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Source: The post is based on an article “India’s tax-GDP ratio may be too high” published in the Indian Express on 8th August 2022.
Syllabus: GS 3 The Union Budgeting in India
Relevance: Tax/GDP Debate
News: In a recent web publication, the IMF published its World Revenue Longitudinal Data set for all countries, from 1990-2019.
Common Observations of India’s Tax/GDP Ratio
(1) India’s Tax/GDP ratio is low, at around 10-11% of GDP. It has stayed close to that level for the last 20 years. In 2019, it hit a decade low of 10% of GDP, the same as in 2014.
(2) In comparison with our peers, India’s tax/GDP ratio is much lower. Therefore, it is argued that it should be increased.
Debates on Tax/GDP Ratio in the Indian Economy
India’s tax/GDP ratio is one of the three important fiscal variables in the economy, i.e., taxes, fiscal deficit, and debt. And it is lower than what it “should” be.
These fiscal variables are interrelated. Therefore, a lower tax/GDP ratio impacts the other two fiscal variables. I.e., lower tax revenue means higher fiscal deficit, for the same level of expenditures, and higher deficit means higher debt. All three, directly or indirectly, are assumed to affect growth and/or inflation.
It has been argued that the low tax ratio in India has led to a lower rate of investment, a higher fiscal deficit, and lower GDP growth.
What are the issues in the arguments for low-tax/GDP ratio in India?
However, there is no empirical evidence to indicate a causal relationship between tax ratios or fiscal deficits and growth. But no doubt there is a well-established relationship between investment and growth.
India should compare its tax-GDP ratio with the tax/GDP ratio of the G20 countries. There is a misinterpretation because the tax collected is a function of the average level of per capita income. And Per capita income in the G20 varies from around $2,100 (India) to around $65,000 (US).
In the pre-pandemic year 2019, India’s tax-GDP ratio was 16.7%. It was higher than that of China (15.9%), Mexico (14.1%), Indonesia (11.0%), Saudi Arabia (5.9%), and Turkey (15.9%) among G20 economies.
If the comparison is done with the tax-GDP ratio adjusted for PPP per capita income, the IMF’s data reports that the world average tax gap is -1.3 percent and India is at +1.2 percent for the nine years 2011-2019. So, India’s tax GDP ratio averages 2.5 percentage points more than an average economy.
Among 70 Emerging economies, excluding Advanced Economies and countries belonging to the former Soviet Union, India’s rank is 20, i.e., India’s Tax ratio is higher than 50 peers on a systematic basis.
Debates over the structural measures to increase the tax/GDP ratio of India
Hike Corporate Tax Rate View: Some experts argued to increase revenue from corporate tax (one of three major components of tax revenue, the other being income and indirect taxes). Because inequality was increasing, the rich should pay more taxes to lower the fiscal deficit.
Lower Corporate Tax Rate View: A small minority of economic experts argued that the higher corporate tax rates will stifle investment, increase tax un-compliance, and lower growth. Therefore, there should be a lowering of the corporate tax rate in India to meet the intended goals
Various Structural Change Measures Taken for Increasing the Tax Collection in India Post-2019
Corporate tax cut 2019: In September 2019, the Finance Minister lowered the corporate tax rate by around 10 percentage points. This was one of the largest corporate tax cuts in world history. Unfortunately, the pandemic struck the world a few months later and disrupted world economies.
Efficacy of the tax cut in India
The corporate tax revenue has increased by 66%, and GDP by 33% based on the use of fiscal 2019-20 as a base. It means, there has been an average tax buoyancy of 2.0 over three years since 2019.
Tentatively, the tax-GDP ratio in the fiscal year 2022-23 will average over 18 percent in India, a level close to Japan and the US.