Political Economy of Tax Regime: India

8 August, 2010Saumen Chattopadhyay

JNU, India

Introduction• Political economy of tax regimes (Theme 1)• Who are the major formal and informal lobbies and

what are their political and economic interests?• What is the extent and nature of their influence over

policy formulation and implementation?• What are the key political factors affecting the makeup

of earmarked revenue and general budgetary support?• What are the key political factors affecting the policies

and institutional arrangements for fiscal federalism and decentralization?

• What is the impact of the above on historical and current reform efforts?

Some Issues• Designing of a tax policy is determined not only by the application of the

economic theory but also how the ruling party wants to use economic theory in the context of a socio-economic situation. It is after all a political decision.

• Tax administration is as important as tax policy and the failure of tax administration is symptomatic of an absence of a strong political will.

• Tax-GDP ratio in India is low. Tax payers were merely 1% population while we embarked on economic reform in 1991, it is nearly 3% now. Of course, agricultural income is not taxable.

• India ranks 128th in the world in terms of per capita income (Economic Survey 2009-10) and 134th in terms of HDI with nearly 35 percent living below the poverty line. Sengupta to Commission on the Unorganized Sector showed that 3/4th of our population is poor and vulnerable. 77% consume less than Rs 20/- per day in 2003-04.

The Political Economy of tax policy making

• The Ministry before the budget presentation does meet the Industrial groups/various representations, chambers of commerce and all sections of the people.

• Free press, democracy and invoking theory ensure that the tax policy is not altogether hijacked by any lobby/class, but tweaking the tax policy/provisions to benefit a particular lobby or a section is quite common as it is done in the name removal of anomalies.

• For income tax reform, the approach is to foster voluntary tax compliance through a reduction in the tax rate, expansion of tax base and strengthening of the tax information network (TIN) through computerisation.

• Cooperation from all the states to facilitate indirect tax reform is being solicited by the Centre.

Tax-GDP ratio: central taxes

Table 1: Major Central Taxes as percentages of GDP Gross Tax CIT PIT Customs Excise Service

1990-91 10.12 0.94 0.95 3.63 4.31 1991-92 10.31 1.20 1.03 3.41 4.30 1992-93 9.97 1.19 1.05 3.18 4.12 1993-94 8.82 1.17 1.06 2.58 3.69 1994-95 9.11 1.36 1.19 2.65 3.69 0.04 1995-96 9.36 1.39 1.31 3.01 3.38 0.07 1996-97 9.41 1.36 1.33 3.13 3.29 0.08 1997-98 9.14 1.31 1.12 2.64 3.15 0.10 1998-99 8.26 1.41 1.16 2.34 3.06 0.11 1999-00 8.87 1.58 1.32 2.50 3.20 0.11 2000-01 8.97 1.70 1.51 2.26 3.26 0.12 2001-02 8.21 1.61 1.40 1.77 3.18 0.14 2002-03 8.81 1.88 1.50 1.83 3.35 0.17 2003-04 9.23 2.31 1.50 1.77 3.30 0.29 2004-05 9.41 2.55 1.52 1.78 3.06 0.44 2005-06 9.88 2.73 1.51 1.76 3.00 0.62 2006-07 11.05 3.37 1.75 2.02 2.75 0.88 2007-08 11.99 3.90 2.07 2.10 2.50 1.04 2008-09 10.86 3.83 1.90 1.79 1.95 1.09 2009-10 RE 10.27 4.14 2.03 1.37 1.65 1.10 2010-11 BE 10.77 4.35 1.74 1.66 1.90 0.98 Source: Union Budget, various issues and NAS.

Effective tax rate: Corporate

Table: Profile of Sample companies across range of profits before taxes (financial year 2007-08) Profit Before

Taxes Number of companies

Share in profits before taxes (in %)

Share in total income (in %)

Share in total CIT payable (in %)

Ratio of total income to PBT (in %)

Effective Tax Rate (in %)

1 Less than zero 132356 0.00 0.58 0.36 - - 2 Zero 24529 0.00 3.27 1.39 - - 3 Rs 0-1 crore 188584 3.17 3.78 3.56 79.95 25.52 4 Rs 1-10 crore 16596 7.47 7.55 7.87 67.88 23.99 5 Rs 10-50 crore 2907 9.32 8.51 9.14 61.37 22.35 6 Rs 50-100

crore 531 5.51 4.98 5.37 60.75 22.21

7 Rs 100-500 crore

551 16.99 15.50 16.60 61.29 22.26

8 Greater than Rs 500 crore

179 57.54 55.83 55.71 65.18 22.05

9 All Sample companies

366233 100.00 100.00 100.00 67.17 22.78

Note: the sample size is 366233; Rs 1 crore = Rs 10 million Source: Receipts Budget 2010-11, table 1, Annexure 12.

Tax Expenditure

Table : Tax Expenditures: Revenue Foregone 2005–06 2009–10

In Rs crore

% of total tax

% of own tax

In Rs crore % of total tax % of own tax

CIT 34618 9.45 34.18 79554 12.06 31.2 PIT 13550 3.70 21.30 40929 6.48 32.7

Excise 66760 18.23 60.02 170765 27.04 167.4 Customs 127730 34.88 196.31 249021 39.43 294.8 Total 244290 66.72 … 540269 85.56

Less Export credit related

37590 10.27 37970 6.01

Grand Total 206700 56.45 502299 79.54

Source: Receipts Budget 2008–09, Table 11, page 58, Union Budget 2008–09, GoI and Receipts Budget 2010-11, Tab le 12, page 57, Union Budget 2010-11.

