India’s tax woes aren’t due to the usual suspect causes. Look elsewhere

Most discussions about Indian tax systems centre on two contrasting viewpoints. The first is that of individual taxpayers who, all said and done, are a harassed community. The alternative view is from the standpoint of curbing ‘black money’, reportedly because out tax-to-GDP ratio, an index of administrative effectiveness, is much lower than that of
global peers.

There is merit in both viewpoints, but the actual challenge lies elsewhere -- the developmental imperative which, viewed in a non-partisan way, has remained unchanged since Independence!

The tax-to-GDP ratio is undoubtedly low. It was 11.31 per cent in 1999; it is now 11.46 per cent. It hit a low of 9.97 per cent in 2019-20 and a high of 11.95 per cent in 2007-8, showing stagnancy over several decades. Yet, we have one of the most digitally sophisticated and administratively complex tax systems worldwide.

The direct taxes systems tap into more than 50 different activity fields, ensuring no-leakage with their mandatory Aadhaar linkage requirement, etc. Each field has its own set of KYC compliances, apart from the need for frequent renewals. Barring isolated ‘tech wizards’, most people are left struggling to keep their compliances up to date.

Similarly, in indirect/sales taxes, the nationwide GST is often claimed to be one of the most exhaustive and sophisticated systems in the world. Escaping the Indian tax net now requires higher levels of wizardry than that needed elsewhere. Yet, none of this has had any significant effect on our tax-to-GDP ratio.

It is not quite clear whether the non-GST revenues of state governments, such as levies on liquor and stamp duties, are currently captured as tax or as non-tax revenues. If the latter, then our tax-to-GDP ratio could actually be higher than depicted. However, note that our total government revenue-to-GDP ratio is also still the lowest amongst our peers.

The developed countries group – the OECD group -- report tax-GDP ratios from upwards of the mid-20s and most well into the high 30s. Denmark has the highest ratio of 46.9 per cent. In the developing world, South Africa’s fluctuates in the 20s, but Turkey, Brazil and Russia have tax ratios in the ‘teens’. It could be argued that these countries have higher per capita incomes, with higher tax potential, and so we must reckon the Indian tax collection machinery in a better light.

However, a large number of countries in Africa, Latin America and the Caribbean also have ratios in the ‘teens’. Ghana, whose per capita income is lower than ours, has a somewhat better ratio of 13.4 per cent. So, why is our ratio so low despite a more sophisticated machinery.

It is often argued that the tax exemption to agriculture is the reason. But this does not stand scrutiny. The present average landholding is around 1 hectare. The currently reported agricultural Gross Value Added (GVA) of Rs 49.82 lakh crore on a gross crop area of 195 million hectares generates a per-hectare income far below the taxable income levels.

There could be individual exceptions of extra-large holdings, but tax liability is individual, not familial, and on the ‘net’, not ‘gross’, incomes. So, the probability of high tax collection
here is low.

The export sector, too, has tax exemptions, but these are also found elsewhere. Similarly, nations compete in offering fiscal support to attract manufacturing investments. The residual cause for our low tax ratio could thus only be that the tax shelters created for the tax-paying classes in India are higher than global equivalents.

Illustratively, our tax threshold to per capita income, as also our tax attitude toward various officially provided perks is relatively more liberal than OECD averages. However, the quantum involved as a percentage of GDP may not again be significantly large. The answer to our low tax woes could lie elsewhere.

A search for commonalities amongst nations, which also involves a unique Indian stance, takes us to the urbanisation index. Our official index is relatively low at 34.5%. Most analyses also mention the existence of ‘unofficial urbanisation’ while discussing India/South Asia, but not so frequently for other global peers. Ghana has an urbanisation index of 56.5, versus 32.4 in 1990; South Africa is at 67.85; Africa, as a grouping, is at 43.4; Latin America 80.8; Russia/Turkey are in the 70s. OECD countries are even higher. A useful topic for debate is thus whether this correlation is spurious or whether greater official interest in urbanisation, in centres outside various capital cities, could have had a more beneficial impact on our tax-to-GDP ratio.

Several World Bank and other studies reveal the benefits of transactional efficiencies attained by widely available, high-quality urbanisation, which in Indian conditions would imply focusing on several hundred cities, instead of the current few dozen! This will, however, require an administrative machinery with higher levels of decentralised powers than the present top-heavy system created by centralised planning ambitions