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The presentation of the Union Budget to Parliament is one of the most awaited and watched events of this season. Our democracy requires that not even a rupee can be spent by the government unless we give our consent. This consent is given in the form of the passage of the Finance Bill by the Lok Sabha. The Rajya Sabha’s approval is not needed for the Finance Bill. The members of Parliament vote on the bill, and approve it on behalf of all of us, the citizens who are also taxpayers.
Can the revenue raising capacity of the government not be more toward taxes on the current generation, and less toward borrowing?
The expenditure of the government is ultimately borne by taxpayers. If it is running a fiscal deficit, then that is paid by borrowing, which is nothing but taxation on future unborn taxpayers. The size of the deficit of the Union government has been rather large, because of the burden of extra spending due to the pandemic. As of this fiscal year, roughly 21 trillion rupees of spending is raised as tax revenue, and 14 trillion rupees is through borrowing. This excludes some non-tax revenue like privatisation, which is small in relative terms. So, the size of borrowing i.e., fresh loans are a two-third of revenues. That borrowing is in the form of 10, or 20, or 30-year sovereign bonds, which must be repaid. But the repayment is from revenue raised by taxation. So that is why, deficit financing is nothing but future taxation. Can the revenue raising capacity of the government not be more toward taxes on the current generation, and less toward borrowing? Excessive borrowing and high fiscal deficit become unsustainable and can lead to a debt trap or spiraling inflation.
If one person gets all is his income from agriculture and another gets her income from a salary, then the two are taxed very differently. This is a consequence of the fact that our constitution prohibits income tax on agricultural income, and only the States have the right to tax that income.
How should more revenue be raised by a higher level of current taxes? Nobody likes to be taxed. So, the answer to this question depends on what is the “least bad” solution to the challenge of taxation. Firstly, it has to be efficient i.e., the cost of collecting taxes should not be more than what is collected. Secondly it should be efficient in the sense, that imposing of taxes should not alter taxpayer behavior. For example, a steep tax on solar lamps will make people simply abstain from buying solar lamps, defeating the social objective of promoting renewable energy. Thirdly, taxation should also be efficient in the sense that there should be less leakage and no room for tax evasion. Thankfully digital trails of all banking transactions make it difficult to hide or evade taxes.
Finally, taxation also has to be fair. There are two notions of fairness, vertical and horizontal. Vertical fairness means that the rich should bear a higher burden than the poor (in relative and absolute terms). Our income tax system does follow this principle. But if a rich person is making all his income through capital gains and dividends, it is possible that he pays less taxes than someone who has only salaried income. So, we need to examine the violation of vertical fairness. The other notion, i.e., horizontal fairness means that if two people are making the same income, their tax burden should be the same. This latter notion is often violated. For instance, if one person gets all is his income from agriculture and another gets her income from a salary, then the two are taxed very differently. This is a consequence of the fact that our constitution prohibits income tax on agricultural income, and only the States have the right to tax that income.
Ideally the GST rate should be uniform for all products except perhaps only a tiny, excluded set. As of now GST covers only about 40 percent of the GDP, with a vast number of goods and services excluded. And even among those which are included, there is a demand for lowering the rate from 18 to 12 or 5 percent.
One broad indicator of the fairness of taxation is the share of direct taxes in total taxes collected. About thirty years ago the share of direct taxes, which included income tax and tax on capital gains, was merely 19 percent. Indirect taxes which include excise duties (which later were subsumed as Goods and Services Tax i.e., GST), sales tax, import duties etc, made up the remaining 81 percent. The share of direct tax in total revenue is a sign of the maturity of the tax system. By charging a higher tax rate on richer individuals, the direct tax system becomes more “progressive”. Even if we had a single flat tax rate, with just one slab for all, it would still mean richer individuals pay a more absolute amount. This is not as progressive as multiple slabs, with increasing marginal tax rates.
An indirect tax system is however regressive. That is because the tax paid depends on the price paid and not on the income of the buyer. So, the GST paid on a pack of biscuits is the same for a rich or a poor person. It will however pinch the poor person more, and hence is regressive. To reduce the regressivity of GST, multiple slabs were created, with a low rate for essential items like food and medicines, a median rate for most goods, and a high rate for luxury goods. But this classification is arbitrary. A plain biscuit is classified as essential and a cream biscuit is luxury. Chappals are essential and shoes are not. This can lead to too much power of discretion in the hands of the taxman, endless litigation, even harassment or corruption. Ideally the GST rate should be uniform for all products except perhaps only a tiny, excluded set. As of now GST covers only about 40 percent of the GDP, with a vast number of goods and services excluded. And even among those which are included, there is a demand for lowering the rate from 18 to 12 or 5 percent.
The share market rose by nearly 100 percent from the lows of March 2020, yet capital gains tax collection has not even risen by 20 percent.
The reality is that the share of indirect taxes which had gone down from 81 in 1990-91 to 44 percent in 2014-15, has gone up again to around 55 percent now. Thus, our system has become more regressive. We need to have a higher share of direct taxes, from not just salaries but all sources of incomes. The share market rose by nearly 100 percent from the lows of March 2020, yet capital gains tax collection has not even risen by 20 percent. We are able to tax dividends since taxes can be deducted at source (TDS) at the company level but taxing realised capital gains remains a challenge. Similarly taxing other forms of wealth or inheritance is still a bridge too far. As a result, our system remains regressive, and the total tax to GDP ratio is barely 10.5 percent, among the lowest compared to large peer countries. We need to move to a more fair, equitable and efficient tax system, with a greater share of direct taxes, and a lower dependence on fiscal deficit financing.
(Dr.Ajit Ranade is an economist and Senior Fellow, Takshashila) Institution)