What’s the news?

• India sees a surge in taxpayer base amidst tax policy challenges; a stable tax-to-GDP ratio raises questions on fiscal maneuverability and economic growth prospects.

Central idea

• In the lead-up to each budget, the Union government cites limited tax revenues as a spending constraint. Recent years have seen a surge in direct and indirect tax payers, challenging the idea that only a small segment contributes. This should ideally raise the tax-to-GDP ratio, yet tax rate cuts and pandemic disruptions have limited fiscal gains, hinting at a deliberate shift to a low-tax regime.

What is meant by fiscal maneuverability?

• It refers to the government’s ability to adjust its revenue and expenditure policies in response to changing economic conditions, budget constraints, and policy goals.

What is Tax-to-GDP Ratio?

• The Tax-to-GDP ratio is a financial indicator that measures the total tax revenue collected by a government as a percentage of its overall GDP for a specific period, typically a fiscal year.
• This ratio is used to assess the level of taxation relative to the size of the economy.
• A higher Tax-to-GDP ratio suggests that a larger portion of a nation’s economic output is being collected in the form of taxes.

What Factors Have Led to the Government’s Limited Fiscal Maneuverability Before Budgets?

• The common refrain: Historically, the Union government has often cited its limited tax revenues as a significant constraint on its ability to maneuver effectively in the run-up to budgets.
• Steady increase in tax base: It’s noteworthy that there has been a consistent increase in both direct and indirect tax payers over recent years.
• Economic context: This expansion in the tax base has occurred during a phase of slower, uneven economic growth.
• Impact of tax cuts and disruptions: Despite the increase in taxpayers, cuts in both direct and indirect tax rates (including GST) and pandemic-induced economic disruptions have limited the fiscal gains from this surge in taxpayers.

How Has the Taxpayer Base Evolved in Recent Years?

• Growth in the taxpayer base: The tax base has shown substantial growth in recent years, challenging the belief that only a small section of society pays taxes.
• Direct tax base expansion: The number of companies paying tax grew by about 43 percent, from 7.46 lakh to 10.7 lakh, between the assessment years 2014–15 and 2022–23.
• Individual taxpayers: Individual taxpayers increased by 65 percent over the same period, rising from 5.38 crore to 8.9 crore.
• Role of small taxpayers: It’s important to note that a significant number of these new tax payers have incomes less than Rs 5 lakh.

Trends and Factors in the Expansion of the Indirect Tax Base

• Indirect tax base growth: The number of active GST payers increased from 1.2 crore in 2019 to 1.4 crore by June 2023.

• Composition: About 80 percent of these taxpayers are proprietorships, with another 10 percent being partnerships.
• Incentives for registration: Smaller establishments are incentivized to register under GST to avail of the input tax credit.
• Indirect tax impact: The growth in the indirect tax base may also be influencing the increase in direct tax payers.

Impact of Tax Rate Reductions

• Corporate tax rate reduction: In September 2019, the government announced a cut in the corporate tax rate for existing companies from 30 percent to 22 percent.
• Impact on revenue: As per government figures, the revenue loss on account of this corporate tax reduction was Rs 1.28 lakh crore in 2019–20 and Rs 1 lakh crore in 2020–21.
• Corporate tax-to-GDP ratio: The corporate tax-to-GDP ratio declined from 3.5 percent in 2018–19 to around 3.1 percent by 2022–23.
• Personal income tax rebates: In the interim budget of 2019, the government announced that individual taxpayers with taxable income up to Rs 5 lakh would get a full tax rebate.
• Personal income tax-to-GDP ratio: The personal income tax-to-GDP ratio increased from 2.5 percent in 2018–19 to 3 percent by 2022–23.
• Increase in zero tax liability: Notably, the number of individuals with zero tax liability also increased from 2.9 crore in 2019–20 to 5.16 crore in 2022–23, which may limit the gains from an expansion in the tax base.

What are the challenges?

• Revenue Sustainability: A challenge arises in ensuring that the gains from an expanding tax base translate into sustainable revenue streams. Despite the increase in taxpayers, tax cuts and disruptions may limit the fiscal benefits.
• Tax Evasion and Avoidance: Addressing tax evasion and avoidance remains a significant challenge. Although the formalization of the economy makes tax evasion more complicated, it requires effective measures to combat tax evasion further.
• Balancing Tax Cuts: The reduction in tax rates, such as the corporate tax cut, has implications for government revenue. Striking a balance between encouraging economic growth through lower taxes and maintaining adequate fiscal resources is a constant challenge.
• Targeted Spending: As the government’s fiscal space expands with a growing tax base, it faces the challenge of allocating resources effectively. Prioritizing and targeting spending on key development objectives while avoiding wasteful expenditures is essential.

Future Prospects

• Fiscal Sustainability: With an expanding economy and tax base, there is potential for improved fiscal sustainability. If managed effectively, this can provide the government with more resources to meet its long-term financial commitments.
• Development Opportunities: The growth in the tax base offers opportunities for increased public investment in critical sectors, fostering economic development, and improving the overall quality of life for citizens.
• Reduced Reliance on Borrowing: An increased tax base can reduce the government’s reliance on borrowing to meet budgetary needs, potentially leading to lower interest payments and debt management challenges.
• Incentive for Formalization: As more individuals and businesses enter the tax net, there’s a natural incentive for greater formalization of the economy. This can reduce the size of the informal sector and promote economic stability.
• Policy Flexibility: A broader tax base can provide the government with greater policy flexibility. It can consider adjustments to tax rates, exemptions, and deductions to support specific policy goals, such as promoting investment or addressing income inequality.
• Enhanced Economic Growth: With appropriate fiscal policies, the increased revenue potential from a growing tax base can contribute to sustained economic growth, job creation, and poverty reduction.

Conclusion

• The government’s strategic choices regarding tax rates have influenced the country’s tax landscape, expanded the taxpayer base while maintained stable tax-to-GDP ratios. As India’s economy continues to evolve, these gains should not be squandered through excessive giveaways but rather strategically allocated to promote sustainable development and economic growth.

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