Tax /GDP ratio is partly a function of the year. In a good year, interpreted as a year in which growth is good, it touched 12% of GDP, almost 6% direct and the rest indirect. The direct part is divided into a shade over 2% for personal income tax and a shade below 4% for corporation tax. The indirect part consists of customs, excise and service tax. There are bits of the direct part connected with expenditure, wealth, gift and estate duty, but those aren’t quantitatively significant.
Two figures are often bandied around . First, only 35 million people pay income tax. Second, only 42,800 people have annual income more than Rs. 1 crore. Both involve minor misstatements : 35 million is the number of people who submit income-tax returns. In a pedantic sense, they may or may not pay income tax. Even if they do, tax paid could be marginal.
And that 1-crore figure for 42,800 is taxable income. There are 78.9 million urban households in India. Half of them can be expected to be below the threshold. Indeed, there is some multiplicity: in a single urban household, there can be more than one individual who submits income-tax returns.
But the illustrative point remains . Since rural households are outside the ambit of income taxes, 35-40 million is the maximum income tax base we can get. Why are we so shocked that just 3% of the population pays personal income tax?
Since 2006-07,Budgets have had a tax revenue foregone statement. For direct taxes, this is divided into corporates, non-corporate firms and individual taxpayers. Notice that all tax exemptions are implicit subsidies to preferred categories of taxpayers. In individual taxpayer category, around half are salaried. Salaried taxpayers are entitled to limited deductions. That’s not true of non-salaried taxpayers. They are entitled to several profit-linked deductions too. And there are many deductions for non-corporate firms too.
Depending on what GDP figure you take, all those exemptions, direct as well as indirect, amount to anything between 5% and 5.5% of GDP. That 12% figure doesn’t include all state level or local-body taxes. If you include those too, the tax/GDP ratio would be around 17%. However, if all exemptions were to go, tax/GDP ratio would be in excess of 22%.
Also, if all subsidies, Centre as well as state, explicit as well as implicit , are included, subsidies amount to 14% of GDP. Before considering abolition of a tax, we, therefore, need to ask questions. Where will the revenue come from? Which expenditure item will be slashed on a continuing basis, not as a one-shot revenue realization from asset sales (such as privatization)?
When figures like 35 million are cited, there is an impression there’s tax evasion. There certainly is evasion . But there’s an important difference between evasion and tax avoidance . When arguments are made about middle class — not all middle class people are salaried or urban — suffering from income tax, it’s really an argument about limited tax avoidance options being available to salaried people.
Second, as long as there are exemptions , compliance costs cannot be reduced significantly. One needs to pin down the expression compliance costs. Does it mean administrative costs of collection? Does it mean costs to taxpayers, including harassment and bribes? And does it include other social costs?
For income tax, administrative costs aren’t actually that high. For every Rs. 100 collected, it’s around 60 paise . Through the large taxpayer unit, it’s around 4.50 paise. That’s today. Studies done 10 years ago suggest if all compliance costs are included, compliance costs are 49% of personal income-tax collections and the system is regressive. Of course, there’s an argument for simplification . DTC was meant to do that, but has deviated from original intent. And, yes, one should simplify the appellate and refund process.
If income tax is scrapped, what will replace it? Every economist should argue direct taxes are superior. If income tax is scrapped, it can’t be scrapped only for personal income, retaining it for corporate taxation. So, there will be a transition from direct to indirect taxation.
While actual revenue numbers depend on elasticities, we need a rough doubling of indirect tax rates, which are inherently regressive. The only argument in favour of indirect taxation is that it’s easier to enforce . Since we can’t or won’t tax rural income, let’s do it via the indirect route. This isn’t a new idea either.
For those who are advocating an abolition of income tax, there also seems a presumption that compliance costs will be zero under the new framework, whatever that new framework is. The argument that there are countries with no personal income taxation won’t wash either. Those are either tax havens or those with large natural resource bases. Besides, precedence is no argument . Just because Peter the Great taxed beards, should we?
