice-president at the Council for Leather Exports.

Though the agriculture and food sector has performed better than most others, here, too, stress is visible in the informal segment. “…almost 70% of the rice and flour mills are under pressure to repay their bank loans and settle the bills, including power and water taxes,” said Bharat Bhushan, chairman of Lucknow Dal and Rice Millers Association.

In the textile hub of Surat, nearly 20% of the units are either shut or running at less than a half of their capacity following the pandemic, said Devkishan Mangani, former president of the Federation of Surat Textile Traders Association.

However, the diamond units in Surat have recovered fast following the first and the second Covid waves and almost managed to recoup initial losses now, said Dinesh Navadiya, chairman (Gujarat region) of the Gems and Jewellery Export Promotion Council.

However, in the gold jewellery segment, industry executives say many neighbourhood stores in Delhi, Mumbai and Kolkata couldn’t cope with the losses and demand compression, and closed down.

(With inputs from Sajan Kumar in Chennai & Deepa Jainani in Lucknow)

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