Inequality and taxation in India - Prof Arun Kumar on Aljazeera TV

Direct tax collections reflect disparities | Arun Kumar (in Business Line May 9, 2024)

Business Line May 09, 2024  
 

The taxpaying citizens largely belong to the organised sector. Their incomes have risen substantially and they pay more tax

BY ARUN KUMAR
 
Direct tax collection by the Central government comes from incomes, wealth and transactions. | Photo Credit: Prakash Bharti 

The Central Board of Direct Taxes has announced that net direct tax collection has exceeded its target for 2023-24. It has increased 17.7 per cent over last year and much faster than the income increase of about 9 per cent. Analysis of this data is also important since the Prime Minister has set in motion the issue of redistribution in the economy. 

Net Direct Tax collections of the Centre at Rs.19.58 lakh crore are higher than the budget estimate of Rs.18.23 lakh crore for 2023-24. This was revised to Rs.19.45 lakh crore in the Union Budget 2024-25 and the actual has turned out to be even higher by 0.67%. The net figure is arrived at by subtracting the refunds to tax payers. The refunds have also increased substantially by 22.74% over the last year’s figure of Rs.3.09 lakh crore to reach Rs.3.79 lakh crore. What does it tell us about Indian economy’s performance in 2023-24? 

Rising Share of PIT

Direct tax collection by the Central government comes from incomes, wealth and transactions. Tax on wealth – wealth tax, estate duty and gift tax – has been negligible since it is largely eliminated. Income tax is collected both as Personal Income Tax (PIT) and Corporation tax.
PIT has sharply increased by 24.26%. Corporation tax has increased by 10.26% and is 46.53% of the total direct tax collection, considerably less than its share of 49.64% in 2022-23.
In 2018-19, revenue from Corporation tax exceeded PIT by 40.3%. In 2019-20 this excess declined to 13.05% due to the sharp reduction in the Corporation tax rate. In 2020-21, the excess turned into a deficit of 6.4% but in 2021-22 Corporation tax collection again exceeded that from PIT but after that PIT has been higher. Why these swings?
The increase in tax collection can occur for two reasons. First, an increase in the base of tax collection. That is more entities come under the tax net. With inflation, nominal incomes rise and those who were not under the tax net also come under it. The number of people in the direct tax net has risen from 7,42,49,558 in FY 2016-17 to 9,37,76,869 in FY 2021-22. Further, those already in the tax net have a higher income. Second, if the government raises the rate of tax, collections increase. Both these factors are at play currently.  
Income tax rate has been raised through a surcharge on tax payable while keeping the base rate unchanged at 30% and education and health cess at 4%. In 2014-15 a surcharge on income tax of 10% was introduced for an income above Rs. 1 crore. In 2016-17, it was raised to 12% and in 2017-18 to 15%. In 2018-19, a surcharge of 10% for income between Rs.50 lakh and Rs. 1 crore was introduced while 15% on incomes above Rs.1 crore remained unchanged. In 2021-22, a levy of 25% on incomes between Rs.2 crore and Rs.5 crore and 37% on income above Rs.5 crore was introduced. There was no change in surcharge for income below Rs.2 crore.
 
In brief, while the Corporation tax rate was reduced, the tax on incomes has been raised. Naturally, tax collection under PIT has increased faster than from Corporation tax. Further, the big increase in income tax collection is no indication of a rapidly growing economy. It could be claimed that the increase is a result of better tax compliance due to control of black economy but that does not appear to be the case.  

Narrow base of PIT  

To resolve the issue whether or not compliance has improved, there is need for more granular data on which entities are paying more of income tax. Detailed data is available for 2020-21 and some data for 2021-22. What does it reveal ?
First and foremost, the base of tax payment in India is very narrow. Only those in the top rung of the income ladder in the country are in the income tax net. In 2020-21, 6.6% of the population filed a tax return. But most of them did not pay any income tax since their income was below the taxable limit. Effectively, only 0.68% of the population had high enough income to pay a significant amount of income tax, these are called the effective tax payers. Further, 0.016% declared an income above Rs.1 crore with a share of 38.6% of the declared taxable income.
It is this 0.68% and 0.016% which has had to pay a surcharge and a higher tax rate. Even if their income did not rise, they had to pay a higher tax rate.  For income between Rs.2 crore and Rs.5 crore, there was an increase of 3% in the tax rate and for an income above Rs. 5 crore the increase was 6.6%. This rate increase explains a part of the increase in PIT.  
The other part is due to a rise in inequality in the economy. The tax paying citizens’ largely belong to the organized sector. Their incomes have risen substantially and they pay more tax. The unorganized sector incomes are mostly below the taxable limit.  
Further, Data on Q3 of GDP for 2023-24  shows a decline in the share of consumption. This indicates a shift in incomes’ share from the poor to the well-off, since higher the income, smaller is the per cent of it consumed. So, as the income share of the well-off increases PIT would increase without compliance improving.  

