The problem of tax buoyancy

For two successive years, the sanctity of the Budget’s tax revenue numbers presented to Parliament as the Revised Estimate (RE) has been destroyed. The actual net tax revenue collections in 2018-19 fell short of the RE numbers by Rs 1.67 trillion, or 0.9 per cent of gross domestic product (GDP). The shortfall in 2019-20 is a little lower at Rs 1.49 trillion, or 0.7 per cent of GDP.

Such large deviations, as brought out in detail in an earlier article, are a cause for deep concern. Worse, they undermine everyone’s trust in the Budget numbers and can mislead policy-makers into believing what is not real. Corrective steps to prevent the recurrence of such shortfalls taking place in the current year, which is quite likely, should be accorded the highest priority by the government.

Given that there are forecasts of the economy contracting by over 5 per cent in 2020-21, the government would do well to consider restating its Budget revenue numbers, even if the reduced numbers might lead to an early recognition of a higher deficit. Making that declaration upfront is far better and wiser than springing a nasty surprise with provisional actuals showing later that the tax revenue numbers in RE were wide of their mark.

What else can the government do? Of course, it should consider reverting to the earlier practice of presenting the annual Budget at the end of February. Advancing it by four weeks has certainly made an adverse impact on the finance ministry’s ability to forecast the RE revenue numbers correctly, although it did help in speeding up spending in the first quarter of the year. But maintaining the sanctity of the revenue numbers is no less important than achieving speedier disbursal of funds.

In any case, the original idea behind the advancement of the Budget presentation date is long forgotten. Sometime in 2016, the year of demonetisation, the government had mooted yet another disruption by examining if its financial year could be changed from the current April-March cycle to the Gregorian calendar year cycle of January to December. Advancing the Budget presentation date was seen as the first move in that direction. The idea was that in the space of a year or two, the Budget presentation date would be advanced to the last week of November, facilitating the financial year change.

Nobody in the government at present is toying with that idea of switching over to a January-December financial year cycle. It would, therefore, be a good idea to move the date of Budget presentation back to the end of February and give the finance ministry bureaucrats more time to mull over their revenue numbers to be declared in RE. This should help eliminate or at least reduce the extent of such large variations in revenue numbers.

But that alone would not be enough. Far more fundamental problems have afflicted the way the tax revenue assumptions have been made in recent years. For the last couple of years in particular,  the finance ministry has failed to recognise that there has been a significant deterioration in the Union government’s tax buoyancy. The Modi government had taken a lot of credit for a sharp jump in its gross tax buoyancy in 2015-16, when it rose to 1.63 after having dipped to 0.85 in the previous year.

But since then the buoyancy in the Centre’s gross tax collections has been steadily falling. From 1.63 in 2015-16, it dropped to 1.54 in 2016-17, 1.05 in 2017-18, 0.77 in 2018-19 and to (-) 0.47 in 2019-20. Direct taxes buoyancy too has followed a similar trend and it was 1.23 in 2018-19 and (-) 1.21 in 2019-20 — the two years when the finance ministry had to eat humble pie for having allowed huge deviations in its RE numbers on tax revenue. Personal income-tax buoyancy in these two years was 1.15 and 0.22, respectively.

The Union government’s tax buoyancy has never been very high. In the last three decades, the buoyancy in the Centre’s gross tax collections was higher than 2 only once — in  2002-03. For direct taxes and personal income-tax, the buoyancy has had a slightly better record. In as many as eight years, but all of them belonging to the period before the global financial crisis, the direct taxes buoyancy was over 2. In contrast, personal income-tax saw buoyancy crossing 2 only on three occasions in the last three decades.
 

Deteriorating tax buoyancy cannot be taken lightly by the government. It must examine what has been responsible for this decline. Is it because of increasing tax evasion? Or has the tax administration been lacking in its efficiency, even though its manpower strength has seen a 76 per cent increase in the last one year? Note that the share of tax deduction at source and advance taxes in total direct tax collections has been steadily rising from 74 per cent in 2016-17 to 78 per cent in 2018-19. Or is it because the government has allowed the tax base to shrink over the years in its desire to exempt more people from paying direct taxes?

In the last two Budgets, the government has exempted individuals with a taxable income of up to Rs 5 lakh a year from paying any income tax. Of the 55 million taxpayers as at the end of March 2018, about 35 million individuals had reported a gross annual income of under Rs 5 lakh. Under the new dispensation, these 35 million taxpayers will continue to file their returns, but will not pay any taxes. Their combined gross total income in 2017-18 was about Rs 11 trillion or a third of the total gross income reported by all individual taxpayers. The erosion of such a large tax base certainly will have an adverse impact on tax buoyancy and renewed efforts should be made to address such concerns. A similar cleaning up operation must also be undertaken to remove as many exemptions as possible in the goods and services tax (GST) regime. The objective should be to rationalise and lower indirect taxes, while expanding its coverage to include more taxpayers.

An area of added focus could be non-tax revenues, which have maintained steady growth even during the last few years when tax growth has been relatively muted. Total non-tax revenues six years ago were only about 22 per cent of the Centre’s net tax revenue, but last year their share rose to 24 per cent.
 

But the larger message from the dismal tax revenue numbers is that the government must make a clean breast of its fiscal deficit situation arising out of such tax revenue shortfalls. It has made a good beginning with the Budget documents revealing the extent of such window dressing. It has also stopped accessing the off-Budget borrowing route more than what has been made public in the Budget. That’s why, the revenue shortfall in 2019-20 over RE was made good by additional borrowing, and not by increased access to off-Budget borrowing, even though that meant conceding a higher fiscal deficit.

Now, it is equally important to focus on a more fundamental problem of revenue growth and tax buoyancy.