Context: In a recent web publication, the IMF published its World Revenue Longitudinal Data set for all countries, from 1990-2019.

• What the data conclusively show is that the debate on the Indian economy should shift away from simplistic notions (borrowed from the West?) of the tax-GDP ratio being low in India.

Common Observations of India’s Tax/GDP Ratio

• India’s Tax/GDP ratio is low, at around 10-11% of GDP. It has stayed close to that level for the last 20 years. In 2019, it hit a decade low of 10% of GDP, the same as in 2014.

• In comparison with our peers, India’s tax/GDP ratio is much lower. Therefore, it is argued that it should be increased.

Debates on Tax/GDP Ratio in the Indian Economy

• India’s tax/GDP ratio is one of the three important fiscal variables in the economy, i.e., taxes, fiscal deficit, and debt. And it is lower than what it “should” be.

• These fiscal variables are interrelated. Therefore, a lower tax/GDP ratio impacts the other two fiscal variables. I.e., lower tax revenue means higher fiscal deficit, for the same level of expenditures, and higher deficit means higher debt. All three, directly or indirectly, are assumed to affect growth and/or inflation.

• It has been argued that the low tax ratio in India has led to a lower rate of investment, a higher fiscal deficit, and lower GDP growth.

India’s low tax-to-GDP ratio

• One of the stylised beliefs in India, and amongst some leading economic commentators both in India and abroad, is that our tax/GDP ratio is lower than what it “should” be.

• This low tax-to-GDP ratio is blamed for a lower rate of investment, a higher fiscal deficit, and lower GDP growth — and all because the tax ratio is too low.

• There can be reasonable doubts about the presumed links.

• There are three important fiscal variables in the economy — taxes, fiscal deficit, and debt.

• They are inter-related — lower tax revenue means higher fiscal deficit, for the same level of expenditures, and higher deficit means higher debt.

• All three, directly or indirectly, are assumed to affect growth and/or inflation.

Debates over the structural measures to increase the tax/GDP ratio of India

• Hike Corporate Tax Rate View: Some experts argued to increase revenue from corporate tax (one of three major components of tax revenue, the other being income and indirect taxes). Because inequality was increasing, the rich should pay more taxes to lower the fiscal deficit.

• Lower Corporate Tax Rate View: A small minority of economic experts argued that the higher corporate tax rates will stifle investment, increase tax un-compliance, and lower growth. Therefore, there should be a lowering of the corporate tax rate in India to meet the intended goals

Various Structural Change Measures Taken for Increasing the Tax Collection in India Post-2019

• Corporate tax cut 2019: In September 2019, the Finance Minister lowered the corporate tax rate by around 10 percentage points. This was one of the largest corporate tax cuts in world history. Unfortunately, the pandemic struck the world a few months later and disrupted world economies.

Efficacy of the tax cut in India

• The corporate tax revenue has increased by 66%, and GDP by 33% based on the use of fiscal 2019-20 as a base. It means, there has been an average tax buoyancy of 2.0 over three years since 2019.

• Tentatively, the tax-GDP ratio in the fiscal year 2022-23 will average over 18 percent in India, a level close to Japan and the US.

Road Ahead

• In India, the debate should shift to expenditures, and quality of expenditures (and perhaps to reform of the direct tax code). In this regard, suggestion that freebies be critically examined is most timely and welcome.