Expanding India's tax base

Praveen Chakravarty makes the point that India's very high income tax threshold, one of the highest in the world at 2.5 times the country's per capita income, is a major contributor to the country's low tax base. For the record, only 3 per cent of Indians and just seven out of 100 voters file tax returns!

Without getting into the merits of this proposition, I would argue that this is unlikely to make much dent on the problem of low tax base. 

Even assuming a 10 per cent tax on all income above Rs 1 lakh (i.e. 1 to 2.5 lakh) and assuming everyone one of the 10 million (assesses with income below Rs 2.5 lakh) have an income of Rs 2.5 lakh, we are left with an increment of 0.1 per cent of GDP to the tax-to-GDP ratio. This is a rounding error!

This goes back to the point that Ananth and I tried to make here.  Any which ever combination of policies (base expansion, forensics, agricultural income, higher income tax rate etc) to expand the tax base are most likely to be orders of magnitude off from the 3-5 percentage points increases that one would expect from a country of comparable economic development. We should do all of them for sure, but expectations should be tempered.

When we make inferences based on anecdotal and our own life experiences (the apparently countless people around us who have cars, go for vacations, and own expensive houses) and feel aghast at the low tax compliance, we may be overlooking the fact that the representative sample is misleadingly small. For sure, we can triple or quadruple that wth better compliance etc. But even that would be marginal. 

We could also look at several urban proxies of consumption - aspirational food like burgers/pizzas from global chains, vehicle ownership, consumption of services like vacations and cosmetic procedures, retail purchases of consumer durable brands etc - in comparison with others at similar stages of growth and my guess is that we would find that the real "consuming" middle class is relatively narrow. No wonder that fast food chains are already hitting a growth plateau, just a few years into their full-growth phase. Given our representative sample One would have thought that these things should have comfortable double digit growth for atleast 10-15 years.

More reliable quantitative measures can be obtained from an analysis of e-commerce transactions and comparing trends in other similarly placed countries and China. I would be very surprised if they contradict these trends. 

A recent analysis of the Socio-Economic Caste and Census (SECC) data by the excellent folks at Credit Suisse gives a sense of the scale of rural deprivation. It found that 30% of rural households had cultivation as the source of income, but a large 51% do manual labour, indicating a small percentage of HHs controlled the majority of rural income. Only 17 mn, or less than 10 per cent households had salary income, of which nearly two-thirds were in government or government-owned firms. Only 6.5 mn (3.5 per cent of total rural households) had private salary income (and the vast majority would be those with annual incomes below Rs 2.5 lakh), indicating the limited reach of corporate India. 

Given that agriculture formed 29% of GDP in 2011 and just 30% of the 180 million rural households got their income from cultivation (and only a very minuscule proportion of them are likely to be anywhere close to contribute significantly to tax revenues), the scope of squeezing out significant tax revenues from even agriculture income is marginal. As a disclaimer, this is not to say anything about the merits of taxing agriculture income, but a reminder about the futility of significant tax base increases from such efforts.

So what should be done? Apart from the broader issue of more capital accumulation covered in our book, a more realistic and fruitful place to start, would be in plumbing issues. The Central Bureau of Direct Taxes (CBDT) should quickly establish professionally competent tax policy and data analytics divisions. They should develop an eco-system of data sharing, with appropriate safeguards, with various state and central government departments. The former should use data for better tax policy design, and the latter should use it to improve assessments, compliance and collection. 

Even initiating a debate on assessment of agriculture incomes, without any tax payment, would involve some idea of the numbers involved, currently lacking with the policy designers.