Covid may further skew India’s tax profile

nNEW DELHI: With Covid-19 infections crossing a million last week, and the virus spreading to new regions, India’s pandemic challenge is bound to become more difficult. Unless daily cases start coming down, business and consumer sentiment is unlikely to recover. This has also raised some doubts about government finances, especially revenue collections. A look at the available numbers suggests that indirect taxes might end up accounting for an even larger proportion of total taxes this year than they typically do.

This is more than just an economic curiosity and has an important political economy implication for India, where governments have traditionally guarded against being seen as levying taxes on the poor.

Direct taxes are progressive in nature – the rich pay at a higher rate than the poor – and a fall in share of direct taxes in total revenue entails retrogression in the tax burden. A person earning ~10 lakh per year faces a lower income tax rate than someone who earns ~1 crore per year. Indirect taxes do not make this distinction. Petrol is sold at the same rate whether it is meant for a motorcycle or an expensive car.

India’s political economy landscape has two basic contradictions. Agriculture produces less than 15% of the GDP, but employs more than 40% of workers. And just a little over fifty million of India’s 400 million workers pay income taxes. These two numbers are often used to caution against any radical redistribution in favour of the ‘have-nots’, at the cost of the ‘haves’ in the economy. The rich are important for economic growth and revenue collection, and penalising them will not be fair, it is argued.

That hasn’t stopped the government from taxing the rich more, though. In July 2019, finance minister Nirmala Sitharaman imposed a surcharge on the super-rich, which took the peak income tax rate to 42.7%. The move attracted a lot of criticism, and Sitharaman, in principle, accepted the criticism. “Ideally, we should bring it (peak income tax rate) down. Ideally, but we 1980-81

CHART 2

Tax collections as percentage of previous year collections

Apr-20

May-20

Direct Tax have to see when the timing is proper for this”, she told HT in an interview. In September last year, the government announced a major reduction in corporate tax rates, which it then estimated would lead to a revenue loss of ~1.45 lakh crore. The actual shortfall has turned out to be more . The reduction in corporate tax rates offset the revenue from the increased tax liability on the rich in 2019-20 (at least some of its beneficiaries were the rich). The share of direct taxes in the Centre’s gross total revenue came down by 2.5 percentage points from the 2018-19 level of 54.1%.

RBI data shows that direct taxes, which include income tax and corporate tax, had a share of less than 40% in total tax revenue of the centre and states. The share of direct taxes increased sharply in the decade preceding the 2008 financial crisis (it used to be in the low double digits), reached a peak in 2009-10 and has stagnated at a slightly lower value since. In most OECD countries, direct taxes account for much of the total taxes -- up to two-thirds in some cases. Some see this as a sign of efficiency; others, who believe in income redistribution to offset inequality, see it as only fair and equitable. (See Chart 1)

How will the pandemic affect this distribution? It is early to comment on this. Data from the Controller General of Accounts (CGA) with the ministry of finance has tax collection data until May, 2020. A comparison on a year on year basis shows direct taxes suffered a bigger shortfall in comparison to indirect taxes in the first two months of the fiscal year. Total collection of corporate tax and income tax in April and May was ~52,707 crore, which is 14.6% less than the collection in April and May 2019. Collection of the Goods and Services Tax (GST), customs and excise duties, three major indirect tax heads, in April and May was ~71,961 crore, which is 52% less than the April and May 2019 collections.

We will have a better picture when the June tax collections are released next month. However, a look at monthly rather than cumulative numbers paints a different picture. While indirect tax collections vis-a-vis previous year’s collections improved in May, direct tax numbers seem to have followed the reverse trend. (See Chart 2)

The recovery in indirect taxes is likely to continue in the month of June. The government reported June GST collections to have crossed ~90,000 crore, which was 91% of the collections in June 2019. The June collections could have included tax filings for previous months, as deadlines were extended during the lockdown.

Both the central and state governments, especially the former, have increased taxes on petrol and diesel rather than passing the advantage of low crude prices to the consumers. An HT analysis showed that the gap between fuel prices here and international crude prices in the post-pandemic period continues to be the highest ever. With petrol and diesel consumption inching back to normal levels, governments will make a windfall in taxes. Petroleum ministry data shows that petrol and diesel consumption might be close to last year’s figures in July. (See Chart 3)

On the other hand, it will not be surprising if the shortfall in direct taxes becomes bigger. Companies might have held back on lay-offs and pay-cuts in April in the hope that the lockdown would yield quick results. Such hopes have been belied. Most institutional and private forecasts for 2020-21 GDP have worsened over time. This means that outlook on profits and salaries, and therefore direct tax collections, will worsen overtime.for example, Indigo, India’s largest private airline, announced on Monday, that it was laying off 10% of its workforce.

Anecdotal evidence supports this hypothesis. A Mint report by Prashant Kumar Nanda earlier this month said at least 100,000 workers a day dipped into their statutory retirement savings in June as they grappled with income and job losses . With profitability taking a beating, corporate tax collections will also suffer. In effect, the contribution of indirect taxes, seen by some as affecting the poor more than the rich, in overall tax revenue, that was already skewed in India, is likely to become even more so because of the pandemic.