Direct Tax Collections, Growing Disparity and Need for Redistribution | Arun Kumar

( This is a longer version of the article published in the Businessline on May 09, 2024, Titled ’Direct tax collections reflect disparities’ )

CBDT has said that net direct tax collection has exceeded its target for 2023-24. It has increased 17.7% over last year and much faster than the income increase of about 9%. Analysis of these facts is important in the light of the contentious debate set in motion by the PM regarding redistribution of wealth in the economy.

Trying to put the opposition on the defensive the PM said that the Congress would take away one of the two buffalos and women’s mangalsutra. This is also an attempt to divert attention from the rising disparity in the economy where a few of the super wealthy (resorting to cronyism) have been rapidly accumulating wealth. The attempt is to scare the common people that their wealth would be expropriated by the government through Wealth Tax. Further, they would not be able to pass on their hard earned wealth to the next generation due to Inheritance tax. How valid are the PMs arguments and is there a justification for Wealth and Inheritance taxes in India?

Direct Tax Collection Exceeds Targets

Net Direct Tax collections of the Centre at Rs.19.58 lakh crore are higher than the budget estimate of Rs.18.23 lakh crore for 2023-24. This was revised to Rs.19.45 lakh crore in the Union Budget 2024-25 and the actual has turned out to be even higher by 0.67%. This figure is arrived at by subtracting the refunds to tax payers (that is why it is called net tax) which have themselves increased substantially by 22.74% over the last year’s figure of Rs.3.09 lakh crore to reach Rs.3.79 lakh crore. A creditable performance. What does it tell us about Indian economy’s performance in 2023-24?

The tax performance is good since the real GDP is likely to have grown by around 8% and the nominal GDP at about 9%. So, net direct tax collection has increased at about twice the rate of its base, the GDP.

Direct tax collection by the Central government comes from incomes, wealth and transactions. Tax on wealth – wealth tax, estate duty and gift tax – has been negligible since it has been eliminated. Tax on income is collected as Personal Income Tax (PIT) and Corporation tax. PIT is levied on individuals and firms. Corporation tax is collected from the corporate sector. Transaction tax is on Securities transactions and data for it is included in PIT. Corporation tax and PIT are largely collected from the high income earners and have grown at the same rate for long. But now they are growing at very different rates. Why?

Rising Share of PIT

In 2022-23, PIT has increased by 24.26% but Corporation tax has increased by 10.26%. So, the latter’s share of the total direct tax collection, has dropped from 49.64% to 46.53%.

In 2018-19, Corporation tax collection was more than PIT by 40.3%. In 2019-20 Corporation tax rate was reduced substantially so it was higher than PIT by only 13.05%. In 2020-21, the gap reversed with PIT higher by 6.4%. In 2021-22 Corporation tax collection again exceeded that from PIT but after that PIT has been higher. Why these swings?

The increase in tax collection can occur for two reasons. First, the base of tax collection increases. That is, more entities come under the tax net. This can happen due to inflation which raises nominal incomes rise. So, those who were not under the tax net also enter the tax net. The number of people paying direct taxes has risen from 7,42,49,558 in FY 2016-17 to 9,37,76,869 in FY 2021-22. Also, those already in the tax net have a higher taxable income. Second, the government may raise the rate of tax. Both these factors have been at play.

Income tax rate has been raised through a surcharge on tax payable while keeping the highest base rate unchanged at 30% and education and health cess at 4%. In 2014-15 a 10% surcharge on income tax was introduced for incomes above Rs. 1 crore. In 2016-17, it was raised to 12% and in 2017-18 to 15%. In 2018-19, a surcharge of 10% was introduced for incomes between Rs.50 lakh and Rs. 1 crore while those earning above Rs.1 crore continued to pay 15%. In 2021-22, for those earning between Rs.2 crore and Rs.5 crore the surcharge was increased to 25% and for incomes above Rs.5 crore it was made 37%. The surcharge for incomes below Rs.2 crore remained unchanged.

In brief, while the Corporation tax rate was reduced, the tax rate on incomes has been raised. No wonder the tax collection under PIT increased faster than from Corporation tax.

The above points to the fact that much of the increase in income tax collection (PIT) is due to an increase in the rates and in inflation. The increased direct tax collection helps rein in the high fiscal deficit and present a better macroeconomic picture of the economy. The government has also claimed that the increase is a result of better tax compliance due to control of black economy. Is that true?

Narrow base of PIT

To resolve the issue whether compliance has improved, there is need for more granular data on which entities are paying more of income tax. Detailed data is available for 2020-21 and some data for 2021-22. What does it reveal [1]?

First, the base of direct tax in India is narrow. Only those in the top rung of the income ladder are in the direct tax net. In 2020-21, 6.6% of the population filed a tax return. But most of them did not pay a tax since their income was below the taxable limit. Effectively, only 0.68% of the population had high enough income to pay a significant amount of income tax; these are called the effective tax payers. Further, 0.016% declared an income above Rs.1 crore with a 38.6% share of the declared taxable incomes.

