INDIA’S TAX MESS
3% of GDP by 2008. The fiscal glide path, the term used for bringing down the deficit as prescribed under the Act has since been adjusted owing to the adverse economic developments. The 1991 Budget made the first noise about the need for fiscal consolidation.
“In the macro-management of the economy, over the medium term, it should be our objective to progressively reduce the fiscal deficit of the Central Government, to move towards a significant reduction of the revenue deficit, and to reduce the current account deficit in the balance of payments,” Singh said in his Budget speech. Fiscal deficits, while they have come down compared to where they were in 1991, have not stabilised to the levels envisaged in the FRBM Act. The pandemic’s shock is likely to administer a long-term shock to fiscal consolidation.
The issue of fiscal conservatism or prudence has always been a polarising one among economists. Even Singh tried to pre-empt some of this criticism while arguing for fiscal prudence in his 1991 speech. “During the period of transition (to a low deficit phase), it shall be our endeavour to minimise the burden of adjustment on the poor. We are committed to adjustment with a human face. It will also be our endeavour that the adjustment process does not adversely affect the underlying growth impulses in our economy,” he said.
The economic virtue of fiscal intervention gained popularity after British economist John Maynard Keynes gave his idea of government investment acting as a multiplier of growth in a recession affected economy during the Great Depression of the 1930s. Keynesian ideas held sway after the Second World War until the 1970s, often referred to as the Golden Age of capitalism. A neoliberal economic revolution after the Oil Shocks brought fiscal conservatism and deregulation of finance back in favour.
Questions have been raised about the purported virtue of fiscal prudence, especially during an economic downturn by many economists across the world. The view found a reflection when the FRBM Review Committee under the chairmanship of NK Singh submitted its report in 2017.
“One disadvantage of headline fiscal balance rules is that they do not have counter-cyclical properties. For example, when growth – and therefore revenues – is above potential, policymakers should ideally be reducing fiscal deficits, and thereby creating fiscal space that can be used in downturns. However, adhering to a fiscal deficit target necessarily results in those extra revenues being spent. Similarly, during downturns, as automatic stabilizers work, one would want the fiscal deficit to expand, but that is precluded by adherence to a headline deficit rule, thereby making fiscal policy pro-cyclical. There is widespread evidence that fiscal policy in emerging markets tends to be pro-cyclical rather than counter-cyclical, in part because of political incentives to run large deficits in good times when financing is available.”
The question of fiscal prudence bringing a pro-cyclical element to economic policy — as was pointed out by the NK Singh Committee — is extremely relevant given the fact that India’s fiscal stimulus to deal with the pandemic’s economic shock has been among the smallest among major economies. (See Chart 4)
The nature of tax burden and the question of tax evasion
There is one area where the vision set in the 1991 Budget has seen a reversal: the objective of raising the share of direct taxes in overall tax revenue. “The revenue from direct taxes, both as a proportion of GDP and as a percentage of total tax revenues, has registered a steady decline over time. This trend has to be reversed, so as to restore equity in, and balance to our fiscal system,” Singh said in his Budget speech.
According to the Centre for Monitoring Indian Economy (CMIE) database, share of direct taxes in total tax revenue of Centre and states fell from 18.3% in 1981-82 to 16.3% in 1990-91. This share would increase consistently in the postreform period to reach a peak of 43.2% in 2009-10. It has since then fallen steadily. It fell to 36.1% in 2015-16 before rising marginally to 38.9% in 2019-20. Recent numbers are likely to be even lower, thanks to the corporation tax cuts in 2019, fall in direct taxes due to the pandemic and the increased reliance on petrol-diesel taxes in the post-pandemic phase. The goal of reversing this decline in the share of direct taxes is still worth pursing.
It needs to be understood that this objective cannot be pursed without rationalising the tax structure and plugging various loopholes which existed 30 years ago and continue to, today. The absurdities of India’s tax system in 1991 are best captured by this exemption
Singh abolished in his speech.
