JUNE 07, 2023

By Pratap Singh, Principal CIT

AS per the IMF, Taxes are unrequited payments to the Government . Further, taxes are not in proportion to services received by individual payees from State. In fact, taxes are transfer of funds from private (taxpayers) to the government to provide public goods which otherwise could not be supplied by private sector efficiently. In India, the power to levy, collect and administer taxes is divided among the three tiers of the Government, namely Central Government or federal Government, State Governments and Local Bodies and Panchayat. The Central Government collects Income Tax, Central Excise, Customs Duty and Service Tax etc. The State Governments, on the other hand, administer Sales Tax/Value Added Tax, Excise on Liquor, land revenue, stamp duty on registrations and motor vehicle tax/road tax, taxes on agricultural income etc.; and the local bodies, like municipal corporations, etc., collecting octroi, property tax, fair tax etc. The taxes may also be classified as direct taxes (Income Tax) or indirect taxes (customs, central excise, state VAT etc.) depending upon whether they are collected directly from the person or indirectly through vendors though borne by respective consumers . The broad division of taxation powers has been provided under Article 246 of the Constitution, more particularly under 7th Schedule of constitution, which contains three lists; namely union list, state list and concurrent list delineating areas coming under jurisdiction of respective Governments. Of course, the residual taxation powers lies with the Centre. As per the constitutional scheme, jurisdiction on mobile taxes, like income-taxes, customs, and service tax, etc., was assigned to the Central Government, while less mobile taxes have been given to the state governments.

Now let us analyze the trends of collections of direct taxes and indirect taxes of Centre and their relative share in overall central revenue. The figures of direct and indirect taxes of Centre are taken from CBDT statistics, Ministry of Finance publications and Principal Controller of accounts data and are analyzed in Table 1 from 1980-81 onwards.

Table 1: Revenue of Union Government

(Rs. In crores)

Source: CBDT Budget statistics, 2018

Figure 1: Trends of Central Taxes

Source: CBDT Budget statistics, 2018, constructed by author from Table 3

Figure 2 : Composition of direct and indirect taxes

Source: CBDT Budget statistics, 2018, constructed by author from Table 1

From comparison of direct tax collection vis-a-vis indirect tax collection as shown in Table 1 and figure 1& 2, it may be noticed that though the nominal value of direct taxes have increased from 1981-82 onwards but their ratio remained stagnant at about 20% till 1991-92. However thereafter it has grown significantly not only in absolute terms but more importantly as ratio of total taxes. From about one fifth of central taxes (about 20% of total) up to 1991, direct taxes ratio gradually and steadily increased to 40% in the year 2003-04, and to 52.70% in the year 2007-08, when it crossed the half way mark. Within a span of two years, it improved further to a peak position of 60.64% in the year 2009-10. However thereafter it came down slightly and has been in the range of 54% to 56% till 2015-16 but in the year 2016-17, once again indirect taxes beaten direct taxes by a narrow margin of 50.34% to 49.66%, on account of higher revenue from central excise as levies on petroleum products were increased. However in the very next year, the direct taxes once again outperformed indirect taxes. The year 2007-08, has been the watershed in the history of direct tax collections, when it surpassed indirect tax collection. Later it attained the peak in the year 2009-10, when it stood at little over 60% of the central taxes. Of course, the worst year in terms of revenue generation has been 1998-99, in which the tax collection had shown a negative growth of 3.50% and negative tax buoyancy which is on account of one-time tax receipt of Rs. 10,000 cr under VDIS 1997 scheme in the year 1997-98.

It is widely accepted that the increase in the direct tax revenue has more to do with the rapid growth of the organized sector, expansion in the interaction of the financial sector with the rest of the economy and administrative measures taken by tax administration in extending the coverage of TDS (tax deduction at source) than with improved compliance arising from the reduction in marginal rates of tax. The extension of permanent account numbers (PAN) to cover a larger number of potential taxpayers and the expansion of the tax information system (TIN) are expected to advance this cause further, by generating an extensive and reliable database. Third party information, AIR (Annual Information Returns) and 360 degree profiling of tax payers has helped a lot in checking the tax evasion.

