Higher revenue more reflects discretionary policy changes than economic activities
The high tax buoyancy in recent years, even with falling growth rates, has invited government claims of improved compliance, administrative efficiency, formalisation, base enhancement and other such as reasons. Yet there’s little evidence to tell us exactly what and how much these efforts have contributed to the increase. As we know, tax buoyancy (TB), as opposed to tax elasticity, includes all additional revenue measures (ARMs) during any fiscal year. Since the frequency of tax policy changes has been extraordinary (see table) compared to its past, the suspicion is that much of these buoyancies capture the impact of ARMs.
Unfortunately, revenue receipts from these ARMs are mostly not public, making it harder for outside observers to link it with the underlying economic cycle.
One would implicitly assume that tax authorities have a fair idea of respective ARM receipts and, therefore, have better tax elasticity and buoyancy estimates for the corresponding taxes towards reliable revenue projections. But it appears they also find revenue forecasting equally challenging. For example, the significant undershooting of the Centre’s net revenue receipts in FY19 (-11.0%) and FY20 (-17.7%) against the budget estimates. The degree of errors was starker against the revised estimates in these years, i.e. a respective -11.3% and -9.8%, considering these were only two months ahead forecasts. Thus, such unpredictability often becomes a source of policy uncertainties, deters investment planning, and invites perceptions of tax terrorism. Moreover, the monthly tax revenue collections turn a less-dependable leading indicator for assessing the growth cycle.
To illustrate the issue at hand, the main direct and indirect tax changes in successive budgets from FY15, with some key out-of-budget measures, are summarised in the table. As we can see, changes in tax rates and the base, the allowable exemptions, new additions and other such are numerous and far-reaching.
The true TB is challenged by inability to distinguish total revenue receipts from the impact of discretionary measures and the improvements in compliance, enforcement and administration. The real TB can be only known only if overall revenues are adjusted for the policy changes to find out the actual receipts from an unchanged taxation system.
RBI estimated the extent of overstatement in indirect tax buoyancy on account of the frequent duty revisions on petrol and diesel for the fiscal year 2015-16. Including these, indirect tax buoyancy was a whopping 3.3, but net of these ARMs, this was under half at 1.2! In FY16, ARMs accounted for 15% of the indirect tax collections compared to 5% in FY15; within indirect taxes, Union excise duty revenues rose 49.6% (23.6% higher than budgeted). In FY17, too, according to RBI, indirect taxes grew 34.5% (21.6% higher than budgeted) on account of ARMs; direct taxes were boosted by the Income Declaration Scheme (IDS), a one-off revenue measure; service tax revenues rose 17.1% because of Krishi Kalyan cess on services from June 1, 2016, and trimming of the Negative List (see table). However, RBI did not estimate adjusted indirect tax buoyancy for FY17.
A second feature of recent TB movements is the raised relative share of indirect taxes in total tax revenues. It is known for sure that a large portion of these are fuel taxes. But others, such as custom duties and cesses, abound too. Every revenue administration has a tax-gap analysis for the respective taxes. It is possible that the indirect tax-gaps are large in India and, therefore, efforts to bridge these are desirable. However, if such gaps are bridged by systematic additional measures to increase tax revenues during a cyclical downturn, it could potentially result in overkill. Consider that product taxes alone outpaced nominal GDP growth in FY16-17 by respective 710 and 324 basis points. In FY20, when real GDP slid to just 4%, the gap in nominal product taxes and GDP growth rates was 176 basis points! This points to fast-paced indirect taxation in a downswing—a period in which gross disposable income (nominal) growth progressively slowed by 3.27 points to a pre-pandemic 7.9% in FY20 from a peak 11.2% (FY17).
We know private final consumption has been slowing from FY18. On average, private consumer spending growth has trended a percentage point lower in FY18-20 compared to its preceding three-year average. Most analysts have attributed the consumption slowdown to financial sector problems, especially NBFCs, since May 2018. It is time to reflect if high taxes have contributed to this slowdown as well, lest it turns structural in the times ahead. When disposable incomes are growing ever slower, rising taxation pushes up prices, adds to the erosion of spending capacity, and exacerbates the decline in aggregate consumption demand.
Rising taxation in a falling or low growth environment adversely affects competitiveness too. RBI’s cross-country comparison of corporate tax rates in September 2019 demonstrates how India was the only country out of 25 with higher rates in 2018 (close to 30%) than in 2006 (little under-20%); all other countries had significantly lower corporate tax rates in this interval except Brazil where it remained constant. Needless to add that, worldwide, the post-GFC growth rates have been lower than the pre-crisis trend.
Perhaps the pressure to preserve or enhance revenue buoyancy in a falling growth environment creates a bias for frequent tinkering with taxation, e.g., changes appear progressively more numerous in the slowdown period from 2017-18, although the interpretation may be superficial. It does, however, suggest an imperceptibility to the adverse effects of raising taxes upon growth in a downturn. The coincidence also raises concerns about timing and sequencing of reforms, be it the GST introduction or the concerted efforts upon formalisation to increase tax revenues. While we do not know how much these, or administrative efficiencies, have contributed to enhance tax buoyancy, the continued slowing of consumption demand is very apparent. For the sake of growth, introspection and analysis are equally warranted.
The author is a New Delhi-based macroeconomist