So, it is this 0.68% and 0.016% which had to pay a surcharge which raised their tax rate. Even if their income did not rise, they had to pay a higher tax rate. In 2020-21, for income above Rs.2 crore the tax rate increase was 3% and for an income of above Rs. 5 crore the increase was 6.6%. This explains one part of the rise in PIT. The other part is a result of growing inequality in the economy.

Increase due to Growing Inequality

Data suggests that the income of workers and farmers have stagnated in real terms. So, the increase in the official GDP by 7 to 8% has been cornered by the well-off, in the form of salary in the organized sector and business profits. The broad incomes data suggests that the well-off sections have cornered the increased incomes.

Data on GDP of Q3 of 2023-24 [2] indicates rising disparities in several ways. Analysis of the Expenditure components of GDP shows a decline in the share of Private Final Consumption from 61.3% to 58.6% and Government Final Consumption from 8.7% to 7.8%. Further, net taxes have increased by 32% compared to previous year’s decrease of (-) 2.6%.

The net taxes growth indicates that the tax paying citizens’ incomes have increased substantially. They belong largely to the organized sector and not the unorganized sector. The incomes of the latter are mostly below the taxable limit so they hardly pay any direct taxes. They are also exempt from GST. So, rising tax collections indicate the growing income share of the well-off.

The decline in the share of consumption in GDP also indicates growing disparity. The higher the income, smaller is the per cent of it spent on consumption. The poor consume most of their income. So, if incomes’ share shifts from the poor to the well-off, the share of consumption in the GDP falls.

Finally, there is a decline in the growth rate of Agriculture, etc. from 5.2% to -0.8% so that its share in GDP has fallen. In employment terms, it is the largest and possibly the poorest component of the unorganized sector. This decline in the share of GDP coming from agriculture would also lead to an increase in inequality. Similarly, the decline in the share of the unorganized sector in GDP would also aggravate inequality.

Clearly, rising disparity would lead to an increase in the income share of the well-off and to good growth in PIT without compliance improving.

Disparity and Taxation

Rising disparity perpetuates itself as the clout of the well-off increases and they are able to get more concessions from society. This has social, political and economic implications leading to growing instability. It also results in a growing sense of social injustice, alienation and growing strife All this increases the difficulty in achieving national goals.

Inequality can be reduced if productive employment becomes available to those at the lower income rung and making available free/cheap public services. The funds required for this can be obtained via direct taxes if the black economy is checked and there is taxation of property of the well-off. The justification for property taxation is provided by the Haig-Simons definition of income and the `Ability to Pay’ argument for progressive taxation.

Taxation of wealth along with gift tax and inheritance tax would not only provide resources for development and public services, it would also reduce disparities both at present and across generations. It would also help check the black economy which would lead to increased direct tax collections, providing yet more resources for public services. Further, investment productivity would increase and raise the rate of growth of the economy. This would be a win-win situation for all - including those who will pay more tax since their businesses would expand and they would earn more profit. Their profit instead of decreasing due to higher payment of tax will increase – it would not be a zero-sum game but a positive-sum game. This runs contrary to the static analysis put up by the pro-business lobbies who argue that taxation of property would be a disincentive to investment.

The wealth and inheritance tax would largely be paid by the top 3% in the income ladder, with maximum amount collected from the top 1%. It is said that many of the rich will leave India with their wealth. It is true that the High Net worth Individuals (HNI) have been turning into NRIs and basing themselves in tax havens. There are an estimated 2,50,000 HNIs in India – 0.018% of the population. They can transfer some of their financial wealth but not their physical wealth situated in India. So, substantial tax can still be collected from them.

Some changes in the tax laws would be required to implement the taxation of wealth. It would benefit 97% of the people as employment generation becomes robust and good quality public services are provided to all. A scarecrow is set up when it is implied that the little wealth of the middle class and the poor would also be taxed away by the government. This is far from the truth. Instead, they will actually benefit if the extra tax collected is used to provide public services and also to reduce the regressive indirect taxes.

Finally, it is said that the wealth tax and estate duties were eliminated in India since they did not contribute much to tax collection. This was a result of the pressure from the rich to eliminate them. The reason these taxes collected little was that a large number of exemptions and concessions were granted to the rich so that they had to pay little tax. In the US, President Biden said that large corporations pay little tax due to the breaks they get. He added that it is a shame that school teachers and firefighters pay higher tax rates than them and the super-rich. This can be corrected via collection of taxes on property and reducing the concessions and deductions to the well-off – the question is one of political will.

Conclusion

In brief, the increase in the net direct tax collection and especially in PIT collections indicates increasing income disparity between the organized sector which falls in the tax net and the unorganized sector that lies largely outside the tax net. The direct tax base is narrow with 0.68% of the population paying effective direct taxes. This reflects in increasing wealth disparity which in a vicious cycle causes further disparity in income. This has adverse social, political and economic impact. Taxes on property will largely fall on the top 1% in the income ladder. It would check black income generation even though the corporate economists argue to the contrary since it suits them. Finally, these steps will reduce disparities and benefit society through more equitable growth.

(Author: Arun Kumar Retd. Prof of Economics, JNU, is also the author of `Indian Economy’s Greatest Crisis: Impact of the Coronavirus and the Road Ahead’ 2020)