It is widely believed that the increase in ratio of direct taxes happened because of improvement in tax compliance after rationalization of tax rates to a reasonable level of 10%, 20% and 30% from 1997-98 onwards, induction of technology and automation and better enforcement. E-payment of taxes, e-filing of returns and computerization of departmental functions also facilitated this process. It may also be mentioned that 2003 to 2008 has been the best period for Indian economy in terms of growth and investment, which is reflected in direct tax collection also, but in the same period there has been significant fall in the contribution of indirect taxes as growth largely came from services sector and manufacturing did not show any improvement.

2: Trends in direct tax collection :

Direct taxes can broadly be classified into corporate tax and personal income tax, as security transaction tax is still a small in coverage and collections (contributes about 1% of the total revenue) and other direct taxes like wealth tax, BCCT, interest tax and Fringe benefit tax etc. stand abolished. Though it is noticed that the direct taxes collection in India has been steadily increasing on decent pace in last 30 years, yet it is important to see as to how its components are faring over a period of time. From the Table -2 it can be seen that up to 1991-92 the quantum of corporate income tax collection used to be equal or lesser than Personal Income tax collection but thereafter it gradually took over personal income tax collection and from 2002-03, it outpaced personal income tax collections by a huge margin . In the year 2010-11, it was almost double of personal income tax collection. There are few important trends points which could be noticed from the above Table 2 and Figure 3. It is seen that F.Y. 2002-03 to 2007-08 has been the best years for the Indian economy, in terms of GDP growth and overall economic well-being, which is reflected in tax collection figures as also in tax buoyancy. As is clear from the above Table -2, the growth in taxes during this period was ranging from 20% to 40%, which was largely because of tremendous performance by corporate taxes in this period. The tax buoyancy also reached a peak figure of 2.42 (2006-07) during this phase. However post 2007-08, the pace of growth in taxes lost steam because of slow down in global economy. Even the tax buoyancy declined significantly during this period and has been close to one or below one, which is not a very healthy sign for a growing economy, like India.

Table -2: Direct Tax Collection al Cn

( Rs. In crores )

Source: CBDT Budget statistics, 2018, Ministry of Finance statistics 2017, Income Tax Department, Admin Hand Book, 2018 

Figure. 3: Trends in corporate and personal income tax in India

Source: constructed from Table 2

Figure. : 4 : Growth in direct taxes

Source: compiled from Table 2

However, from the analysis of trends of growth in tax collection as reflected in the Figure -5 and Table 2, there appears to be no direct and immediate co-relation with the GDP growth. It has been seen that in some of the years, though the GDP growth has decelerated but the growth in tax collection has increased. This gives only one indication that there may be significant tax evasion and parallel economy and an indication that even in the years when GDP growth is small, the growth in tax collection could be higher if proper enforcement and supervision is done by the tax administration, as is reflected in Figure 5.

Figure 5: All India GDP Growth vs Tax Collection Growth

Source : constructed by author from Table 3.2

3: Analysis of Tax-GDP Ratios:-

Interestingly, the trends in tax ratios of direct and indirect taxes follow different paths, as is seen from Figure- 6. The tax ratio for direct taxes remained virtually stagnant throughout the forty-year period from 1950 to 1990 at a little over 2 percent of GDP. Thereafter, coinciding with the reforms marked by significant reduction in the tax rates and simplification of the tax structure, direct taxes increased sharply to over 4 percent of GDP in 2003–04, to 4.5% in 2004–05, to 5.39% in 2006-07 and to 6.26% in 2007-08. Thereafter, tax-GDP ratio has come down slightly and has been in the range of 5.4 to 5.6% of GDP, until 2014-15 but improved to 5.8% in 2016-17. In contrast, much of the increase in the tax ratio during the first forty years of planned development in India came from indirect taxes, which more than tripled, from 4 percent of GDP in1950–51 to 13.5 percent in 1991–92. Since then, however, ratio of indirect taxes has fallen back to around 11 percent of GDP. The decline in the total tax ratio observed since 1987–88 has occurred mainly at the central level, especially in indirect taxes, which came down significantly in proportionate terms, because of reduction in tariff rate and since Centre accounts for about 60 percent of the total revenue, it affected overall tax-GDP ratio.

