Until recently, in discussions on the state of public finance in India, the dominant view has been that the volume of public resources mobilised through taxation by the state is short of potential, given the size of India’s GDP.
With the tax-GDP ratio at the Centre currently in the neighbourhood of 11.5 per cent and that in the States at around 5.5-6 per cent, the ratio for the government in general has hovered around 17.5 per cent.
Differences on how it should be increased — broadening the tax base as opposed to hiking income tax rates and/or introducing wealth taxation, relying more on direct taxes rather than indirect taxes, and so on — were common. But the view that the figure had to be raised had widespread support.
Where is the money?
But ever since policymakers embraced neo-liberalism in the 1990s, and took the view that the state’s role was to facilitate and incentivise private investment, governments have been inclined to adopting a light touch when it came to taxation, especially direct taxation. Once that was taken as given, calls for added state expenditure in essential and crucial areas were met with the response: “But where is the money?”
Recently policy makers have gone one step further. Following the presentation of Budget 2024-25, the Revenue Secretary reportedly argued that India’s “tax to GDP, given (its) level of development is actually not so low”. Noting that the ratio is around “12 per cent for the Government of India, and another 6 per cent in States, so it is about 18 per cent,” he reportedly went on to say (The Hindu, July 26) that: “if you plot it with per capita income of various countries, then we are slightly above what that per capita income should actually indicate.”
There are two arguments implicit in that assertion. The first is that there is a clear cross-country relationship between the tax-to-GDP ratio and the level of per capita income, with the former rising along with the latter. The second is that along that “curve”, India can be identified as being located more or less where it should be. In sum the country’s position along the curve reflects the adoption of “international best practice”.
Chart 1, providing the distribution of a set of 170 countries in term of the tax-to-GDP and per capita income relationship, examines the veracity of the first of these arguments. It shows that while countries with per capita incomes of less than $10,000 (which is where India is located with $7,712), tend to bunch together at levels of tax mobilisation that are below 20 per cent, there are many with higher ratios in the 20-25 and 25-30 per cent ranges.
If we ignore outliers, a positive relationship between tax performance and per capita income begins with countries in the 25-30 per cent tax-to-GDP range. The case that India is located where it should be, looks doubtful.
This also emerges from an examination of the set of countries that have climbed up the next step in terms of taxation, with tax to GDP ratios that are in the 25 to 30 per cent of GDP range (Chart 2). There are at least 9 of 25 countries that fell in that range in 2022, which had per capita incomes that were less than $10,000. These include Mozambique, Angola, Bolivia, Belize and Nepal. India with its size and diversified economy should be able to do better.
There is another issue. Even granting some relationship between per capita income and the tax-to-GDP ratio, which suggests that there are limits on the proportion of income at different levels that can be taxed away, it is important to take into account the role of inequality in income distribution.
Progressive taxation
If more of total income, at any level of per capita income, is in the hands of the richer deciles of the population, then it is possible to tax away a larger share of that income, through a progressive direct tax regime. A measure of income inequality is the Gini coefficient (varying from 0 to 1, as we move from full equality of income to extreme inequality).
The measure is seen as inadequate to capture actual inequality, not least because personal income estimates of the population are hard to come by, and because incomes in the higher income ranges tend to be missed or underestimated. But that is the measure we have that is easily available across countries.
One set of cross-country estimates places the Gini coefficient for India at 0.33. (Bear in mind that other ratios such as the Palma ratio of top 10 per cent to bottom 40 per cent of incomes, show much higher inequality than the Gini.)
Chart 3 provides the tax GDP ratio of a subset of the countries for which the data is available and for which the Gini coefficient falls in the 0.32 to 0.34 range. As can be seen, in that subset, India has the lowest tax-to-GDP ratio except for Guinea-Bissau.
As evidence of income and wealth inequality in India accumulates, this absence of a strong relationship between its position in the inequality ladder and its tax to GDP ratio does suggest that the super-rich in the country are being let off lightly at the expense of the state’s ability to meet its development commitments.
In the last four decades or so the highest marginal rate of taxation in India fell from 60 to 30 per cent, or by as much as 50 per cent in relative terms. That is the rate at which higher incomes are taxed.
Inequality is not only in income but also in wealth. And there is a strong case to tax the wealth of the super rich, since even a small tax would yield large revenues given inequality. India’s corporate sector according to the government’s Economic Survey 2023-24 released just before the Budget is “swimming in profits”. It is also buried in wealth.
Some, if not all, leading business families have by their conspicuous consumption and display of wealth made it clear that they have more than enough accumulated wealth that warrants them being touched for larger social benefit. But there is little income and no wealth tax imposed on them.
Thus, the evidence is clear. There is large scope for raising the volume of revenues that can be mobilised by taxing the under-taxed rich and super rich in India. Despite this, there is now a virtual campaign to argue that India is adequately- or even over-taxed.
This is no more than an attempt to legitimise a questionable public finance regime under which there has been an engineered transfer of income and wealth to the richer sections of the population.