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India and its aversion to taxes
February 10, 2018, 3:50 pm
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Taxpayers all over the world love to hate the taxman; the Indian taxpayer is no exception. According to latest available figures from the Indian Income Tax department, only 2.8 percent of India's 1.3 billion people, around 36 million filed income tax returns in 2017. Of those that filed income taxes, nearly 10 million claimed exemption by reporting income less than the tax threshold of Rs250,000. And, of those paying taxes, only 2.4 million reported an annual income of more than Rs1,000,000.

High poverty, low average income and a host of other reasons can be attributed for the India's perennially low tax base, but probably the biggest one is the average Indian's reticence to pay due taxes. The taxman would probably have found it easier to wring money out of the hands of Ebenezer Scrooge than wrest it from an Indian taxpayer.

Successive governments have pandered to this popular distaste for taxes by repeatedly raising the income tax exemption limit. In the last 20 years the income tax threshold has increased six-fold from Rs40,000 to Rs250,000. With a per capita GDP of a little over Rs100,000, it is clear that a large chunk of India's vast population will remain outside the income tax bracket and be exempt from paying taxes.

Going against the grain of political correctness, it would be worth pointing out a major reason for India’s low income tax base is the country's high ratio of per capita GDP to income tax exemption thresholds. The average of this ratio across 20 developed and developing countries is 0.5 percent –  in the US and Germany it is 0.2 percent, in Philippines and Turkey it is around 0.4 percent, in Argentina, Brazil, Indonesia and South Africa, the ratio is about 1.0 percent – in India it is five times higher at 2.4 percent.

While presenting the 2017-18 budget last year, Finance Minister Arun Jaitley generously lowered the rate for those in the first income tax bracket from 10 percent to 5 percent, making India once again an outlier in this respect. Had the finance minister, while lowering the tax rate also lowered the tax exemption limit to Rs150,000, this move on its own would have netted a further 11 million Indians into the tax bracket and consequently more income to the exchequer.
With this year's annual budget brouhaha having settled down, perhaps now is a good time to take a look at the average Indian taxpayer’s aversion to taxes and the low rate of tax compliance in the country.

Ask any Indian you meet and they will invariably tell you that taxes in the country are way too high. While the ordinary taxpayer will moan the high taxes and place the blame squarely on the shoulders of current or previous governments, depending on their political affiliation, the armchair economists among them will let loose a tirade on the inequities of Indian tax system. They will argue that ‘regressive’ indirect taxes lead to tax avoidances, ‘progressive’ direct taxes foster tax evasions, and that both results in low tax compliance. 

But everyone who calls for axing taxes will also in the same breath complain about the country’s poor infrastructure and development initiatives, the pot-holes on roads, crumbling bridges and school sheds, the lack of civic amenities and social supports. They will point to other countries that offer high-quality universal healthcare, free education and other social welfare systems to citizens. “Look at how the wonderful GCC states mollycoddle their citizens; look at the social care available in even in small Nordic countries such as Sweden, Norway, Denmark or Finland,” they say. We say, “Read the tax-to-GDP ratio.”

The ‘Tax-to-GDP ratio’ refers to the total annual tax revenues expressed as a percentage of national gross domestic production (GDP), and is a metric that enables easy comparison of tax receipts year to year. The higher this ratio, the more funds the government has to invest in various social schemes and development initiatives.

While it is true that GCC states have negligible or low tax to GDP ratios, most of these nations are rentier states that rely on hydrocarbon reserves for their revenue. As long as petrol continues to fetch premium prices these states can afford to pamper their population.

More pertinently, according to the World Bank, tax revenue as a percentage of GDP of the five Nordic countries averaged 26 percent in 2015; the tax-to-GDP ratio of UK and France — two countries with a GDP close to that of India — were 25 and 23 percent respectively. In contrast, in 2018, gross tax collections as a percentage of GDP in India stood at 11.3 percent. 

There are several factors behind India’s low tax-to-GDP ratio, including a very small base of direct-tax payers; those eligible to pay taxes often under-report their income, or pay less due to various exemptions in the tax law; the presence of a parallel economy; a large unorganized sector; and, in general the public penchant for not paying taxes. 

The government has various options to increase the tax-to-GDP ratio, including by raising taxes; enlarging the tax base by retaining the tax exemption limit at nominal prices for a few years; reducing the number of tax exemptions and lowering the tax exemption slabs; imposing new surcharges; boosting demand and maintaining fiscal consolidation. However, equally important is inculcating a culture of tax compliance among the public.

While tax evasion is illegal in India, tax avoidance is perfectly legitimate and is often a preferred choice of many businesses. Legions of wily tax consultants make a living from advising companies and individuals on ways to avoid taxes. One reason behind widespread tax avoidance is the existence of a large number of tax exemptions granted to various sectors and under different tax scenarios. Nearly 50 percent of the 700,000 companies that file income tax (IT) returns end up showing zero or negative income.

Each year, after the budget is announced, tax specialists pour through the voluminous budget documents to ferret out details that entities can leverage to avoid paying taxes. The accounting community’s obvious support for tax avoidance was once again blatantly displayed after the recent budget, as financial advisors appeared to trip over each other in their hurry to offer advices on ways to defer or dilute the newly introduced Long Term Capital Gains Tax and other levies. It is estimated that the country loses around 5 percent of GDP to the various tax exemptions currently in place.

There is also a stark disparity in the taxes paid by the salaried class and business people in the country. According to finance ministry sources, salaried people pay more tax than business people in the personal income tax category. For assessment year 2016-17, the 18.9 million salaried employees who filed IT returns paid a total of Rs1.44 trillion in taxes, which works out to around Rs76,000 per individual salaried taxpayer. Meanwhile, the 18.8 million individual business tax payers, including professionals, who filed their IT returns paid a total of Rs480 billion, which works out to an average of around a little over Rs25,000 per individual business tax payer.

No doubt, countries which today have higher tax-to-GDP ratios and a wider tax base did not reach those rankings overnight. The Indian economy is evolving and it will take time to mature. We appear headed in the right direction; latest finance ministry figures show that effective tax payer base in the country has gone up from 64.7 million in April 2014 to 82.7 million by March 2017, with 8.6 million new tax payers filing I-T returns in fiscal year 2017. The government’s two mega economic reforms — demonetization of select currencies in November 2016, and introduction of Goods and Service Tax (GST) in July 2017 — are expected to further improve the tax-to-GDP ratio and hopefully inculcate a culture of probity and tax compliance among the Indian public.


 

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