The analysis of the trends in central tax revenue shows that the sharpest decline in the tax-GDP ratio was in indirect taxes—both customs duties and central excise duties. The former declined by about half, from 3.6 percent in 1991–92 to 1.8 percent in 2004–05. Revenues from excise duties fell by one percentage point, from 4.3 percent to 3.3 percent during the period. One explanation for the declining trend in excise duties throughout the1980s is that the rate structure assumed was not revenue neutral when the input tax credit was allowed. Continued exemption of the small business sector, expansion of its definition to include businesses with annual turnover of Rs. 1 crore, and widespread use of area-based exemptions are other important reasons for the decline in excise duty revenues. Further, since 1997–98 more than 75 percent of the increase in the GDP is attributable to the growth of the service sector and the manufacturing sector has been relatively stagnant, implying an automatic reduction in the ratio of excise taxes on the manufacturing base as a percentage of total GDP. The figures of Tax-GDP ratio from 1980-81 onwards are tabulated in Table 3.

Table 3 – Tax-GDP Ratio of Different Taxes In India

Source : compiled from CBDT statistics 2017, Ministry of Finance statistics 2018, and Income Tax Handbook 2018 .

Figure 6: Tax-GDP Ratio in India

Source: constructed by author from Table 3.3

From the discussion in foregoing paragraphs, the following conclusions can be drawn:

- Tax GDP ratio of direct taxes was in the neighbourhood of 2 percent for almost forty years from 1950 to 1990 until large scale reforms were carried out.

- It changed upwards after 1990 reforms to 6.26 percent by 2007-08, while ratio of indirect taxes came down significantly while that of state taxes remained more or less same. Therefore overall tax-GDP ratio did not reflect any significant increase.

- Direct taxes ratio showed a slow down there after and hovered around 5.5 percent until 2017, while that of indirect taxes marginally increased.

- Increase in ratio of direct taxes is on account of induction of technology and better TDS coverage as also on account of improved corporate tax performance.

As per a study carried out by Rao (2017), the revenue productivity of the Indian tax system has not only been low but has not shown any perceptible increase over the years, despite increases in the per capita incomes. In fact, it has shown a decline in the 1990s from 15.3 per cent in 1991-92 to 14 per cent in 2001-02. Thereafter, it steadily increased to 17.5 per cent in 2007-08, but declined to 15.5 per cent in 2009-10 and hovered around 16.5 per cent thereafter. He further observed that the tax GDP ratio of India presently (2017-18) should have been about 19% and 22.84% in the year 2030-31, considering nominal growth of 7% and inflation at 5% and dollar exchange rate of 67. Future projections of tax GDP ratio were worked out as under.

Table 4: Predicted Tax-GDP ratio for India

Source: Rao (2017)

4. Phases of Direct Taxes Collection:

Table 5: Phases of Tax Collection in India

Source: compiled from literature on taxation and table 3.3

5: International comparison:

Figure: 7 Tax –GDP Ratio of different countries

Source: OECD Revenue Statistics, 2017; CBDT statistics 2016.

Figure: 8: Tax –GDP Ratio- Region wise

Source: The World bank classification and WDI report 2015, OECD report 2017.

SAR- South Asia Region, MENA- middle east and north Africa, LAC- Latin American countries,

ECA- Europe and central Asia, EAP- East Asia and Pacific , AFR- Africa

Figure 3.9– Tax GDP Ratio of OECD and Non OECD Countries for Year 2014 .

Source: OECD comparative tax administration, 2017 and IMF data

Table 6 : Comparison with BRICS Countries

Source: OECD comparative tax administration, 2017 and IMF data

The tax GDP ratios in respect of OECD countries and major economies of the world for the year 2014 are shown in the Figure -9, which indicates that OECD countries have much higher average of 34.4%, while global average at 18% is also slightly higher than Indian ratios. The China's ratio at about 19% is marginally better than India. Therefore, it may be concluded that India is still a long way to go in reaching close to OECD and developed countries' tax ratios, thus indicating that there is a lot of scope for improvement. Therefore, further tax reforms in policy as also in tax administration are required and to do that, global best practices needed to be emulated besides bench marking of Indian tax administration.

