Introduction:
India has one direct taxpayer for every 16 voters, with only 1% of the population paying income tax. The Tax-GDP ratio, representing the proportion of tax revenue to GDP, is a crucial indicator of the government’s financial strength. India’s Gross tax-to-GDP ratio for FY22 is projected to be 10.8%, significantly lower than the emerging market economy average of 21% and the OECD average of 34%.
Body:
The Tax-GDP Ratio:
- The tax-to-GDP ratio is a metric that measures the proportion of tax collected relative to a nation’s gross domestic product (GDP), providing policymakers and analysts with a tool for comparing tax receipts over different years.
- India’s Gross tax-to-GDP ratio was 11% in FY19, declined to 9.9% in FY20, marginally improved to 10.2% in FY21 (partly due to a decline in GDP), and is expected to be 10.8% in FY22.
- A higher tax-to-GDP ratio indicates the government’s capacity to extend its fiscal reach, reducing dependence on borrowing and serving as an indicator of effective control over a country’s economic resources.
- This ratio offers insight into the scale of a country’s tax collection efforts, directly linking the strength of its financial position to the relationship between tax revenue and GDP.
- A greater tax-to-GDP ratio not only signifies the government’s broader fiscal influence but also contributes to reducing reliance on borrowing, emphasizing the importance of this metric in assessing a government’s fiscal responsibility.
Reasons for Low Tax-to-GDP Ratio:
- The substantial informal sector in India fosters greater tax evasion, contributing to a low tax-GDP ratio. The dominance of the agricultural sector, constituting a significant portion of households, results in a large exemption from taxes.
- High levels of disputes between tax authorities and taxpayers, coupled with low recovery rates of tax arrears, contribute to the low tax-GDP ratio.
- India’s direct-to-indirect tax ratio (35:65) is lower compared to OECD economies (67:33), impacting revenue generation from direct taxes.
- Generous government policies providing tax exemptions disproportionately benefit the affluent private sector, further reducing tax revenues. Low per capita income and high poverty levels contribute to the overall low tax-GDP ratio.
Implications of Low Tax-to-GDP Ratio:
- Diminished tax revenues limit government spending on national security, welfare, and public goods.
- Heavy reliance on borrowing leads to a persistent fiscal deficit bias in India’s fiscal policy. The political incentive to borrow for populist measures hinders the development of an effective tax system, impacting economic growth.
- Unchecked tax evasion hampers economic growth, burdening high-productivity sectors with the majority of the tax load.
- Reduced tax collections limit the government’s capacity to fund welfare schemes, exacerbating social inequality. Increased dependence on regressive indirect taxes further adds to economic disparities.
Various Measures to Increase the Tax-to-GDP Ratio:
- Expand the individual taxpayer base to enhance revenue collection. Implement the merging of CBDT and CBEC based on recommendations from the Tax Administration Reform Commission (TARC).
- Re-assess exemptions under provisions like transfer pricing and base erosion and profit shifting (BEPS).
- Simplify direct tax laws as suggested by the Justice Easwar committee and introduce GST with robust IT infrastructure (e.g., Project SAKSHAM, Project INSIGHT).
- Foster a sense of national responsibility to change citizens’ attitudes towards tax compliance.
Conclusion:
To boost the tax-to-GDP ratio, it is crucial to implement progressive income taxes along with a mix of indirect taxation, property taxes, and capital taxes. The focus should be on not just deepening but widening the tax base, particularly by integrating India’s informal sector into the formal economy. This comprehensive approach is essential for sustainable fiscal growth and economic development.
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