Low tax to GDP situation in India

India’s tax to GDP ratio at 16.6% is well below the emerging Market Economies (EME) and OECD averages of about 21% and 34% respectively. Taxation is the key to long run political and economic development.Therefore, bringing more and more people into the tax net via some form of direct taxation will help in realizing the promise of Indian democracy.

Following reasons may be attributed to the low tax (both direct and indirect) to GDP ratio in India:

1.Structural factors like low per capita income. Low average incomes and a high poverty rate result in a very small portion of the labor force being eligible to pay personal income taxes.
2.Small tax base and its adverse effect tax buoyancy- India’s ratio of taxpayers to voting age population is significantly less than that of comparable countries (amounting to 4% while 23% is desirable). A small tax base unnecessary burdens the honest tax payer. According to Shome Panel, in the last 10 years though the direct tax collection has increased by more than 700%, the number of tax payers has merely grown by 35%.
3.Tax exemption and subsidy policies- The exemptions in the taxable income have grown at a much faster rate than the income. As a result, there is less tax buoyancy. Similarly tax expenditure in the form of tax subsidies and exemptions was more than 6 Lakh crores in FY 2016-17.
4.High Tax evasions- Tax compliance in India is extremely low, especially w.r.t. indirect taxes
5.Lingering of contentious, adversarial tax issues- India has one of the highest numbers of disputes between tax administration and taxpayers, with lowest proportion of recovery of tax arrears. For example the Vodafone tax dispute involving Rs.20k crore lingering since 2008.
6.Loop holes in double tax avoidance treaties- Provisions for tax exemption from short term Capital gains are often misused by companies to re-route their investments from such countries (called round-tripping of funds).Similarly issues related to tax evasion, double non-taxation, and transfer pricing need to be fixed.
7.Lapses in tax administration- Tax Administration Reforms commission point to various areas for example removal of artificial separation between direct and indirect tax administration, and need for enhanced co-operation between CBDT and CBEC among others. Corruption too possess its economic costs and should be eliminated. Cash transactions facilitate tax evasion.
8.Flourishing informal market ecosystems – Informal sectors like paying-guest accommodations, kirana stores, stationery shops, etc. evade taxation.

Measures to improve tax to GDP ratio in India:

1.Widening the tax base by Implementation of GST- GST will be a game changer as it will radically improve collection efficiency, will phase out a number of exemptions in a phased manner, lower tax rates, increase the compliance level and generate more revenues from indirect taxes. GST will widen the tax base and generate additional annual revenues of about 1.5 per cent of gross domestic product (GDP).
2.Improving compliance rate of tax laws- GAAR provisions may be useful in dealing with tax evasions where tax benefits exceed Rs. 3 crore.
3.Fixing loopholes in taxation agreements- Renegotiating double tax avoidance treaties which are frequently misused to evade tax. Recent amendments in Mauritius double tax avoidance agreement is a case in point. (Mauritius has been the source of around 34 per cent of all foreign direct investment inflows into India between 2000 and 2017).
4.Fast tracking of tax disputes, reducing discretion of taxman and creating a predictable dispute resolution mechanism.
5.Efficient targeting of subsidies and phasing out tax exemptions- Subsidies to the well-off need to be scaled back, similarly tax exemptions to be reviewed and phased out ; reasonable taxation of the better-off, regardless of where they get their income from—industry, services, real estate, or agriculture.
6.Developing property taxation-They are not only progressive and buoyant but also difficult to evade since they are imposed on a non-mobile good, which can with today's technologies, be relatively easily identified. Given the extent to which property is a critical constituent of wealth and a potential source of local government revenues, property taxation reforms should be an important part of the country’s tax reform agenda
7.Creation of Tax policy council and tax research unit as suggested by Shome Panel for both direct and indirect taxes. These will be crucial in analyzing computerized tax data.
8.A number of issues in tax policy and tax administration need to be addressed as mentioned in Tax Administration Reforms Commission. For example: avoiding retrospective taxation, separate dispute management verticals in CBDT and CBEC etc.

As pointed by Economic Survey 2016-17, one low hanging fruit would be to refrain from raising exemption thresholds for the personal income tax, allowing natural growth in income to increase the number of taxpayers.It is in India’s long term interest to increase tax to GDP ratio as it holds the key to rapid economic development which is crucial for India’s transformation into a developed economy.

By: Harman Sandhu