Tax rate increases are in the air, especially since all of us have read about the fiscal cliff in the US, the 99 per cent vs 1 per cent fashion, President Hollande of France (an economy closest to us in its non-economic and Luddite views) proposing prohibitive tax rates on the rich, etc.
C. Rangarajan, advisor to the prime minister, stated, appropriately on Financial Inclusion day, that one need not disturb the structure of income tax system as it is now. But add a surcharge for income above [a] particular level. I believe as we go along, we need to raise more revenues and the people with larger incomes must be willing to contribute more.
Note the populist appeal to the super-rich. They should be willing or else, off with their heads (income). As discussed in my earlier article, Taxing the rich and other fantasies (IE, January 23), there is precious little evidence to support Rangarajans recommendation. What the data do suggest, as documented extensively below, is that the reason tax revenue is considerably below potential is because the middle income group, those earning between Rs 5 to Rs 10 lakh, is quite unwilling to pay taxes, even at an average tax rate of 10 per cent! And that the most willing are the super-rich, those earning above Rs 20 lakh a year. The raise tax rates recommendation should be junked, especially since stable tax rates have generated good tax revenue and allowed compliance to increase more than threefold from the abysmally low levels which prevailed prior to the 1997-98 budget.
Until 2005-06, India, via CAG reports on the ministry of finance, had access to data, some data, on the distribution of income and taxation. After that whoosh all the information stopped. Now the reports only reveal the total number of taxpayers in the economy, about 3.24 crore, out of which about 1 crore file tax returns but dont pay any tax because their incomes are below Rs 1.8 lakh.
What the tax department, and all of us, should be interested in is maximising tax revenue. The table reports all the relevant tax parameters for fiscal 2011-12 who pays taxes, who should pay taxes, rates of taxation, revenue collected, etc.
Some suggestive conclusions:
The total amount of personal income tax (PIT) that could have been collected in 2011-12 was Rs 517,000 crore or Rs 5.17 trillion. The total amount that was collected was Rs 1.72 trillion indicating an overall compliance rate of 33 per cent. So two-thirds of the taxable population avoided paying taxes altogether or paid two-thirds less taxes than they should have.
The dominantly large share of the flow of black money each year is indicated by the gap in tax collected and tax due and for 2011-12 this gap, Rs 3.45 trillion, is about 4 per cent of GDP. For the 10 years 2002-03 to 2011-12, 4 per cent of average GDP is Rs 20 trillion. This suggests that the recent estimates pegging black money at around Rs 25 trillion are in the right ballpark and that our missing tax estimates are broadly correct.
The largest share of missing taxes is among those earning between Rs 5 to Rs 10 lakh a year. They are in the top 7 per cent of the population, they number around 25 million, and only about 10 per cent of such individuals pay any tax. How much missing taxes is in this group, a group for which the average tax rate is only 10 per cent? About equal to the entire tax collected in 2011-12: Rs 150 thousand crore.
About Rs 1 trillion is lost among those earning between Rs 10 and Rs 20 lakh a year. Such individuals are in the top 2 per cent of the population, and only a third of such individuals pay any tax.
The super-rich or those earning more than Rs 20 lakh a year: there were 88 lakh such individuals and 58 lakh paid taxes, yielding a compliance rate of 66 per cent. Missing taxes for this group: Rs 0.46 trillion, or only 13 per cent of the entire amount of PIT missing in India.
If compliance levels stay the same, a surcharge of 3 per cent on super-rich incomes will yield about Rs 2,600 crore. Alternatively, the government could make an effort, with support from its tax administration officials, to reduce corruption, reduce black money, and increase taxation of the top 7 per cent. If compliance in this group was brought to only the average of the economy that is, 30 per cent that alone would generate an extra Rs 35,000 crore, that is, five million extra taxpayers, paying an average tax rate of only 10 per cent, on average incomes of Rs 7 lakh. Okay, if tax administration increased compliance by only 3 percentage points, from 10 per cent to 13 per cent among this middle income group of Rs 5 to Rs 10 lakh, the extra revenue gained would be Rs 5,250 crore or double that gained from putting a 3 per cent surcharge on the super-rich.
These simple calculations yield at least three recommendations. First, it should be mandatory for the finance ministry to release data on tax compliance by income groups a practice common in most economies in the world. Surely, no one can oppose the release of this statistic, so why isnt it being practised? Possibly because it will cast a very black shadow on the workings of the tax administration in India? Second, the biggest revenue gainer is via an increase in compliance, especially for the middle income group. Third, stop thinking of populist measures like surcharges on the super rich, or copy French measures like increasing tax rates for anybody. If any such measures are introduced in the budget, it would not be a responsible budget as the finance minister has promised and not responsible by a long shot.
The writer is chairman of Oxus Investments, an emerging market advisory firm, and a senior advisor to Blufin, a leading financial information company