We now have a peculiar combination in the economic policy of India: a declared attempt at fiscal consolidation, combined with a reluctance to do what it takes to raise tax revenues. This unfortunate juxtaposition has meant a squeeze on Central government expenditures, and particularly those relating to social spending that directly affects most people in the country. Despite various signs of economic slowdown such as languishing industrial production and adverse effects of the drought on rural livelihoods and demand, the government is apparently unable or unwilling to increase public spending to mitigate people’s material distress or to kick-start economic activity to increase employment.
Whenever demands are made for such spending to be increased — which is also required to fulfil the government’s obligations for meeting the social and economic rights of citizens — the official response is that there just isn’t enough money in the public coffers to do this. Increases in such spending will therefore cause the fiscal deficit to increase, which is seen as unacceptable not because of the inflationary implications (which are no longer seen as a real threat in the current deflationary global environment), but because it will send a “wrong signal” to global investors and therefore affect future investment and growth. This fear clearly takes precedence over any signals sent out to the people of the country in terms of the government’s seriousness in improving their condition.
Decline of direct taxes
But in any case, this argument sidesteps the basic issue. Obviously, if fiscal deficit targets are sought to be maintained, the only way to provide the necessary increases in public spending is to increase government revenues, and tax revenues in particular provide the obvious mechanism. But India’s record in collecting taxes has been pathetic, and recently has been getting even worse.
India already has one of the lowest tax-to-GDP ratios among the G20 countries — in fact, only Mexico and Indonesia perform as poorly. This is not just because India’s per capita income is still relatively low; many countries that are even lower in the income ladder show higher ratios. At around 18 per cent (for Central and State governments combined), the tax-to-GDP ratio in India is lower than several Sub-Saharan African countries and significantly below China.
New data from the Ministry of Finance give us a sense of how tax revenues — and particularly direct taxes — have moved in recent years. The first disturbing trend is that the tax-to-GDP ratio has barely increased over the years of the economic boom, unlike the expected pattern whereby it increases as incomes rise. So economic growth has not delivered greater fiscal space for public spending to meet the needs of citizens.
More worryingly, there is a greater reliance on indirect taxes, which are inherently more regressive because they fall disproportionately on the poor. In fact, the perception among the elites and middle classes that they are the only ones who pay tax is hugely misplaced: it is possible for tax incidence to be even higher among the poor than the rich. Because the poor tend to spend nearly all of their income (and sometimes even more through borrowing), they end up paying substantial amounts of taxes in the form of excise duties, sales taxes and import tariffs that are reflected in higher prices. By contrast, the rich do not spend all of their income, and they are able to utilise various tax incentives provided to savers and producers to reduce their tax burden.
In 2009-10, direct taxes peaked at 60.8 per cent of total taxes, but by 2012-13 the share had fallen to only 54.2 per cent, and the provisional data for 2015-16 suggest that the share of direct taxes was only 51 per cent. In the last two years, this is also because direct tax collections did not even increase as rapidly as money incomes did. In 2014-15, nominal GDP increased by 10.5 per cent but direct tax collections increased by less than 9 per cent. In 2015-16, nominal GDP increased by 8.2 per cent but direct taxes increased by only 6.7 per cent. In that same year, indirect taxes increased by a whopping 31 per cent, as the government chose to grab all benefits of the lower global oil prices through successive increase in petroleum product duties. So, increasingly, the poor have been paying to provide revenues for the Central government.
Corporate tax avoidance
This is also because the tax system provides many tax breaks and incentives to rich individuals and companies, that allow them to avoid paying the full tax rate. So, quite apart from the illegal tax-avoidance mechanisms that were so blatantly revealed by the Panama Papers, it is possible for the rich to reduce the effective tax rate through perfectly legal use of loopholes and concessions.
Corporate taxes have not increased as they should have along with corporate profits. Although the statutory rate of taxation for companies is 33.84 per cent, the average tax rate actually paid in 2014-15 was only 24.64 per cent. The larger the companies (and profits), the lower the effective tax rates: companies that had profits of less than Rs.1 crore paid taxes at 29.37 per cent, but those with profits in excess of Rs.500 crore paid only 22.88 per cent. Public sector companies had a higher tax rate than private sector companies, which are obviously more oriented towards aggressive “tax planning”.
This system creates some bizarre anomalies. As social investor Rohit Parakh has noted, in 2014-15, 52,911 companies made profits but either paid no corporate tax or in some cases were net recipients of funds from the government. Some sectors have benefited disproportionately, with massive declines in effective tax rates in the past five years. These include financial leasing companies, for which the effective tax rates fell from 21.94 per cent in 2010-11 to 1.53 per cent in 2014-15, and mining contractors, for which the drop was from 32.29 to 14.02 per cent. It is hard to miss the political significance of some of these beneficiaries.
It is not as if the government does not know all this. Indeed, the Budget documents provide estimates of the revenues foregone through various tax concessions that are explicit and legal. In the past two years these have amounted to as much as 4.5 per cent of GDP — significantly higher than the declared fiscal deficit. For corporate taxes alone, the revenue losses because of various incentives provided were estimated to be Rs.65,067 crore in 2014-15, which increased to Rs.68,711 crore in 2015-16.
Individual savings stratagems
Personal income tax collection is similarly inadequate. The data show that the number of individual tax assessees was only 48.6 million in 2014-15, just 6 per cent of the estimated adult population of around 800 million in that year. Many of these assessees do not actually pay any income tax; in fact, data for 2012-13 suggest that around 2 million taxpayers accounted for the bulk of the personal income tax collections. But even here the underestimation of taxes due is clearly evident. Given the amount of luxury consumption that is openly flaunted across India, who can believe that in 2012-13 less than 20,000 people across the country had annual incomes of more than Rs.1 crore?
Consider the opportunity cost of these losses in tax revenue. The amount of Rs.1,28,639 crore in direct tax concessions in 2015-16, which was a gift to rich individuals and corporations, can be compared with other important expenditures. Only Rs.35,754 crore was spent on the Mahatma Gandhi National Rural Employment Guarantee Scheme, which could benefit several hundred million rural people if only it were to be taken seriously. The Integrated Child Development Services (ICDS) got only Rs.15,394 crore, while maternal and infant health and nutrition indicators remain appalling in most of India. School education got only Rs.42,187 crore even though government schooling is woefully inadequate in terms of both quantity and quality. The expenditure on all these put together could have been doubled, simply with the amount given away as tax breaks.
The low and declining rates of direct taxation are therefore an indication of the political choices of the government. What is remarkable is how we, the people of India, allow the government to get away with these unjust choices.
Jayati Ghosh is a professor of economics at Jawaharlal Nehru University, New Delhi.