How India's informal black economy severely hurts the government

May 27, 2015

- By Vivek Kaul

Vivek Kaul
The annual report of the ministry of finance points out that the total number of income tax assessees as on October 30, 2014, had stood at 4.79 crore.

The number had stood at 4.7 crore as on March 31, 2014. As on March 31, 2011, the number had stood at 4.08 crore. This means that between March 2011 and March 2014, the number of assessees filing their income tax returns went up by a minuscule 4.8 per year.

In fact, the method of measuring the total number of income tax assessees was revised in March 2014 and this revision has pushed up the number of assessees considerably. As per the earlier method, the total number of assessees as on March 31, 2011, had stood at 3.55 crore. The new method pushed up the total number of assessees by more than 50 lakh, as of end March 2011. This is not a reason to worry given that the new methodology is more reliable and accurate.

Nevertheless, despite this revision, on the whole, the total number of income tax assessees in India remains very small. In comparison, nearly 45% of American population files income tax return. What this means in an Indian context is that India has a huge informal economy which as Taimur Baig of Deutsche Bank Research puts in a recent research note, operates "outside the lens of formal observation, oversight, or analysis."

"India's statistics commission suggests that half the gross national product is accounted for by the informal economy...Numerous businesses are unincorporated, transactions involving huge quantities proceed daily on a cash basis, most people and businesses do not file for taxes, making a sizeable chunk of the economy unregulated and unsupervised...The government finds it hard to widen the tax net, ending up overburdening the formal sector," writes Baig.

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The government's inability to widen the tax net as Baig writes and as data in the annual report of the ministry of finance suggests, has led to a situation where the government has to regularly slash expenditure towards the last few months of the financial year. Take the case of the last financial year 2014-2015, the total expenditure of the government when the budget was presented in July 2014 had stood at Rs 17,94,892 crore. By the time the next budget was presented in February 2015, the total expenditure had been slashed by 6.3% to Rs 16,81,158 crore. This is a trend that has played out in each of the last three financial years.

Typically when the government has to cut down on its expenditure, it is the plan expenditure which faces the severest cut. Take the case in 2014-2015, the plan expenditure at the beginning of the year had been set at Rs 4,53,503 crore. It finally came in at 19.1% lower or Rs 3,66,884 crore As I have often pointed out in the past, plan expenditure is essentially money that goes towards creation of productive assets through schemes and programmes sponsored by the central government.

Non-plan expenditure on the other hand is an outcome of plan expenditure. For example, the government constructs a highway using money categorised as a plan expenditure. But the money that goes towards the maintenance of that highway is non-plan expenditure. Interest payments on debt, pensions, salaries, subsidies and maintenance expenditure are all non-plan expenditure. Given the regularity of the non-plan expenditure the asset creating plan-expenditure gets slashed. And that is clearly not a good thing.

This largely happens due the inability of the government to grow its tax base. Another disturbing trend that has emerged over the last few years is the growing dependence of the government on revenues from indirect taxes like customs duty, excise duty and service tax.

Data from the Reserve Bank of India shows that in 1990-1991, direct taxes (income tax, corporation tax and wealth tax, which has been done away with from this financial year) formed 16.06% of the total taxes collected by the government. Indirect taxes formed 83.94%.

In 1991-1992, the year economic reforms were first initiated, direct taxes jumped to 20.2% whereas indirect taxes fell to 79.8%. Since then, direct taxes maintained their upward move and by 2009-2010 formed 59.5% of the total taxes. The share of indirect taxes had fallen to 40.5%.

The trend has been reversed since then and in 2013-2014, the share of direct taxes had fallen to 53.9%, whereas indirect taxes had jumped to 46.1%.

This is a clearly worrying trend simply because indirect taxes are regressive. A regressive tax is essentially a tax which is applied uniformly on everyone and given that it means that individuals with lower-incomes are hit harder.

That isn't the case with direct taxes like income tax where the marginal rate of taxation goes up as the taxable income goes up. Given this, it is important that the government focuses on increasing the total number of people paying direct taxes.

As Baig of Deutsche Bank Research points out: "Tax authorities in recent decades have handed out simplified procedures to file for taxes and register businesses, although the results have not been encouraging. Previously untaxed parts of the economy, especially in the services sector, have been brought into the tax net, but the fact that tax yield has not improved suggests room for improvement."

Also, the government seems to be focussed on recovering the black money that has already been accumulated. Some focus on widening the tax base and ensuring that the black money that will be generated in the future comes down will not do it any harm.

Vivek Kaul is the Editor of the Diary and The Vivek Kaul Letter. Vivek 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. The latest book in the trilogy Easy Money: The Greatest Ponzi Scheme Ever and How It Is Set to Destroy the Global Financial System was published in March 2015. The books were bestsellers on Amazon. His writing has also appeared in The Times of India, The Hindu, The Hindu Business Line, Business World, Business Today, India Today, Business Standard, Forbes India, Deccan Chronicle, The Asian Age, Mutual Fund Insight, Wealth Insight, Swarajya, Bangalore Mirror among others.

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6 Responses to "How India's informal black economy severely hurts the government"

PRITAM MALHOTRA

May 31, 2015

Total no of assessies of income tax in India is just 4.79 crores while PM Modi boasts of roaring poulation of 125 crores of Indians in most of his speeches.

Due to improper taxation methods about 30 -35% population gets scot free in payment of Income tax each year.
If salaried class, pensioners and persons falling in TDS
net are deleted from existing 4.79 crores what will be the exact number of tax payers?
Much improvisation is needed to arrest black economy lying hidden in cash transactions and freebies in taxation known to CAs and advocates only.

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abhay dixit

May 28, 2015

Vivek, it will be difficult to believe that governments will reduce the burden on existing tax payers if more people come in Income/Excise/Vat tax net. Probably, they will find more schemes to distribute that money to govt servants and their cronies.

Looking at productivity of governments, is it better to keep money out of reach of our governments?

Does it mean we are a much bigger economy than we think?

Black gives us connotation of something sinister. It is not. It is just unaccounted. Better to call it UNACCOUNTED than BLACK. It is productive, generates employment and demand.

I am not supporting tax evasion but just pointing a reality.

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Amal

May 28, 2015

It's no rocket science to widen the tax Base..Instead of trying complex methods, simpify tax calculation and procedures for all citizens, make the refund process super efficient, throw out corrupt I. T. officers , and work towards an India where every citizen world be proud to pay his taxes. In brief correction is to be made by the government and it must undo years of congress misrule.

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S.Krishnan

May 28, 2015

The only way is to curb all cash transactions. The argument that this will inconvenience uneducated/rural population does not sound correct. With govt efforts to bring all under banking system this argument does not hold water.
To start with beyond a certain value say Rs20,000 can be brought under non cash category for individuals. Banks should not accept any cash above Rs20,000 on a single day.
A spin off benefit would be it will make that much difficult to spend bribe money.
A strong political will is required to implement this.

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kcshah

May 27, 2015

In USA if r paid one day salary, tax is deducted. So one has to file return to claim refund. Even though woman may not working but husband files return jointly to pay less taxes, which brings more % of tax payer.Even social security earners tax is deducted.

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Girish Patkar

May 27, 2015

It is a known fact that proprietary, small and medium scale businesses pay very little or no tax on income. Transactions are done in cash. The only way to widen the tax base is therefore to dis intensivise tax evaders through a carrot and stick approach. The FM has shown the carrot by promising to reduce rates and the administration must now show the stick.

There should a mix of strategies. Clear and simple tax rules and reasonable tax rates for those who comply and those who want to comply. Shock and Awe for those who are believe that taxes are never to be paid.

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