Table -7: Composition of Tax Revenues of different countries ( in Percentage )

Source : OECD Revenue Statistics (1965-2008) , Indian Public Finance Statistics (2008-09), Govt. of India; and Ministry of Finance, Govt. of Malaysia .

It is also seen that in the developed and OECD countries, major component of overall taxes is income tax which is above 50%, while developing countries like India still depend largely on indirect taxes or consumption taxes. Reasons are not far to seek, because as the per capita income increases and country becomes richer more and more taxes come from direct taxes or more particularly the income taxes. India is still largely dependent on indirect taxes for its tax revenue which contribute about 66% of total taxes. However, as the country will get richer, share of personal income tax is going to increase.

6: Tax Elasticity Analysis:

The theoretical arguments indicate that a sound tax system should be elastic and should automatically generate greater tax revenue with the growth in Gross National Income. In order to verify this theoretical premise, an attempt is made in the present paper, to conduct tax elasticity analysis to see as to how elastic the tax collections are vis- a-vis GDP growth. In doing so the Tax is treated as the dependent variable whereas GDP is treated as an independent variable. The relationship was defined as:

InTAX =a 0 +Inß 1 GDP t +u t,

Where a 0 (alpha) is constant, TAX is dependent variable, GDP is independent variable, ß1 is factor and regression was run on the data as per Table 3.8.

Table 3.8: Tax Collection and GDP

Source: Public Finance Statistics, 2017, CBDT Statistics 2018

On computerized statistical (regression) analysis, the convergence was reached after 5 iterations and the results were worked out as Table 9. The analysis was done through the help of computer software STRATA 13, which uses iterative scheme of analysis, ending into convergence at certain level. This was done to see as to how elastic tax collections are vis a vis GDP growth and by what percent the tax collection growth increases for every percent growth in GDP.

Table: 9: Estimated Model of Tax Elasticity

Source: Computed by the author from Table -8

From the above results, it can be concluded that the GDP growth is positively influencing growth in tax collection. In other words, increase in every percent in GDP leads to increase of tax revenue to the tune of 1.31 percent. Hence, the tax growth is highly elastic (since it is more than unity) to growth in GDP.

7. Impact of Economic Reforms on Direct Tax Revenue in India: An Interrupted Time Series Analysis (ITS) of pre and post-tax reforms in India:

While the preceding analysis has revealed that the tax growth is highly elastic for the time period covered in the study, it should be noted that the country has experienced major tax reforms from the FY 1991-92 onwards. It is therefore important to examine if the tax reforms have made any difference to the tax elasticity in the country. This method uses rather a simple linear regression technique as compared to ARIMA models. It controls secular trends, and accounts for serial correlation of the time series data. The model specification of this technique is as under (Lagarde, 2012) :

Where Yt is the dependent variable (Direct Tax Revenue (Rs. in crore) in the present case)) at time t, Time indicate time since starting of the study and captures the structural time trend of dependent variable independently from the policy intervention (pre-reform period), policy intervention is a dummy variable that is coded as ‘0' for the observations pertaining to pre-policy period and coded as ‘1' for the observation fall under policy regime. Finally, post slope variable represent the change in the dependent variable after implementation of a policy and the constant (ß0) capture the starting level of dependent variable. The above model is estimated using the software STATA 13. The final estimates are obtained through Prais-Winsten regression that uses generalized least square (GLS) method to estimate the coefficients in a linear regression model.

