For the next budget 2013-14, there appears to be a welcome dedication to bring down the fiscal deficit by at least 0.5 percentage points from the present level of 5.3 per cent of GDP. As is well known, the laudable goal of fiscal deficit reduction can be brought about by either reducing the share of expenditures in GDP, or increasing the share of taxes. This dilemma and choice is quite obvious in the recent fiscal cliff debate in the US. Indeed, the concentration seems to be much more on reducing the share of expenditures. The debate on the personal income tax increase, recommended and/or being discussed, has to be seen in this context, that is, yes the fiscal deficit must be reduced, but it does not follow at all that any tax need be raised. Unless there is evidence in the context of fairness, or morality, or efficiency to do so, emotive appeals to “sacrifice” should be dispensed with.
As discussed in my previous article, ‘Blinded by tax revenue’ (IE, January 12), the only data source that we have on personal income tax revenue (Standing Committee on Finance, The Direct Taxes Code Bill 2010, March 2012) is inconsistent in the information contained for different income categories. For example, the top income category, those earning more than Rs 20 lakh, shows four lakh taxpayers paying an aggregate income tax of Rs 93,000 crore. This has an implied average tax per person of Rs 23.25 lakh. These “official” numbers also imply that the top 1.3 per cent of taxpayers accounted for 63 per cent of total personal income tax revenue (hereafter tax revenue) — and paid an effective tax rate of 52 per cent, well above the statutory maximum tax rate of 30 per cent.
If you believe these numbers, then there are several used bridges and cars you can buy. But you certainly cannot, and should not, be arguing for a tax rate hike, or a surcharge, on these super-rich 1 per cent. These worthy individuals are already paying for a higher fraction of tax revenue than any other country in the world, developed or developing. The second highest sock-it-to-the-rich country is the US, with the top 1 per cent paying “only” 37 per cent of tax revenue — most countries the percentage is less than 30 per cent. Note that the top 10 per cent of taxpayers have a share of 27 per cent in Sweden and 31 per cent in Germany.
If the “official” figures cannot be believed, then how should armchair experts analyse the situation? (The chair experts in the bureaucracy have all the data and presumably know when the data are reliable or not — one hopes!) Examination of aggregate known data can help in the analysis. The table shows some known data and some implied estimates. The latter are obtained from a synthetic income distribution constructed for 2002 on the basis of the tax returns, average income etc, contained in the Kelkar committee report on direct taxes, 2002. The distribution was so constructed to match the total tax collected from the income categories and the number of tax returns filed, as presented in the Kelkar report.
The data show that to a surprisingly large extent, the tax system in place has delivered. Between 2002 and 2011, income per worker has gone up by 221 per cent, the income subject to tax has increased by a much larger 350 per cent, and the realised tax revenue has increased by a whopping 795 per cent. And the average tax compliance rate has doubled from 16.1 per cent in 2002 to 31.2 per cent in 2011-12. The definition of compliance here includes both the compliance in terms of the number of people who should be filing tax returns and are filing tax returns, and compliance in terms of income declared.
But if the average compliance rate is 31 per cent, then it means the tax administration is only gathering a third of the actual taxes owed. If every taxpayer was an honest conformist, the total tax revenue in India in 2011-12 would have been Rs 5,51,000 crore, more than three times the actual collection of Rs 1,72,000 crore. It is for this reason that many analysts (and all the economists attending the finance minister’s meeting in early January) argue that putting a tax surcharge on the super rich is “pissing in the wind” compared to the increase in tax revenues obtained from a modicum of reform in tax administration.
The last few years have seen a significant amount of concern on the part of the polity, and especially the middle class, on corruption in India. This class is no longer taken in with platitudes about helping the poor and therefore let us sock it to the rich. And while the elite of this class, especially the intellectuals, will take up whatever the glitterati concern is in the US and apply it with equal force in India, the pragmatic middle class wants some questions answered. For example, if there is such massive leakage in public distribution systems, why shouldn’t there be better enforcement? And if there are food subsidies for the poor, then how come the food continues to rot in ever larger numbers?
And how come two-thirds of the potential tax revenue is lost? This cannot happen without the full and enduring compliance on the part of tax administration officials. Today, income tax reforms mean an improvement in tax administration and an increase in tax compliance. And before you begin to fret, note that all the data indicates (including the bad “official” data) that tax compliance among the super rich (>20 lakhs) is more than three times the compliance in the Rs 5-10 lakh category.
And for the glitterati arguing for a tax hike, let them note that tax compliance in the US is well above 90 per cent. When we get even halfway to the tax compliance of rich countries, we can begin to talk about sacrifices and morality and fairness in tax systems. Until then, increase tax compliance — and decrease the growth in populist expenditures which, by definition, do not accrue to the bottom half of the population.
The writer is chairman of Oxus Investments, an emerging market advisory firm and a senior advisor to Blufin, a leading financial information company