Dangers Of A Wrong Diagnosis

Context: Indirect taxes are now higher than direct taxes. But cutting indirect tax rates to address this will amount to barking up the wrong tree.

Trends in composition of Gross Tax Revenue in India

• In 1990-91, the share of direct taxes in GDP was woefully low at 1.94 %, while indirect taxes accounted for 8.17 % of GDP.
• By the end of 1995-96, the share of direct taxes in GDP rose to 3 % and that of indirect taxes declined to 7 %.
• By 2008-09 and for the first time in post-reforms India, direct tax revenues rose to 5.8 % of GDP, inching ahead of indirect taxes at 5.18 % of GDP.
• In 2016-18, direct taxes were at a level lower than indirect taxes, but not because the former grew at slower pace.
  • Indeed, direct tax revenues maintained a healthy share of 5.52 % of GDP. But indirect taxes saw a boom, raising their share in GDP to 5.63 %. In 2017, the direct tax reached the highest at about 6%.
  • This was largely due to the following reasons:
    • Sharp increase in excise duty on petroleum products.
    • Individual income-tax exemption rules were amended in 2019, as a result of which annual income up to Rs 5 lakh became tax-free - another 13 million individual tax returns did not require to pay taxes
    • Corporation tax rates too have been lowered from 2019, and the impact of lower taxes began to be felt on the corporation tax revenues in the following years.
• In 2021, the share of direct tax revenues in total GTR was 4.7 % of gross domestic product (GDP), much lower than indirect tax revenues at 5.4 % of GDP. This was mainly due to the increase in the excise and customs duty.
  • In 2020-21, therefore, Customs duty collections rose by over 23 %, and excise collections jumped by about 63 % over those in the previous year.
  • In terms of their share in GDP, Customs duty rose from 0.54 % to 0.68 %, and excise reported a rise from 1.18 % to 1.97 % in the same period.

Arguments against cutting indirect taxes: While it is known that indirect taxes are regressive in nature, it is nowhere a reason for decreasing indirect tax. This is because of the following reasons -

• The share of indirect taxes in GDP went up in 2020-21, but it is still nowhere near the levels of 6-8 % of GDP that used to be quite normal till about 2001.
• Indirect taxes are easier to collect with less scope for leakage. And since most of the rates are ad valorem, their buoyancy is automatically ensured in keeping with inflation.
• Almost two-thirds of the Central cess and surcharges are levied through indirect taxes. Thus, higher collections in indirect taxes allow the Centre to share fewer taxes with the states. Cess and surcharges are not shareable with the states.

Way Forward:

• Revamped direct tax: The agenda for a revamped direct taxes structure should be not just to phase out exemptions but also to widen the tax base.
  • In a country like India with a per capita income of less than Rs 1.5 lakh, income of up to Rs 5 lakh cannot be allowed to remain tax-free through exemptions.