Here’s One Thing Modi Govt Should Do in Its Remaining Budgets

narendra_modi

The annual budget of the Narendra Modi government will be presented by the finance minister Arun Jaitley on February 29, the last day of this month.

Given this, it is a season where everyone has been advising Jaitley on how to go about the entire thing. Some economists have said that the government should increase the public investment, in order to get the economy growing at a faster pace. Others have said that it is important that the government maintain the fiscal deficit target that it has set for itself and not spend more in the process of increasing public investment. Fiscal deficit is the difference between what a government earns and what it spends.

Regular readers of the Diary will know that I am in the government trying to maintain its fiscal deficit camp. Having said that I am not against the government ramping up public investment as long as it can find the money to do so without increasing the fiscal deficit and borrowing more in the process.

As World Bank chief economist Kaushik Basu writes in his new book An Economist in the Real World—The Art of Policymaking in India: A fiscal stimulus is like an antibiotic. It is very effective when used for a short period of time. But if used repeatedly and over long stretches of time, the side effects tend to outstrip the benefits. In India’s case a large deficit is likely to fuel the inflation rate.”

Given this, it is very important as to how the government goes about increasing public investment. As Basu writes: “Choices have to be made very carefully. The first task to which more effort needs to be directed is raising tax revenue.”

Take a look at the accompanying table. Between 2010-11 and this financial year, the taxes as a proportion of gross domestic product have more or less been similar, and have varied within a narrow range. Interestingly, the taxes as a proportion of GDP have fallen since 2007-08.

 

Year Direct taxes as a % of GDP Indirect taxes as a % of GDP Taxes as a % of GDP
2004-05 4.1 5.26 9.36
2005-06 4.47 5.4 9.87
2006-07 5.36 5.62 10.98
2007-08 6.26 5.6 11.86
2008-09 5.93 4.79 10.72
2009-10 5.83 3.76 9.59
2010-11 5.72 4.4 10.12
2011-12 5.59 4.43 10.02
2012-13 5.59 4.75 10.34
2013-14 5.63 4.37 10
2014-15 5.63 4.31 9.94
2015-16 5.66 4.58 10.24
Source: Reserve Bank of India Average 10.25

 

One possible explanation for this lies in the fact that both the stock market as well as real estate prices rallied between 2002-03 and 2007-08. This meant that investors would have made a lot of capital gains, on which they would have paid capital gains tax. This would have pushed the total amount of income tax collected by the government.

In 2001-02, the direct taxes amounted to around 2.94% of the GDP. By 2007-08, they had jumped up to 6.26% of the GDP. Another possible explanation for this lies in the fact that the salaried class got very good increments during the period. Also, the wealth effect was at play as well. With stock prices and real estate prices going up, people felt wealthy and in the process indulged in greater consumption. This led to the collection of higher indirect taxes. The collection of indirect taxes fell dramatically after 2007-08. In 2009-10, indirect taxes collected were at 3.76% of the GDP.

Since 2010-11, the collection of direct as well as indirect taxes as a proportion of GDP has been more or less flat. What this means is that the same set of people are essentially financing the Indian government and there seems to have been no effort made to expand the tax base. As Basu puts it: “Not only is India’s tax-to-GDP ratio low, it went down over the last seven years. Global comparison suggests that India can do much better.”

How does India fair in comparison to other countries when it comes to the tax to GDP ratio? A study titled Tax Revenue Mobilisation In Developing Countries: Issues and Challenges points out: “In comparative perspective, developing countries raise substantially less revenue than advanced economies. The ratio of tax to GDP in low-income countries is between 10% and 20% whereas for OECD economies [or developed economies] it is in the range of 30- 40%.”

What this clearly tells us is that India is at the lower end of the spectrum when it comes to collecting taxes and hence, there is tremendous scope to improve. As Basu puts it: “India should aim to reach a tax revenue-to-GDP ratio of 15 percent within two or three years, and then set an even higher target of, for instance, 20 percent over the medium term.

This does not mean that the government has to raise tax rates. As Basu writes: “This can be done almost entirely through plugging of loopholes and prevention of tax evasion, and the implementation of a more rational tax code, without having to raise taxes.”

Interestingly, along with the budget every year, the government releases the statement of revenue foregone. As the statement released with the last budget pointed out: “The aggregate revenue impact of incentives available in respect of direct and indirect taxes (levied by the Central Government) is Rs 5,49,984.1 crore for 2013-14 and is projected to be Rs 5,89,285.2 crore for 2014-15.” The point being if the tax laws did not have a significant number of exemptions, the government would have collected more tax.

As the statement further points out: “The estimates and projections are intended to indicate the potential revenue gain that would be realised by removing exemptions, deductions, weighted deductions and similar measures.”

Hence, there is a lot to gain for the government if it goes about plugging these loopholes. But then that would mean side-lining corporate lobbies and big business, which finance political parties. Can the Modi government afford to do that?

On that your guess is as good as mine!

The column was originally published in Vivek Kaul’s Diary on February 25, 2016

 

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About vivekkaul
Vivek Kaul is a writer who has worked at senior positions with the Daily News and Analysis(DNA) and The Economic Times, in the past. He is the author of the Easy Money trilogy. Easy Money: The Greatest Ponzi Scheme Ever and How It Is Set to Destroy the Global Financial System , the latest book in the trilogy has just been published. The first two books in the trilogy were published in November 2013 and July 2014 respectively. Both the books were bestsellers on Amazon.com and Amazon.in. Currently he works as an economic commentator and writes regular columns for www.firstpost.com. He is also the India editor of The Daily Reckoning newsletter published by www.equitymaster.com. His writing has appeared across various other publications in India. These include The Times of India, Business Standard,Business Today, Business World, The Hindu, The Hindu Business Line, Indian Management, The Asian Age, Deccan Chronicle, Forbes India, Mutual Fund Insight, The Free Press Journal, Quartz.com, DailyO.in, Business World, Huffington Post and Wealth Insight. In the past he has also been a regular columnist for www.rediff.com. He has lectured at IIM Bangalore, IIM Indore, TA PAI Institute of Management and the Alliance University (Bangalore). He has also taught a course titled Indian Economy to the PGPMX batch of IIM Indore. His areas of interest are the intersection between politics and economics, the international financial crisis, personal finance, marketing and branding, and anything to do with cinema and music. He can be reached at vivek.kaul@gmail.com

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