Income Tax Revenue statistics-size distribution

Range of income (Rs. In ml)

1999-2000 (Assessment Year)Numbers as a multiple of 1990-91

Number of returns

0.2 to 0.5 10.9

0.5 to 1 33.4

Over 1 49.9 Total: 13.8

Income of Returns (in Rs.)

0.2 to 0.5 9.6

0.5 to 1 31.9

Over 1 30.4 Total: 17.0

Tax Payable (in Rs.)

0.2 to 0.5 4.3

0.5 to 1 14.2

Over 1 14.3 Total: 8.0

Source: Shetty, 2009 in EPW. Based on IPFS 2005. AES .

Direct tax

• Tax expenditures as a percentage of tax collection has been substantial because of a plethora of tax concessions.

• The effective tax rate has gone down. More for personal income tax.

• It may decline further with the possible introduction of Direct Tax Code from April 2011.

• DTC seeks to reduce the effective tax rate, expand tax base through withdrawal of tax concessions to foster voluntary tax compliance.

Political Economy of DTC

• A further reduction in the personal income tax is acceptable to the taxpayers (largely the middle class), withdrawal of tax concessions is unlikely to be so.

• Outcome may be a decline in the effective tax burden and fiscal consolidation may suffer (Rao and Rao, EPW, 2009).

• And the approach should be collect more from direct tax as it is progressive, less distortionary and non-inflationary.

Has tax compliance improved? • Focus has been to foster voluntary compliance. To be effective costs of non-

compliance has to be made greater than its benefits. • We need to distinguish between enforced compliance and voluntary compliance. • A rise in the collection is being attributed to a series of measures initiated like Tax

Information Network (TIN) based on Kelkar Committee recommendations, a reduction in tax compliance costs through e-filing, tax payer services and a reduction in effective tax rate to induce. TDS has contributed to as well (Rao and Rao 2005).

• The nature of growth is also responsible. • The true tax base for income has witnessed a faster growth than GDP so the

buoyancy estimated with respect to GDP would be actually lower with respect to the true base.

• The inequity among the tax payers has risen sharply (because of a surge in the income of the IT professionals and income of skilled workers in the corporate sector) (Kumar, Chattopadhyay and Dharan, Alternative Economic Survey, 2005).

Tax administration: Extent of tax evasion

• NIPFP (1985): Report on the Black Economy found nearly 20% of income was black income for 1980-81

• Kumar (1999) observed that tax evaded income would amount to 40% of GDP for 1995-96 (ignoring bribes and double counting) with only 8% being in the illegal sector. This is based on corrected NIPFP study. Indirect tax evasion leads to direct tax evasion.

• Kumar argued that failure of tax administration to curb evasion could persist because of a nexus between the bureaucracy, the political masters and the business class.

• Despite pro-market reform, the number of fraud and scam has not really gone down. Got nothing to do with tax rates.

• Das-Gupta and Chattopadhyay (NIPFP, 2001) role of tax consultants in facilitating tax evasion was found to be significant. Even the salaried with TDS resorted to tax evasion. Common among the corporate sector.

• Kumar, Nagar and Samanta, NIPFP study (2007) argued that volunatry compliance is not more than 50% in IT and CIT.

Indirect Tax reform: GST

• The overall approach is to move towards consumption based taxation as evident in the implementation of the Goods and Services Tax (GST) in a nation of 29 states.

• Excise levied by the centre, VAT by the states and services tax all combined into one to create a common market at the country level.

• Implementation is a highly political issue. How to reconcile fiscal autonomy of the states with a near perfect design with low compliance costs.

Tax compliance cost: GST• Implementation of GST: major challenge is to arrive at a consensus

both with regard to designing and implementation. Some states are opposing as fiscal autonomy is argued to have been curbed.

• Reduction in the tax compliance costs of GST has become a major issue in the federal set up. As such the states particularly those which are ruled by the opposition parties do not want to forego their discretion over taxation of goods and services.

• While there is a consensus emerging at the initiative of the Ministry with regard to tax structure, the challenge is now to reduce the compliance costs without denting the federal set up.

• Multiple rates may lead to lobbying and serve vested interests without any substantial impact on equity. Difference in tax rates on inputs and outputs need not be there (Rao, 2009).

Concluding remarksWhile political influence on tax administration has become less with

reform, the insulation from the political masters cannot be fully guaranteed.

In a country with acute income disparities, the need is to carry on with the process of building up of the TIN but the concept of voluntary compliance is questionable.

A stronger tax admin with reasonable rates of tax rates on income on the class who can afford to pay (the growing middle class).

The recurrence of scams and frauds are not affected by tax rates but it affects tax collection and service delivery. Political masters need to be more proactive

Given IDT reform, the focus should be to collect more from DT instead of appeasing the middle class. Disparity has increased and not compliance from 2000-01 (AES).