India’s missing income from the tax net

By: | Updated: May 12, 2016 7:40 AM

The tax collection data reveal that all the taxpayers taken together report incomes which are equal to only about 17-18% of the GDP

The data published by CBDT recently point to a massive evasion of personal income tax through under- and non- reporting of incomes. Recent studies indicate that these unaccounted incomes could be more than 50% of the GDPThe data published by CBDT recently point to a massive evasion of personal income tax through under- and non- reporting of incomes. Recent studies indicate that these unaccounted incomes could be more than 50% of the GDP

Over a 40-year period, between FY76 and FY16, the Union government’s share of income-tax revenue has grown from Rs 1,480 crore to Rs 7,42,295 crore, at an impressive rate of 16.81% per annum. For a country struggling to find resources to finance its development, this is no mean achievement. Fortunately, certain time-series data, along with a snapshot of taxpayer data for FY12, has now been published by the Central Board of Direct Taxes (CBDT). This, when read with other databases, sheds much more light on this story. The number of taxpayers in different income categories during FY12, along with the time-series of three key ratios—income-tax-to-GDP, personal income tax (PIT)-to-corporate income tax (CIT) and cost of collection-to-income-tax revenues—are particularly significant.

In FY76, income tax constituted only 24.62% of the Centre’s net tax receipts; by FY06, this improved to 45.32%; currently, in FY16, it stands at 51.05%. In terms of GDP, the corresponding figures are 1.71% for FY76, 4.47% for FY06 and 5.47% for FY16. The PIT-to-CIT ratio, on the other hand, has improved slightly from 0.56 in FY76 to about 0.63 in FY06 and FY16. Finally, the department’s costs of collection declined from 1.36% in FY01 to 0. 62% in FY16.

Prima facie, these indicators suggest that the I-T department has done well; but we also need to see how it compares with developed economies; and what larger picture this paints.

The current income-tax-to-GDP (5.47%) and income-tax-revenues-to-net-tax-collections (51.05%) ratios indicate that now, more than ever before, the Union government relies on income-tax to meet its revenue needs. To that extent, the country’s tax profile has begun to look like that of some OECD countries. As a percentage of GDP, revenues from income tax average about 8.6% for the OECD as a whole, with Finland, for example, standing at 5.8%, Germany (4.7%), Japan (6.0%); and France (5.4%). This reliance of the Centre on income-tax is a healthy development, because this is one of the most neutral taxes. It does not distort preferences of either the consumers or the producers. Unlike excise duty, it does not have a cascading effect resulting from imposing a tax on tax (e.g. when tyres fitted to a car, for example, might be taxed once when they are first produced and then again as part of the final price of the car).

Our country differs from some of the other advanced ones only to the extent that many of the latter supplement income-tax with a universal VAT, which again minimises distortions and efficiency losses in the economy. From an economic perspective, it is, therefore, imperative that the GST should be introduced without any further delay. When it takes effect, this tax will be difficult to evade because of its audit trail. Thus, it will also check the evasion of income-tax and lead to the expansion of the current base for income taxation though an increase in the number of taxpayers.

The country’s performance under some of the other parameters is far less complementary: As a country develops, the tax base begins to expand and revenues from PIT far outstrip those from CIT. Thus, during FY14, the ratio of revenues collected from PIT were 3.63 times those from CIT in Canada; 8.4 times in Germany; 3.75 times in the UK; and 3.48 times in the US. In India, this ratio has been improving incrementally and currently stands only at 0.63. We lag far behind the advanced countries.

The current ratio also points to a massive evasion of PIT at all levels through under and non- reporting of incomes. Studies carried out in recent times appear to indicate that these unaccounted incomes could be more than 50% of the GDP. Since they do not enter the computation of GDP, the actual size of the Indian economy may very well be much larger than the currently estimated GDP figure of $2 trillion.

These inferences would also be obvious from the figures of income- tax payers recently released by the CBDT for FY12. Only 31.19 million taxpayers filed returns. Of these, only 44.37% or 1.13% of the total population of the country of 1,227 million actually paid any income-tax. 85.65% of the filers reported incomes below R5 lakh; 9.48% in the R5-10 lakh range; 3.12% in the R10-20 lakh range; and 1.75% or 5,45,199 persons above R20 lakh. These figures are disquieting as they reveal that all the taxpayers taken together report incomes which are equal to only about 17-18% of the GDP!

Finally, we also need to consider, the critical but often neglected parameter of cost of collection. The department rightly prides itself on its steadily declining and internationally competitive administrative costs. These costs have successively declined from 1.36% in FY01 to 0. 62% in FY16. But they tell only half the story. Governments world over often transfer their own burden of collection to the taxpayers, for example when they require them to deduct tax at source from various payments on account of rent, salary, interest etc. Taxpayers also incur costs when they file returns, maintain records, visit income-tax offices, hire chartered accountants and tax advocates for representation, litigation etc. They thus expend considerable time, money and energy in complying with the law. Typically, all such compliance costs are not only high but regressive in that they hurt small taxpayers much harder than rich ones. They are also often three to four times greater than administrative costs. The total cost to the society for raising revenue is thus much higher than the mere administrative costs incurred by the government. At various point of time, in Australia, compliance costs have been found to be as high as 7.9% to 10.8% of the revenue collected.

There is hardly any study on this subject in India, but anecdotal evidence appears to indicate that compliance costs in our country too are extraordinarily high and are one of the main reasons why many citizens opt out of the system. It is heartening to learn that the CBDT has commissioned two studies on this important subject. It will be interesting to see the findings of these reports when they come out. In the meantime, the CBDT has already taken some steps to reduce the burden of taxpayers.

Development shares an intricate, symbiotic relationship with freedom, suggests Amaratya Sen: political freedom is usually, though not necessarily, a pre-condition for development, but equally, development leads to greater economic freedom. However, regardless of whether we consider development as an end in itself or as means to achieving the end of greater freedom, it requires resources. The amount of revenues a country actually raises for development is thus important. But even more so, is how it goes about the task. And that reflects often how mature and developed it really is.

In the words of Robert Frost, we still have miles to go before we sleep!

The author was formerly chief commissioner of income-tax and ombudsman to the I-T department, Mumbai

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