Akhilesh Tilotia and Akshata Kalloor.
More Indians now assessed to tax, they have higher incomes, tax net is now cast wide, and average effective rates of tax have come down
The fiscal choice for any country is whether it gets more incomes to tax or taxes incomes more. On the back of novel analyses on Indian tax data, we note that the fiscal contract of Indians with their country has changed meaningfully over the last decade.
Last year, we converted the vast data sets emerging from digital tolling on India’s highways to create HeatMaps to get a perspective on India’s economy (Building on the digital data stack, Aug 18, 2023). In this article, we look at the changing base and rates in direct taxes.
A look at the filers
Over time incomes that individual direct tax filers have filed show a move to higher brackets, even as more filers are coming into the tax net (see Chart 1). A part of this can rightly be attributed to higher nominal incomes. However, as we detail later, there is a large real growth in the tax collections.
We note a similar steepening of curve for other direct tax filers too. The number of filers in case of direct taxes has more than doubled from 31.3 million in FY2012 to 67.6 million in FY2021.
Rising tax base and falling effective rates of direct taxes
We work with annual data on (a) cumulative gross total income (GTI), (b) “returned” income (RI, i.e., the incomes offered to tax in the income tax return), and (c) the total tax collected. Aggregate disclosure of GTI and RI on various heads of incomes (salary, house property, business, capital gains, and income from other sources) for various types of assesseess is also available. Trend line and proportions of these incomes against overall GDP and tax collected offers insights on how India’s income composition has changed. This data is currently available only till FY2021.
The proportion of GTI-to-GDP has increased from 24.2% in FY2012 to a 35.1% in FY2021. The ratio of RI to GTI has remained roughly constant at ~90% through the period: we can hence say that the deductions as a proportion of income have not materially changed. India’s per-capita income of ~Rs 146,000 in FY2021 is significantly lower than the minimum income chargeable to tax. It is, hence, heartening to see the deepening of the tax base such that more than a third of the incomes are now offered to tax, up from less than a quarter a decade ago.
The ratio of tax-collected-to-RI has fallen from 18.7% in FY2012 to 15.6% in FY2021, a fall of more than 310 basis points. Lower effective tax rates are mainly driven by a fall in corporate tax rates which, in 2019, were reduced for existing domestic companies and new domestic manufacturing units. The effective corporate tax rate, basis the tax computed to be paid to RI, ranged between 30% and 35% between FY2012 and FY2019 but fell to 24.3% in FY2021. For individuals, average effective tax rates did not significantly change, remaining between 10.4% and 10.8% over FY2012-21.
Deaveraging direct taxes
Overall direct tax-to-GDP ratio has gone up from 4.1% of GDP to 4.9% over FY2012-21. This includes taxes from various “persons”. In Chart 2, we detail the direct tax collected as a percentage of GDP across individuals and businesses over time, juxtaposed with the average effective tax rate.
A note on the methodology: tax refers to the tax payable as computed as per returns filed by assessees of these two categories. There are seven categories of “persons” including firms, association of persons, Hindu Undivided Family (HUF), etc.
Salary incomes (of individuals) constitute 55.1% of total GTI in FY2021, up from 51.6% in FY2012 while business income is down from 33.4% to 29.2% – a roughly 400 basis points interchange in the two largest income categories, which between them account for ~85% of overall incomes.
The numbers used in this analysis may not fully tie in with the direct tax-to-GDP ratio as detailed by the Ministry of Finance in their annual budget documents due to many factors including changes in tax due after assessments, penalties, refunds, etc. Government’s actual collections are higher than the numbers noted here, though the trend is broadly similar.
For individuals, tax computed as due, as a proportion of GDP, increased by ~80 basis points to 2.1% of GDP in FY2021 from 1.3% of GDP in FY2012. This is driven both by (a) the increase in number of tax returns as noted earlier, and (b) an increase in incomes: more than four-fifths of all individual tax filers earned gross incomes of less than Rs. 5.5 lakh in FY2012, this proportion was three-fifths by FY2021. We note the relative stability of the effective tax rate between 10.4% and 10.8%.
For businesses, tax computed as due changed marginally by 10 basis points to 2.6% of GDP in FY2021 from 2.7% of GDP in FY2012. The cut in tax rates in FY2020 shows up clearly in the tax-to-GDP collected from business incomes since that year.
Laffer and other caveats
We know from Budget documents that over the next three years to FY2024, direct tax-to-GDP ratio has continued to rise. As the data are released, it will be instructive to see whether this is due to lower taxes on business incomes leading to higher tax collections or whether the individual income taxes continue to contribute more.
American economist Arthur Laffer famously developed a bell-curve analysis on a napkin in 1974 (“Laffer Curve”). The curve is a graphic representation of the relationship between rates of taxation and the resulting levels of government revenue. While there is no absolute number that the curve posits, it proposes a tax rate, t*, which optimizes tax collection for the government. If tax rates are higher than t*, a fall in tax rates can lead to increased overall tax revenue for the government.
As India saturates in bringing the incomes currently exempt or out of tax net into compliance, it will need to think about the appropriate t*. The nature of the fiscal contract in a USD 10 trillion economy will be very different from the current one.
The authors are with National Investment and Infrastructure Fund. Views are personal.
