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GS 3: Economy

Introduction

India's tax landscape is poised for significant growth in the upcoming fiscal year, with the tax-to-GDP ratio expected to soar to a historic high of 11.7%.

Revenue Secretary  underscores the pivotal role of direct taxes in driving this surge and underscores the government's commitment to streamlining the tax regime for enhanced efficiency and reduced disputes.

Why 'Tax-to-GDP' Ratio Matters?

• Measurement of Fiscal Health: The tax-to-GDP ratio serves as a crucial indicator of a nation's fiscal health, measuring tax revenue relative to the size of its economy.
• Resource Allocation: It aids in evaluating how effectively a government allocates economic resources through taxation, when considered alongside other metrics.
• Development Indicators: Developed nations generally exhibit higher tax-to-GDP ratios, indicating greater fiscal capacity to invest in infrastructure, healthcare, education, and other development initiatives.
• World Bank's Benchmark: Tax revenues exceeding 15% of GDP, as endorsed by the World Bank, are pivotal for fostering economic growth and alleviating poverty.

Forecasted Rise in Tax-to-GDP Ratio

• Anticipated Surge: The tax-to-GDP ratio in India is forecasted to climb to 11.7% in the fiscal year 2024-25, marking a steady increase from 11.6% in the previous year and 11.2% in 2022-23.
• Dominance of Direct Taxes: The upsurge in the tax ratio is primarily attributed to the growth of direct taxes, renowned for their equitable distribution.

Factors Driving Growth

 Direct Tax Collection

• Optimistic Outlook: Revenue Secretary anticipates a surge in the adoption of the new tax regime, characterized by simplified tax structures and a higher tax-free income threshold.
• Personal Income Tax Growth: Personal income tax collections have witnessed a substantial 28% growth, projected to moderate to 20%-22% by the fiscal year-end.

 Rationalizing GST Rates

• Ongoing Review: A Group of Ministers (GoM) appointed by the GST Council is actively reviewing the rate structure, with the aim of rationalizing GST rates on various items.
• Regular Council Meetings: The GST Council is expected to convene regularly to address rate rationalization, although no fixed date has been announced yet.

Projected Revenue Growth

• Modest Projections: Despite buoyant revenue growth of 1.4% this year, projections for the following fiscal year aim for a 1.1% buoyancy, aligning with an anticipated nominal GDP growth of 10.5%.
• Corporate Tax Dynamics: The deadline for availing the reduced corporate tax rate ends in March 2023, with a significant proportion of companies already benefitting from it.
• Enforcement Measures: The Department of Revenue focuses on tax administration, while the Enforcement Directorate intervenes in cases related to money laundering, ensuring comprehensive enforcement mechanisms.

Reasons for Low Tax to GDP Ratio in India

• Presence of Informal Sector: The substantial size of India's informal/unorganized sector poses challenges for tax collection, leading to greater tax evasion and reduced revenue inflows.
• Dominance of Agriculture Sector: With a significant portion of the population engaged in agriculture, which is often exempt from taxation, a large segment of the economy remains outside the tax net.
• Tax Disputes and Low Recovery: High numbers of tax disputes coupled with low rates of tax arrears recovery undermine the effectiveness of tax collection efforts, contributing to a lower tax to GDP ratio.
• Imbalance in Direct-Indirect Tax Ratio: India exhibits a skewed ratio of direct to indirect taxes, with a larger proportion of revenue derived from indirect taxes. This imbalance contrasts with OECD economies and impacts overall revenue generation.
• Generous Government Policies: The presence of numerous tax exemptions and incentives, particularly favoring the richer private sector, diminishes tax revenues and erodes the tax base.
• Low Per Capita Income and High Poverty: India's low per capita income and widespread poverty limit the tax base, as a significant portion of the population falls below taxable income thresholds.

Implications of Low Tax to GDP Ratio

• Limited Government Spending: Decreased tax revenues constrain the government's capacity to invest in crucial areas such as national security, welfare programs, and infrastructure development.
• Persistent Fiscal Deficit: The reliance on borrowing to compensate for low tax revenues results in persistent fiscal deficits, perpetuating a deficit bias in fiscal policy.
• Political Incentives for Borrowing: Political pressures to appease voters through spending rather than implementing effective tax reforms further exacerbate fiscal imbalances and hinder economic growth.
• Unchecked Tax Evasion: Widespread tax evasion undermines economic growth and places a disproportionate burden on high-productivity sectors, stifling overall development.
• Impact on Welfare Schemes: Reduced tax collections limit the government's ability to fund welfare schemes and social programs, exacerbating socio-economic disparities.
• Dependence on Regressive Taxes: Increased reliance on indirect taxes, which tend to be regressive, exacerbates income inequality and places a heavier burden on lower-income segments of society.
• Social Inequality and Economic Disparities: The asymmetric distribution of economic resources perpetuates social inequality, contributing to disparities in access to opportunities and services.

Various Measures to Increase the Tax to GDP Ratio

• Widening Individual Taxpayer Base: Implement policies to expand the individual taxpayer base by targeting tax evasion and bringing more taxpayers into the formal tax net through improved compliance measures and outreach programs.
• Organizational Restructuring: Consider the merger of the Central Board of Direct Taxes (CBDT) and the Central Board of Indirect Taxes and Customs (CBIC) as recommended by the Tax Administration Reform Commission (TARC) to streamline tax administration and enhance efficiency.
• Reassessment of Exemptions: Reassess and rationalize tax exemptions provided under various provisions, such as transfer pricing and base erosion and profit shifting (BEPS), to prevent misuse and ensure fair taxation while minimizing revenue leakages.
• Effective Dispute Settlement Mechanisms: Strengthen dispute resolution mechanisms to expedite the resolution of tax disputes, thereby reducing litigation and enhancing taxpayer confidence in the tax system.
• Cultural Change and Awareness: Foster a culture of tax compliance and civic responsibility by educating citizens about the importance of paying taxes for nation-building and development. Instill a sense of national pride and duty towards contributing to the country's progress through tax compliance.

Reasons for Increase in India’s Tax-to-GDP Ratio

• Equitable Direct Taxes: The shift towards more equitable direct taxes has contributed to the rise, with direct taxes expected to increase from 6.1% of GDP to 6.6% and 6.7% in subsequent years, aligning with economic growth.
• Government's Simplification Efforts: Active efforts by the government to simplify and rationalize the tax regime have reduced disputes and intrusive enforcement methods, fostering compliance and revenue growth.
• Reduction in Corporate and Personal Income Taxes: Recent reductions in corporate and personal income taxes aim to incentivize taxpayers to opt for the new tax regime, boosting compliance and widening the tax base.
• Economic Growth and Per Capita Income: Economic growth and rising per capita income are expected to drive tax revenue growth, following global trends where developing economies experience increased tax-to-GDP ratios alongside economic development.

Conclusion

India's tax-to-GDP ratio is poised to reach a historic high, reflecting the government's efforts to bolster revenue generation through direct taxes and streamline tax policies. This surge underscores the nation's improving fiscal health and resilience amidst economic fluctuations. However, challenges such as the dominance of the informal sector, low tax base, and disparities in tax collections growth rate persist, impacting tax buoyancy. Addressing these challenges necessitates a multi-pronged approach, including widening the taxpayer base, reassessing tax exemptions, and strengthening dispute resolution mechanisms. By fostering tax compliance, enhancing transparency, and promoting economic growth, India can strive towards achieving a sustainable and equitable tax regime, laying the groundwork for long-term fiscal stability and inclusive development.