“Over the years, those with an instinct for gambling have increasingly patronised the races. I propose to withdraw the incometax exemption of ₹5000
(India’s per capita GDP at factor cost was ₹7167.28 in
1991-92) in respect of earnings from races, including horse races. I am sure that persons who place bets will now also have the added pleasure of sharing their earnings with the government.”
The problems facing India’s tax system are far from over. This is best seen from the fact that amount of taxes raised, but not realised by the Union government stood at ₹12.98 lakh crore at the end of 2019-20 (latest available data). To put this number in context, the gross tax revenue of the Union government was ₹20.1 lakh crore in 2019-10.
Of the ₹12.98 lakh crore of revenues not realised, ₹10.42 lakh crore was under dispute, while the rest was on account of lack of assets or the assessee not being traceable. The fact that amount worth almost half of the Centre’s gross tax revenue is mired in dispute raises serious questions about the transparency and simplicity (or lack of it) of India’s tax system. The fact that Goods and Services Tax, which is the biggest indirect tax reform in independent India, had serious teething troubles when it was launched in 2017 and continues to suffer from multiplicity of slabs only underlines the importance of simplifying India’s tax regime.
While the current government’s tax policy has its share of blames, especially on the question of tax burden becoming regressive, the United Progressive Alliance government, where Singh was the Prime Minister, also did not do justice to the ideals of a simple transparent tax system, by decisions such as retrospective taxation. (See Chart 5)
The moral dilemma of conspicuous consumption in a poor economy which also runs a trade deficit
There is practically no rationale against the removal of arbitrary, often stifling, regulations on private enterprise which existed in India before the 1991 Budget. However, there is merit in engaging with the line of argument which was given by many left-leaning economists. This critiques the liberalisation of trade, which had begun in a piecemeal manner before the 1991 reforms and has increased significantly in the last three decades. The logic which was given was that it was the rich who had contributed to the rise in current account deficit by spending scarce foreign exchange on items of luxury consumption.
“There is no time to lose. Neither the government nor the economy can live beyond its means year after year,” Singh said in his Budget speech referring to the high fiscal deficit and current account deficit along with a shortage of foreign exchange.
Ashok Mitra, one of India’s most original Marxist economists, and also a cheeky polemicist, attacked Singh’s logic in his column Calcutta Diary in the July 27, 1991 issue of the Economic and Political Weekly. “It is simply not true that the nation as a whole has been living beyond its means. It is only a minor segment of the nation, the top-most decile, which has lived it up since that egregious doctrine of borrow and spend , borrow again and spend again, became official policy in the eighties,” Mitra wrote.
Singh himself had tried to pre-empt the attack on this front in his Budget speech. “In highlighting the significance of reform, my purpose is not to give to fillip to mindless and heartless consumerism we have borrowed from affluent societies of the West. My objection to the consumerist phenomenon is two-fold. First, we cannot afford it. In a society where we lack drinking water, education, health, shelter and other basic necessities, it would be tragic if our productive resources were to be devoted largely to the satisfaction of the needs of a small minority...our approach to development has to combine efficiency with austerity. Austerity not in the sense of negation of life or a dry, arid creed that casts a baleful eye on joy and laughter. To my mind, austerity is a way of holding our society together in pursuit of the noble goal of banishing poverty, hunger and disease from this ancient land of ours.”
Singh’s Budget speech also referred to the Congress manifesto’s promise of “measures to curb conspicuous consumption” while increasing excise duty on refrigerators, air-conditioners, motor cars, etc.
Conspicuous consumption has increased by leaps and bounds in the three decades since Singh’s warning in 1991, even as millions of Indians continue to live in penury. The richest Indians can enjoy almost all the pleasures money can buy inside and outside the country. Sure, India does not face a foreign exchange crisis today like it did in 1991, even though we continue to run a large trade deficit. Capital inflows and remittance incomes have helped on this front. The possibility of a capital-flight driven balance of payment crisis is remote, if not non-existent today. However, the question of forcing some sort of austerity on the rich to pursue the goal of providing relief to the poor continues to be as relevant and it is politically difficult.