The rise of direct taxes

Direct taxes data, released by the government two days ago, reveals a lot about how the Narendra Modi government has managed its tax administration. In 2013-14, the last year of the Manmohan Singh government, the share of direct taxes (largely composed of individual income tax and corporation tax) in total central taxes had reached 56 per cent, a few notches lower than the record high of 61 per cent in 2009-10.

In its first year, the Modi government maintained the direct taxes' share in total central taxes at the same level of 56 per cent. But the downhill journey of the following two years must have caused alarm bells to ring. The share of direct taxes in central tax revenue fell to 51 per cent in 201516 and further down to 49 per cent in 2016-17. A turnaround of sorts seems to have been achieved in 2017-18 when the share of direct taxes rose to over 52 per cent.

The fall in the share of direct taxes may have been caused as much due to their tepid growth rates of 9 per cent and 7 per cent in 2014-15 and 2015-16, respectively, as to a sudden surge in indirect tax collections in the same period. The gradual recovery in the share of direct taxes should also be attributed to the increased tax compliance efforts in the wake of demonetisation on November 8, 2016.

Direct tax collections grew by over 14 per cent in 2016-17 and by 18 per cent in 2017-18. The direct tax buoyancy, too, has risen at a healthy rate from 0.8 in 2015-16 to 1.81 in 2017-18. It appears that direct taxes will continue to increase their share in total central tax revenue and buoyancy in the current year as well, even as indirect tax collections take their own time to stabilise after the launch of the goods and services tax (GST).

But behind the success story of the direct tax collection recovery is the effectiveness of one instrument at the hands of the tax department that allows it to mobilise income-tax and corporation tax without much hassle or additional cost. This is the system of tax deduction at source (TDS), mandated by law on all those who make payments above a specified level in a year.

In 2014-15, the share of TDS in gross direct tax receipts was about 32 per cent. Last year, it had risen to 36 per cent. The rise in TDS is also a direct outcome of a massive drive launched by the tax department to improve tax compliance. The culture of TDS has spread far and wide and it shows up in the four-percentage-point increase in its share in total direct tax receipts.

If you add advance taxes paid voluntarily by individuals and businesses during the year, another practice mandated by law, the combined share of these two instruments (TDS and advance tax) in total direct tax collections goes up to almost 76 per cent. With almost three-fourths of direct taxes flowing into the exchequer on their own, there may be serious questioning on the future role of the direct taxes department.

The cost of direct tax collections has come down from a high of 0.66 per cent of total revenue garnered in 2016-17 to 0.61 per cent in 2017-18. But with technology playing an increasing role and advances taxes as well as TDS having a dominant share in total revenue collections, the big question that the tax department should face up to is whether it can make do with fewer than the 80,000 people it has on its rolls for direct taxes and bring down the cost of direct tax collections to at least about 0.5 per cent of total revenue collection.

The direct taxes data also throws fresh light on how individual incomes have fared during the Modi regime. The number of individuals filing income-tax returns with a gross annual total income of over ~500,000 has seen a healthy growth rate of 13 to 25 per cent in different slabs in each of the three years starting from 2014-15 to 2016-17. Income-tax returns data for 2017-18 is yet to be compiled.

A decline is noticed only in the income category below ~250,000 for all the three years and only for those with less than ~500,000 income in 2016-17. This decline could be due to the upward income mobility of individuals. It could also be due to the fact that once the tax slabs are raised, individuals who are exempted stop filing returns. Or could it be due to slowing growth in the number of individuals joining the workforce at an annual salary level of ~250,000-~500,000!

At the higher income slabs, the story is different. The number of individuals with income of over ~10 million stood at 59,830 in 2014-15, recording a rise of 24 per cent over the previous year. The following year, their number rose by 13 per cent to 67,783 and by 20 per cent to 81,344 in 2016-17.

The growth in total salary income declared by individuals, however, has seen a deceleration. It was growing at an annual rate of over 18-19 per cent in 2014-15 and 2015-16. But the growth rate fell to 14 per cent in 2016-17. Whether it recovered in 2017-18 will be known only when the government brings out the next instalment of direct taxes data.