Is India’s tax base low?

Praveen Chakravarty of IDFC Institute adds to the debate with interesting data to ponder about.

His basic point is the threshold for exempting income tax is much higher than other countries. The ratio of per capita GDP to income tax exemption threshold is five times higher than world average.

Why is it then a big surprise that a mere 3 percent of Indians file income tax returns?

On the ratio of per capita GDP to income tax exemption threshold, India is a complete outlier in the world. The average ratio across 20 developed and developing countries is 0.5, i.e. the income tax exemption threshold in a country is only half its per capita GDP. For example, the average person in China earns 50,000 yuan but anyone earning more than 18,000 yuan will fall under the tax bracket. Similarly, the ratio of income tax exemption threshold to per capita GDP in Brazil is 0.8. It is 0.2 in the United States and 0.9 in Mexico. India’s ratio is 5 times greater than the world average. As the chart below shows, only Bangladesh has a greater ratio than India.

So, when the Economic Survey suggests that India has among the fewest taxpayers per 100 voters, it is equally important to consider this fact that India has one of the highest exemption thresholds for paying income tax.

So it is not fully fair to say India does not pay taxes. Lower the exemption limit and you have more people part of the tax fold.

In the Union Budget of 2017-18 presented by the Finance Minister recently, the income tax rate for the first income tax slab was lowered from 10 percent to 5 percent. So, India not only has a high income tax exemption threshold but also a very low rate for the first income tax slab.
Again, India stands out in this aspect compared to the rest of the countries in the world. The chart below plots the ratio of income tax exemption threshold to per capita GDP on the X axis and the rate of income tax for the first slab on the Y axis. As evident in the chart, India is a complete outlier yet again, even more of an outlier than Bangladesh, whose income tax rate for the first slab is higher.

Data source: Praveen Chakravarty
Data source: Praveen Chakravarty

In the last two decades, the income tax exemption threshold has increased six-fold from Rs 40,000 to Rs 2.5 lakh. In contrast, the average annual nominal incomes of Indians have multiplied only three-fold in this period.

It is thus premature to conclude automatically that India’s inordinately low tax base is entirely a function of massive tax evasion by Indians. While lowering the income tax rates, had the Finance Minister also lowered the income tax exemption threshold to say Rs 1.5 lakh, 1.1 crore more Indians would have automatically qualified to pay income tax. This would have brought India more in-line with the rest of the world in terms of exemption threshold to per capita GDP ratio.

Hmm..

One needs to dice and slice data to get more ideas..

Actually for a very long time we have been obsessed with taxes and who is paying them. We have not looked at expenditure side at all barring when it comes to subsidies. How efficient has Indian Government’s spending been all these years? One would hypothesise that the record has been a really poor one so far (would like to be proved wrong here).

The Indian government over the years has also nicely spinned the story saying more taxes will enable State to deliver more and help India develop. Well the intention is welcome, but the history of development via taxes more so income tax needs to be understood from a historical perspective.

 

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