Figure -10:Prais-Winsten Estimates of segmented regression for Direct Tax Revenue

Source : Author's estimation using equation (1)

The coefficients of the above model indicate that there was no significant year-on-year change (either positive or negative) in the direct tax revenue before the implementation of economic reforms of 1991. The coefficient Time variable (ß1) that meant to capture the structural time trend prior to reforms is not significant at 5 percent level. In other words, the direct tax revenue in India has not witnessed any significant change in the pre-reforms period. On the contrary, exactly the opposite pattern is observed from the coefficient value of Post Slope variable. The corresponding coefficient (ß3) is not only significant at 5 percent level but also possess the positive sign. This indicates the direct tax revenue of India has substantially increased after the implementation of economic reforms to the tune of Rs. 31,651 crore an average per year compared to the pre-reforms period.

However, the results also indicate that this increase in direct tax revenue has not been achieved immediately after the implementation of economic reforms, but a few years later. This is reflected by the coefficient that captures the immediate impact of the reforms (ß2 Policy Intervention) is not significant at 5 percent level. Hence, it can be safely concluded that the economic reforms of 1991 have certainly positively altered the trend and growth rate of direct tax revenue in India.

8: Impact of Global Financial Crisis on the Tax Collection: A Structural Break Analysis:

The analysis of tax collection trends and the tax elasticity has accounted for a substantial improvement, especially for direct taxes after the reforms have been introduced coupled with the buoyant economic growth that the country experienced. However, the slowing down of Indian economic growth experienced on account of the global financial crisis of 2008 did have its impact on the tax collection. This section has attempted a structural break analysis to check if there has been a significant decline in tax collection following the deceleration in the country's economic growth.

Structural break analysis for tax revenue from 1980 to 2017 has been done with a view to see as to when does the break occurs in the trends of taxes. While doing so different years have been kept as year of structural break and a dummy variable has been introduced which has value 0 before that year and 1 after that. The relationship between tax and GDP growth was defined as under:

Where, InTAX =log(TAX) and time is in years, DUMMY07 is a dummy variable (differential intercept) taking the value of 1 for the observations beginning from the year of break and 0 before that year. On computerized analysis, convergence reached after 13 iterations in the year 2007 and the estimated results of the model are presented in Table 10.

Table:10 Results of Structural Break Analysis-Direct Taxes

Source: Worked out by the author, 2019

The differential intercept DUMMY07 shows how much the average level of tax growth rate has changed since 2007. DUMMY07, which is the differential intercept is positive and significant (at 1.36) showing a statistically significant difference in the tax growth rate of pre and post break point. The slope intercept TIME* DUMMY07 is also significant but negative. The average difference in growth rate before and after the structural break point is negative and significant. This indicates that the average growth rate, after the structural point is much lesser (lesser by 4%) than the growth rate before, implying that the deceleration in the Indian economic growth has adversely affected the growth in tax collections.

9.Conclusions:

The Elasticity Analysis of tax and GDP data for the period 1980 to 2017 through regression analysis shows that relationship between two variables is positive and increase in every percent in GDP leads to increase of tax revenue to the tune of 1.31 percent. Hence, the tax growth is highly elastic (since it is more than unity) to growth in GDP. Further impact of economic reforms on direct tax revenue in India was examined from an Interrupted Time Series Analysis (ITS) for pre and post-tax reforms in India, to see whether the tax reforms made any difference to the tax elasticity in the country by using the software STATA 13. It was found that there was no significant year-on-year change (either positive or negative) in the direct tax revenue before the implementation of economic reforms of 1991. On the contrary, exactly the opposite pattern is observed post reform period where in direct tax revenue has substantially increased after the implementation of economic reforms and to the tune of Rs. 31,651 crores on an average per year as compared to the pre-reforms period. However, the results also indicate this increase in direct tax revenue has not been achieved immediately after the implementation of economic reforms, but actually after a few years. Hence, it can be safely concluded that the economic reforms of 1991 have certainly positively altered the trend and growth rate of direct tax revenue in India. Structural break analysis of taxation data shows that there was statistically significant break in the year 2007. After checking the trend break for several years since 1990-91, the co-efficient of the regression were found to be significant in the year 2007. Analysis indicates that growth rate of direct taxes after 2007 is lesser by about 4.1% as compared to the earlier years, clearly showing deceleration in economic activity as also tax collection, on account of global slowdown.

[The views expressed are strictly personal.]