It’s time our policymakers realised that fiscal space is not a given
By Emmanuel Thomas
Experts remain clueless as to how the various giveaways announced in the Interim Budget will get financed. Their doubts are justified given that the slippages in fiscal deficit targets are averted only by tweaking the denominator, assuming more robust revenue growth and by allowing significant off-budget financing. At the end of the day, as usual, the lack of fiscal space might force the axe on capex.
This shrinking fiscal space should prompt us to devise strategies for ensuring sustainable finance in the short and medium term, if not for the current year. This strategy should necessarily hinge on the tax-to-GDP ratio, which, for the Union and states combined, has hovered around 14-17% during the past four decades. After peaking in 2007-08, it registered a declining trend. And curiously enough, the central tax revenue is tracing a declining trend as a proportion of GDP. A stagnant ratio doesn’t allow us to raise the expenditure on all sectors as a proportion of national income simultaneously.
But demand for allocations is rising every year from various sectors. The National Health Policy, 2017, calls for a rise in the public expenditure on the health sector in a time-bound manner to reach 2.5% of GDP from the current 0.7%. A long-standing demand from the education sector has been to raise the public expenditure from the current less than 3% of GDP to 6%. And doubling of farm income would definitely require massive investment. Our per-capita income level that is well below $2,000, high incidence of poverty and unemployment, poor infrastructure, etc, warrant a higher public expenditure. That is perhaps the reason why mobilisation of tax revenue finds a place under the United Nations Sustainable Development Goal 17.
A typical developed country mobilises about 40% of GDP as tax revenue. The OECD average is 34%. Germany, Norway, Iceland and Luxembourg are the countries where the tax-GDP ratio is above 45%. The figures for Austria, Italy, Finland, Sweden, Belgium, France and Denmark are above 40%. All BRICS countries, too, have figures higher than that of India, with Brazil leading with a figure of above 30%.
An IMF Working Paper “Tax Revenue Mobilization Episodes in Emerging Markets and Low-Income Countries: Lessons from a New Dataset” by Bernardin Akitoby et al published in November 2018 examines 55 episodes of tax revenue mobilisation where tax policy reforms and revenue administration played a crucial role on raising the tax-GDP ratios. These episodes included an increase in the ratio by at least 0.5% over a minimum of three years.
Five countries that stand out in this report are Cambodia, Georgia, Guyana, Liberia and Ukraine. Their per-capita incomes are comparable to that of India. These economies have succeeded in raising their tax-GDP ratio significantly during the last 15 years. Three of them witnessed increases above 10 percentage points and the other two above 5 percentage points.
They achieved this feat by broadening the tax base for both direct and indirect taxes by means of revenue administration and tax policy, especially through improvements in compliance and by reducing exemptions and/or eliminating tax holidays. Many countries focused on indirect taxation. Simplification and raising the efficiency was what worked for them.
The Indian economy has registered impressive growth in the new millennium. Hence, with a progressive tax system in place, the tax-GDP ratio is bound to rise. Rising inequality will only make the ratio rise faster due to bracket effect and a shift towards a consumption basket that attracts higher tax rates. But it was not to be.
Presenting the Interim Budget, the finance minister highlighted the introduction of major tax reforms and significant increases in tax collection and tax base as important achievements of the government. The number of return filers (individuals) grew significantly from 3.04 crore in 2013-14 to 5.08 crore in 2017-18. And the number of taxpayers have risen from 4.97 crore to 7.03 crore during the same period. During this period, direct tax collection increased by 57% in nominal terms. But it had grown by 68% and 128% during the previous two quinquennia. So, the gains in tax collection are not exceptional at all, even after accounting for inflation and base effect.
The picture is not very rosy for the current year either. GST has so far not succeeded in augmenting revenue. The budgeted (2018-19) revenue under GST for the Union is Rs 6,53,900 crore (excluding compensation cess), which requires a monthly collection of about Rs 54,000 crore. But the average collection has only been about Rs 36,000 crore. In direct taxes, too, in spite of much noise about rising number of returns filed, no extra buoyancy is seen.
In his Budget speech in February 2017, finance minister Arun Jaitley had pointed out that the tax-GDP ratio in India is very low. He had also argued, citing income tax data, that “we are largely a tax non-compliant society.” Tax policy reforms that we have introduced included reduction of exorbitant rates. But probably the lesson for us is that such cuts alone do not induce compliance. Similarly, the trends are also an indication that we have not succeeded in dismantling the parallel economy to any significant extent.
Going one step further, we need to ponder why people are reluctant to pay taxes. People will definitely hesitate to part with their income if they do not get anything worthy in return. General public will be more happy to pay taxes if they get better roads, improved public transport facilities, timely and quality healthcare, better education services, uninterrupted power supply, etc, in return. They will also own up the nation when they are treated with respect in government offices. All these require higher initial spending. Funding them will definitely be a challenge with the given fiscal space. Hence, the first steps have to be aimed at improving compliance, ensuring accountability and rooting out corruption.
Nevertheless, it is high time our policymakers realised that fiscal space is not a given. In the ultimate analysis, it is the conscious creation of a society and in India there is lot of room left for expansion of this space. Let’s hope that the full Budget presented by the next dispensation will dare to reimagine the idea of fiscal space and act on it too.
-The author is Doctoral fellow, CESP, JNU, and assistant professor, St Thomas’ College (Autonomous), Thrissur, Kerala