Date: 18/02/2023

Relevance: GS-3: Fiscal Policy and their effects on the economy; Tax structure and Tax Reforms.

Key Phrases: Tax-to-GDP ratio, Tax avoidance, Tax Evasion, Fiscal Policy, Tax Reforms, Capital Expenditure, Gross Capital Formation, Corporate Tax, Policy stability, Effective tax rate, Developing Nations and Advanced Economies, Revenue impact.

Context:

• According to projections by the World Population Review, India has surpassed China as the world's most populous nation.
• Tax evasion and avoidance have always been a headache for the government which has a negative effect on the growth of the Indian economy.

Key Highlights:

• India is a country of 1.4 billion people with a rising middle class.
  • On the face of it, the country presents untapped growth potential.
• According to OECD, a quarter of our population is less than 15 years old which makes us a very youthful nation indeed.
  • Share of elderly population is among the lowest and fertility rates are high.
• The steady upward trend in the working age population is particularly noteworthy as it gives us a definitive edge over our peers and can help drive growth in the coming years.
• There are many broader policy implications that arise – harnessing this workforce effectively to contribute to GDP, providing them the right skill training, providing jobs, social security etc.
  • But a growing workforce should also result in an increase in income tax revenue.

What is the status of Income Tax Base?

• Recently, the Finance Ministry had revealed that the number of people who filed income tax returns stood at 6.8 crore in 2020-21.
  • This means that only 4.8 per cent of the total population filed IT returns in 2021.
  • Of these, only 1.69 crore paid tax since 65 percent of the taxpayers earned less than ₹5 lakh.
  • So effectively, only 1.2 per cent of the population pays income tax as of now.

Why is the Income Tax base narrow?

• Larger Workers in Informal Sector
  • In India, a large portion of the workforce is employed in the unorganized or informal sector.
    • This is one of the reasons why fewer people are filing tax returns.
  • Drive towards formalization of the economy and identifying high income earners in the informal sector can help increase the number of income tax payers.
• Low Worker Population Ratio
  • According to the World Bank, 95 crore people were in the working age group of 18 to 64 years out of the total population of 140.76 crore in 2021.
    • Now, not all those in the working age are employed.
    • For example, Many women are home-makers or care-givers and may not be in the working cohort.
  • The worker population ratio in India is 44.5 per cent, which means that only 42 crore people could be employed in some way or the other in India.
• High Income Threshold
  • As per the tax laws, the tax incidence arises only if the income is above a certain threshold.
    • If we account for people earning under ₹5 lakh per annum, that is likely to whittle down the taxpayer base further.
  • According to Statistics, 67 per cent of Indian households had annual income under ₹6 lakh in 2021.
    • This reduces potential income taxpayers to 7.6 crore.
• No Tax on Agriculture Income
  • The agriculture and allied sector has contributed only to 18 percent of GDP, where about 45 per cent of the population is employed.
  • However, as the income from agriculture is not taxed, irrespective of the level of income, unaccounted money is shown as agricultural income by vested interests.
• False revelation by Non salaried Person
  • Although the share of personal income tax in the total tax collection by the Central Government is only about 15 per cent, it is extremely lopsided.
  • It was mentioned in the 2018-19 Budget speech that the average salary earner pays three times more than a non-salaried taxpayer and this does not include those who submit income tax returns but pay nil tax.
  • This anomaly is essentially due to non-revelation of true income by the non-salaried.

Way Forward:

• Tax on Agriculture Income
  • Those who show their annual income from farming of more than a specific amount can be taxed marginally.
    • It is politically a very tough move, but definitely it will help to curb tax evasion.
• Formalization of Economy
  • By increasing the formalization of the economy, India can broaden its tax base.
  • According to a paper, ‘Measuring Informal Economy in India_ Indian experience’, by SV Ramana Murthy, 90.7 percent of the total workforce in 2017-18 was employed by the informal sector.
    • The report says that besides agriculture, some sectors such as construction, trade, restaurants, communication and other services too have over three-fourth of the entities operating in the informal sector.
  • Bringing such businesses into the formal sector could help direct tax collections.
    • This can be done with some help from the GST system.
    • One of the objectives of the GST regime in its original form was to nudge those in the unorganized sector to shift to the formal sector and file GST returns in order to avail input tax credits or to continue supplying to larger buyers.
    • But leeway provided in the initial phase, such as doing away with invoice matching, dropping reverse charge mechanism etc have diluted this objective.
    • With the GST system now having settled down, implementation of these self-policing mechanisms rigorously could help increase the formal economy.
• Collecting Tax at source
  • Collecting tax at source for purchase of certain goods and services is another way to identify those who earn a tidy sum every year but are not paying any taxes.
  • As of now, TCS is collected for high value goods such as expensive motor vehicles, gold jewelry or overseas remittances.
    • The ambit of TCS can be expanded to consumer durables, domestic luxury travel, stays in expensive hotels etc.
  • This can help identify those operating in the informal sector and earning high income, yet evading tax.
    • While this could hit honest taxpayers, they can reclaim the tax in their annual return based on the form 26AS.
• GST Compliance
  • The more the GST compliance, the better the revelation of true income by professionals, businessmen and traders, and the increase in income tax from the non-salaried taxpayers.
    • The direct and indirect tax departments should get their act together to generate more income tax from non-salaried taxpayers.
• Government should work to plug tax evasion due to illicit trade and smuggling.

Conclusion:

• These improvements aren’t easy to achieve. They depend on hard-to-wrangle fundamentals such as basic digital infrastructure and political will.

Source: The Hindu BL

Mains Question:

Q. Which factors are responsible for a narrow income tax base in India? Also, suggest measures to broaden the tax base. (150 Words).