Note ban helped formalise economy but hit small biz

NEWDELHI: Demonetisation generated tailwinds for formalisation of the economy. Income declared in income tax returns (ITRs), as a share of India’s total Gross Value Added (GVA), increased significantly in 2016-17. But it also generated headwinds for small business incomes.

Growth in the number of tax returns and income shown in ITRs in the up to ₹5 lakh annual non-salary income category suffered a big deceleration. These findings are based on an HT analysis of detailed income tax data for Assessment Year (AY) 2017-18 released on 22 October. AY 2017-18 captures income in fiscal year 2016-17.

To be sure, at least two factors should suggest caution in using these statistics to make grand conclusions about demonetisation’s impact on income tax collections.

2016-17 also saw a voluntary disclosure scheme to declare unaccounted incomes, which is likely to have given a one-time fillip to tax collections.

And, one should wait for a longer period to check whether the change in tax patterns due to demonetisation is sustained or not. If there is one statistic which captures India’s income tax collection challenge, it is the low share of income declared in ITRs as a share of India’s overall economic product. The income tax department gives data on total income declared in ITRs from 2012-13 onwards. This value was just 23% of India’s total GVA in that year. This is not to say that the figure should be 100%. A lot of people with lower incomes need not even file returns. Agricultural incomes are outside the income tax net in the country. A lot of economic activity attracts taxes other than income tax. The figure was almost stagnant between 2012-13 and 2014-15. But it increased at a much faster pace in 2015-16 and 2016-17, increasing by more than 8 percentage points in these two years. This suggests that the economy has been undergoing a formalisation process under the present government.

Chart 1: Share of income shown in ITRs in GVA

The statistics released on October 22 also give details about the number of ITR filings and income shown in ITRs by income categories and different type of taxpayers. HT has used this information to create two broad categories of salary and non-salary income. The slab of ₹5 lakh or less per annum has been taken as the lowest income category. These statistics also give us an interesting idea about income inequality (on declared income) in the Indian economy. The income inequality pattern has a stark difference among the salaried and non-salaried income class. 80% of the total income reported in the former in 2016-17 was from the up to ₹25 lakh category, while this share was just 39% for nonsalaried income. Interestingly, the share of salaried and non-salaried categories was almost similar in the up to ₹5 lakh category. This suggests that there exists a problem of the missing middle – earnings are either too less or too much – among India’s non-salary income earners.

Coming back to demonetisation, a look at annual growth in total income reported in each category can tell us about whether or not there was a class-difference in the policy’s impact. There is merit in examining salaried and non-salaried incomes separately, as 2106-17 was also the year of implementation of seventh pay commission recommendations. Also, it is relatively difficult to conceal incomes among the salaried.

Chart 2: Annual growth in income shown in ITR by non-salaried income returnees.