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Opinion | Tax collections: The start of a virtuous cycle

The ratio of personal income tax (PIT) to the gross domestic product (GDP) in India has hovered around 2%, a steep 6 percentage points lower than the average (of 8%) for the more prosperous countries comprising the Organization for Economic Co-operation and Development. There are multiple reasons for this, including a large informal economy driven by low profitability, low wage levels, cash transactions and under-reporting of taxable transactions, all of which lead to low compliance levels.

It is, therefore, heartening to note that the PIT-to-GDP ratio has inched up from 2.1% in FY16, to 2.5% in FY18 and FY19. This is likely to go up further to 2.7% of the GDP if the budget targets for FY20 are met. As a result of the rise in PIT, the direct tax-to-GDP ratio in the budget in FY19 (5.98%) was the highest in the past decade. This has been triggered by higher PIT collections as corporate tax collections have remained subdued due to weak profits from Indian corporates that have been under strain since the global financial crisis of 2008.

The increase in PIT compliance and collections has been driven by concerted efforts to bring more of the economy into the formal sector. These include the drive to provide all citizens a universal identification linked to a bank account under the Jan Dhan-Aadhaar-Mobile program rolled out in 2014; the introduction of Micro Units Development and Refinance Agency (Mudra) loan scheme in 2015 for small entrepreneurs which led to loans based on registered identification; the appointment of a real estate regulator through Real Estate (Regulation and Development) Act in 2016 which has ushered in a degree of governance in the country’s cash-dominated real estate sector; and the promotion of digital payments through various measures such as the introduction of the Unified Payments Interface (UPI) in 2016. The strengthening of the law against benami holdings through amendments (in 2016) to the Benami Transactions Act and the introduction of the Black Money Act (in 2015) has further acted as deterrents against unaccounted transactions.

There were significant one-off events that also acted as catalysts in this formalization process. The demonetization exercise in November 2016 led to the deposit of high-value notes (86% of the total money in circulation) in bank accounts. The introduction of the goods and services tax in July 2017 led to a jump in the number of registered businesses from around 3.8 million to around 12.2 million till June 2019. It has also helped curb the suppression in reporting of taxable receipts as well as fake invoicing by businesses. Separately, compliance measures by the income tax department have led to substantial increase in the number of taxpayers filing returns. The number of persons filing tax returns totaled 54.4 million in FY18, a 65% increase from FY14.

These concrete measures to formalize the economy have had a positive impact beyond personal tax collections. Domestic savings have been channelised into formal equity and debt markets. The number of accounts with the domestic mutual fund industry was 83.8 million in June 2019, a consistent year-on-year increase over the last five years during which the assets under management have increased two-and-a-half-fold, from 9.75 trillion to 24.25 trillion. The number of investor accounts with depositories has increased from 25.4 million in FY16 to 35.9 million in FY19. Investments in India’s equity markets are now driven equally by domestic institutional investors, a change from the earlier dominance of foreign portfolio investors.

This financialization of the Indian economy could well be the start of a virtuous cycle as the returns generated will be easier to track and tax and will be further invested within the formalised economy. While increased PIT collections represent green shoots for India’s push towards a more formal economy, it will be instructive to see when and how soon they reach a full 3% of the GDP.

Ashutosh Dikshit is partner, Deloitte India

Source: livemint