The post-pandemic period has seen growing financialisation of wealth in India, despite sluggish income growth across vast sections of population and increased indebtedness of households. In addition to the heightened “tax effort” by the government, this too has contributed to recent years’ steep recovery in tax revenues. For the first time in the country’s history, revenue from capital gains tax has outpaced the receipts from all other tax heads. Its share in the personal income tax receipts has reached 10%, and is poised to grow further in the coming years. Yet, the Centre has budgeted for a decline in tax buoyancy (to 1 in FY25 from 1.3 in FY24). It envisages a further rise in share of direct taxes in gross tax receipts (to 57.5% in FY25 from 56.6% in FY24, and just 48.6% in FY17). This indicates that the tax incidence among the (small) fraction of economic players, who pay direct taxes, is set to rise.
With the modest increase in the rates of capital gains tax announced in the Budget, a large part of the additional burden may tend to lie on the rich and institutional players. But a tidy sum of the extra revenue would come from the (not-so-well-off) middle class too. The Centre’s tax-GDP ratio for FY25 is pegged at 11.8%, the highest level since FY08, when it crossed 12%. What’s worrisome is that the tax effort is wearing out, much before the estimated “tax potential” is achieved. To be sure, the country’s current tax-GDP ratio of 18% (for the Centre and states combined) is not only far below the estimated potential of 25%, but even trails the FY08 peak of 18.4%. The managers of the country’s public finances have willy-nilly pushed themselves into a predicament: for any incremental growth in revenues, they have to resort to “taxing” the economy.
The way out of this vicious circle is a certain mix of radical reforms of both the economic structure and the tax policies. India being a predominantly consumption-led economy, the share of consumption taxes in government revenues can grow faster until it reaches a threshold where it turns regressive. At the same time, the direct tax base must widen substantially and diversify, allowing investments, and even income, to be taxed more benignly. While taxing agriculture income is politically difficult, a beginning can be made by stipulating that those under the highest (39% at present) income tax slab must also pay tax on their farm income at the same rate. The economic restructuring must involve resolving the huge income asymmetries, and making free play of market forces a reality, rather than mere rhetoric. Dispersed income is a proven consumption booster. Increased automation of the industry must be carefully calibrated with the goal of creating millions of additional well-paying jobs.
Moreover, as a fast-growing, high-trade-deficit economy in a world struggling to fight economic stagnancy, India must double down on the fight against profit-shifting practices among large multinational enterprises, including tech giants. The current set of multilaterally coordinated anti-avoidance mechanisms, like the G20-OECD Base Erosion and Profit Shifting project, are unlikely to be helpful to the country. These may eventually unravel, given their internal contradictions. A fully autonomous shift to destination-based cash-flow tax for companies, from the current system of origin-based taxation of business income, is worth considering. The objective must be to shun favouring debt (rent) and implicit taxation of investment.