Here's One Thing Modi Govt Should Do in Its Remaining Budgets - Vivek Kaul's Diary
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Here's One Thing Modi Govt Should Do in Its Remaining Budgets

Feb 25, 2016

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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."


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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 4.10 5.26 9.36
2005-06 4.47 5.40 9.87
2006-07 5.36 5.62 10.98
2007-08 6.26 5.60 11.86
2008-09 5.93 4.79 10.72
2009-10 5.83 3.76 9.59
2010-11 5.72 4.40 10.12
2011-12 5.59 4.43 10.02
2012-13 5.59 4.75 10.34
2013-14 5.63 4.37 10.00
2014-15 5.63 4.31 9.94
2015-16 5.66 4.58 10.24
    Average 10.25

Source: Reserve Bank of India

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!

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.

Disclaimer: The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

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4 Responses to "Here's One Thing Modi Govt Should Do in Its Remaining Budgets"

KD

Feb 25, 2016

Don't you get the clue for main budget from rail budget? Why did not they raised fares?

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Satish Shah

Feb 25, 2016

Mr. Vivek,
Why even you are afraid of taxing wealthy farmers? The highest sales of Audi , Pajero and Rover Cars/SUVs are in small towns of Gujrat, Karnataka, Punjab, Haryana, M.P., TAMILNADU ETC., they are cash rich AND ARE ENJOYING FULL NON TAXING BENEFITS and that has led all politicians to buy farm lands and got united in support of non taxing on farm income. Atleast begin with 100 acres or more area holdings. That way small farmers will be spared and Govt. could fill it's coffers without increasing it's borrowing i.e. fiscal deficit. The vital question is having political courage to tax them as Congis., Commies, Lalu, Mulayam, Mayavati , Mamta ,DMK & Anna DMK and New Hero in making Mr. Kejari will raise hue & cry to compete with each other in becoming " MESSIAH " of farmers AND shall bring JATS, PATIDARS alike citizens on streets and guide/ lead them to start arson, loot, rampage etc. to tarnish the image of Govt. and ultimately roll back proposal of levying taxes on farm income.
There are no so called "MESSIAH" FOR URBAN MIDDLE CLASS. May God save our country. JAI HIND.
Satish Shah, Mumbai.

P.S. When you are reffering to tax collection in comparison to other countries, pls try to find out the holidays of tax on farm income vis a vis ours.

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mohan

Feb 25, 2016

percentage comparison can be deceptive. Developed [OECD] countries' tax to GDP ratio is high - fine.
But India is developing country hence, [1] incentives to grow are a must - particularly industries and [2] taxation is also liked to income levels - what's the average income in India and compare that to average income in OECD countries?
Can India afford increase taxation - NO! so efficient tax collection and more use of technology for tracking tax payers, including corporates, is the answer. High time Agricultural income - above certain level [Rs.1 mn or so] should be taxed.

Like (1)

Balakrishnan R

Feb 25, 2016

Dear Mr. Vivek,
It is good that you have given points for improving India. I feel that Governments can invest to reduce the operation costs but should not bear the operation cost. AIR India, BSNL and many public sector companies. Fuel subsidy; with great effort, it has come out of Diesel subsidy; similarly, it should come out of cooking gas subsidy. It can increase the cylinder price by Rs 6 to 10 month and should slowly come out. Everybody say that salary and pension cost is major one. It would be easy to come out this situation with a proper plan. Like Government undertaking companies, where there is no pension but only contributory provident fund exists, similar approach should be followed in the case of government employees. This make budgeting easier; there won't be future cost.

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