Tax Reforms

[op-ed snap] Why expanding India’s direct tax net is relevantop-ed snap


Mains Paper 3: Economy | Mobilization of resources

From the UPSC perspective, the following things are important:

Prelims level: Direct taxes- types and trends

Mains level: India’s rising middle class and its impact on tax collections


Widening tax base

  1. Most citizens pay direct taxes in successful democracies, but not so in India—partly because of high levels of poverty but also because of rampant tax evasion
  2. Finance minister predicted earlier this month that India can have around 120 million taxpayers as more Indians become part of the formal economy
  3. The number of people filing income tax returns in the current assessment year is already at around 60 million, or 50% higher than the previous year
  4. The finance minister is thus predicting a doubling of the number of income taxpayers in the coming years

Will the number actually double?

  1. India has around 250 million families, more than half of whom will anyway be outside the tax net either because they are farmers or they are too poor to pay taxes
  2. That leaves around 125 million families that can potentially pay income tax
  3. FM is implicitly suggesting that most Indians who should be paying taxes will be doing so soon, even if you adjust for the fact that many families will have more than one taxpayer
  4. However, it is important to remember that a tax filing is not the same as a tax payment, and many Indians who file returns do not actually report any tax liabilities

Why the fiscal deepening of the Indian state is important now?

  1. Neither faster economic growth nor foreign aid will suffice to end extreme poverty by 2030
  2. To end extreme poverty sustainably and as quickly as possible, the states governing the world’s poor need to be strengthened such that they are both accountable to the needs of the poor and have the capacity to meet those needs
  3. Most of the poorest people in the world live in countries such as India that are classified as middle-income countries based on average incomes
  4. These countries are unlikely to get enough foreign aid but they do not have the deep fiscal resources to help their poor either directly through redistribution or indirectly through the provision of public goods that will raise their ability to earn extra income
  5. Countries such as India are thus trapped between the very poor countries that get a lot of foreign aid and the wealthy ones with very strong tax collections

Important consequences of getting more people into the direct tax net

  1. First, the overall boost to tax collections means that the Indian state will be in a better position to perform its key duties without running into repeated fiscal crises
  2. Second, higher direct taxes could provide space for significant cuts in indirect taxes such as the goods and services tax, which in effect means a shift from a regressive to a progressive tax system
  3. Third, a widening tax pool because of formalization means the current perverse system in which efficient firms are taxed at a high rate because inefficient firms manage to slip outside the tax system will end

Way forward

  1. The Indian state has historically battled immense fiscal constraints
  2. The recent trends in direct taxes offer hope but are too preliminary to jump to any conclusion

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