Has demonetisation led to a big increase in the number of people filing taxes and in tax revenue collected?
By Rupa Subramanya Economist and researcher @rupasubramanya
Has demonetisation led to a big increase in the number of people filing taxes and in tax revenue collected? In other words, have the tax base and tax revenue increased substantially due to demonetisation?
Minister of finance Arun Jaitley, and assorted defenders of the government, do make these claims. Writing in this newspaper, economist Surjit Bhalla, a part-time member of the prime minister’s economic advisory council, defended demonetisation exactly on these grounds (bit.ly/2Pr07az). In an interview, Bhalla claimed “tax payments went up by an enormous amount”, due to demonetisation (bit.ly/2qHOnS1).
Do the facts support these claims? Let’s start with tax buoyancy. In macroeconomics, this is the elasticity of tax revenues with respect to nominal GDP, or in other words, the percentage change in tax revenues divided by the percentage change in nominal GDP. Greater tax compliance, caused say, by demonetisation, should show up as higher tax buoyancy.
In the two financial years preceding demonetisation, direct tax buoyancy was 0.8 and 0.7 respectively. In 2016-17, the year of demonetisation, this increased to 1.3, and it was 1.4 in 2017-18, the last full financial year for which we have data. Sounds impressive, right? Yes, if we cherry-pick dates to suit our agenda, as defenders of demonetisation often do.
As the first panel of the graphic shows, tax buoyancy was much higher in the early 2000s, with a peak of 2.6 in 2002-2003, the last full year of the previous BJP-led government, and remained high during the early years of UPA-1. Tax buoyancy seemed to fall off a cliff in 2008-09, the year of the global financial crisis, and remained low until picking up in 2012-13 when it was 1.3—which is about where we are now.
Someone looking at these facts objectively and without a pre-determined agenda to claim demonetisation propelled an increase in tax buoyancy would find the defenders’ claims ludicrous. The very most you can say is demonetisation appears to have caused a small fillip to tax buoyancy, but we’re still way below where we were in the early 2000s. What is more, even if we account this as a benefit of demonetisation, that would have to be weighed against the very high cost in terms of lost GDP and the enormous disruption to the cash-based economy.
No sensible person would conclude that destroying 1 to 1.5 percentage points of real GDP growth for a 0.6 percentage point gain in tax buoyancy was worth it. No doubt, because demonetisation is indefensible looking at aggregate direct tax buoyancy, beleaguered defenders such as Bhalla have predictably shifted goal posts and are now talking about personal income tax buoyancy, presumably because demonetisation might have induced more individuals to pay income tax and that this is somehow obscured in the aggregate data. One could debate this shift, but let us accept it for the sake of argument.
According to Bhalla’s data, as shared with me, personal income tax (PIT) buoyancy jumped from 0.8 in the two financial years preceding demonetisation to 2 in 2016-17. I myself have calculated PIT buoyancy using all available official data sources (actual receipts in the budget, MOSPI, and the Controller General of Accounts) and all of these numbers are similar to Bhalla’s for these years. Again, based on these numbers, you might account demonetisation a success, but this, too, would be a function of cherry-picking the data (see second panel of graphic.
My data analysis using CGA data, the same data source Bhalla uses, shows that during financial years 2006-2007 and 2007-2008, PIT buoyancy was 2.1 and 2.3 respectively, which also tallies with Bhalla’s own numbers. (The chart shows both my calculations and Bhalla’s). Yet, the high tax buoyancy in these years was achieved without an unorthodox policy adventure like demonetisation. So, much like aggregate direct tax buoyancy analysed earlier, PIT buoyancy, after falling in the late 2000s, recovered to 1.9 by 2012-2013 before falling again for the next three financial years, spanning the end of UPA II and the first years of NDA II.
PIT buoyancy averaged 1.35 during the ten years of the UPA and has averaged 1.2 for the three full financial years for which we have data for NDA II. Only a blind partisan could possibly conclude from this that demonetisation has been a success in boosting personal income tax buoyancy. We can see the big picture of the importance of direct tax to the economy in the attached graphic which shows the direct tax to nominal GDP ratio as a percentage. The third panel of the graphic clearly shows this ratio rising during the 2000s, coming to a peak of 6.5% in 2007-08, and then remaining remarkably stable close to that level since then. Demonetisation simply does not figure in this story.
The last refuge for defenders of demonetisation is to argue for a large increase in the number of tax filers, that is the number of individuals and other entities filing personal income tax returns. Arun Jaitley has trumpeted that some 6.85 crore returns were filed in financial year 2017-18, the largest in history. It is obvious but necessary to note that, in a growing economy, with a growing population and growing GDP, the number of filers is bound to go up year after year. Therefore, it is hardly surprising that the most recent year sets a record.
Note as well, that the growth rate in the number of filers was almost as high in the financial year preceding demonetisation as it was in the years following. More specifically, according to Income Tax Department data, total IT-R filings grew by almost 15% in 2015-16 and by 20% and 23% in the two following years. Again, you can’t sensibly argue that demonetisation was the cause of the big increase in 2015-16, unless you believe that tax filers the year before foresaw demonetisation and began filing returns! You also have to ask whether a five or eight percentage point increase in the number of tax filers, starting from a low base, was worth the pain of demonetisation.
Remember that the number of tax filers is still a paltry 5% of the total population. In other words, despite recent strides, it is a tiny number of mostly urban middle-class salaried people and corporations who actually file income tax returns and that has not changed due to demonetisation. It is not at all with a sense of glee that I write this. I was one of relatively few economists in the early days following
November 8, 2016, who gave demonetisation a fair chance to achieve at least some of the ex-post facto rationales given for it. Unfortunately, as we now know, not only have the ex-ante goals, such as extinguishing black money, not been achieved, the ex-post goals have also failed, whether it is making India a cash-less society, or increasing tax compliance.
Only someone who pretends that the Indian economy came into being in 2014 could possibly conclude that demonetisation achieved goals such as boosting tax compliance, something already achieved under the UPA.