Conclusion 

In brief, the rapid increase in PIT indicates increasing income disparity between the organized sector which falls in the tax net and the unorganized sector that lies largely outside the tax net. No wonder there is talk of redistribution. 

Author of `Indian Economy’s Greatest Crisis: Impact of the Coronavirus and the Road Ahead’ 2020.
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Income Tax Data Reveals That Increase in Compliance Is Marginal | Arun Kumar

 (This article appeared in The Wire on Nov 27, 2023)

The income tax data released recently points to the highly skewed nature of income distribution in the country, with only about 0.68% people paying effective taxes.

Arun Kumar

 

The Central Board of Direct Taxes (CBDT) has released data on income tax payees for financial years 2013-14 to 2022-23. More detailed data about different categories of tax payees are available for the financial year 2020-21. This data can be used to get an idea of the income distribution of the top income earners in the country.

Few direct tax payers

Income tax is paid by a minuscule percent of the population. Official data shows that 7.4 crore individuals filed tax returns in FY2022-23 and 6.75 crore in FY2020-21. In this earlier year, there were also 2.1 crore people who did not file a tax return but paid Tax Deducted at Source (TDS). So, in FY2020-21, effectively there were 8.85 crore people in the tax net – which was 6.6% of the population. Since we do not have corresponding data on those not filing tax return but paying TDS for FY 2022-23, we do not yet know the total number of entities in the tax net in 2022-23.

Anyone paying income tax or filing a tax return has to have an income above the income tax exemption limit and therefore has to be among the top income earners in the country. What is their distribution?

The exemption limit for determining tax liability is now Rs 3 lakh but has been Rs 2.5 lakh, with some concessions for senior and super senior citizens. With a standard deduction of Rs 50,000 and rebate under Section 87A, till now an individual did not have to pay any tax up to a taxable income of Rs 5 lakh. Of India’s per capita annual income at current prices of Rs 1,50,007 in 2021-22, this is 333%. From the current financial year, tax will have to be paid at income of above Rs 7.5%, 414% of the likely per capita income of about Rs 1,81,000. So those in the tax net are in the tail of the income distribution.

With so much concession, for FY2020-21, out of 6.76 crore e-returns filed, 4.46 crore paid nil tax (67.3% of the total). The 2.1 crore who did not file a return but paid TDS must have had an income below Rs 2.5 lakh, otherwise they would have had to file a return. Adding these two numbers, effectively, 6.6 crore returns out of a total of 8.85 crore (73.4%) were filed by those with low incomes. 91 lakh (10.3% of those in the tax net) had taxable incomes above Rs 9.5 lakh and who can be called well-off in the Indian context. About 2.15 lakh declared income above Rs 1 crore and maybe characterised as wealthy.

In brief, people in top rung of the income ladder in the country were those who were in the income tax net (6.6% of the population) even if they did not pay income tax. Out of these, only 0.68% of the population were the really well off who effectively paid income tax. Further, 0.016% declared an income above Rs 1 crore and had a share of 38.6% of the taxable income.

Caveats

This picture of the well-off, characterised by those who effectively pay income tax, is incomplete. Two additional factors need to be taken into account. First, the rich families split up their incomes. This enables them to take advantage of concessions on each of the returns filed and each of the incomes may then fall in the lower income bracket on which a lower tax rate may apply. Second, the well-off resort to black income generation by not declaring their true income.

The first point implies that the 0.68% people who paid significant amounts of income tax belong to an even smaller percent of the families. So, the actual family income of the well-off is much higher. Since the poor face unemployment, under employment and joblessness, their family income is not much higher than what a poor individual earns. The implication is that the gap in family incomes between the well-off and the poor would turn out to be much larger than gap in incomes shown by the data on individuals paying tax.

Further, black incomes are generated by the well-off, who have substantial incomes. Those who have an income below the taxable limit don’t need to hide their income. They do not have to file a return or declare their income to the tax authorities. Those who have a taxable income of, say, up to Rs 9.5 lakh, need pay only a few percent of it as tax, if they take advantage of deductions under 80C, 80D, 80TTA, etc. So they will hardly benefit from hiding their income and will not be generators of black incomes.

It is the well-off, especially businessmen and professionals who declare a lower income to tax authorities so as to pay a smaller portion of their income as tax. Some of them completely escape the tax net by not filing a return or by showing an income below the taxable limit.

All these factors lead to the official data underestimating the skewedness of income distribution in the economy.

Has compliance increased

The organised sector has higher incomes and contributes most to direct taxes. It produces 55% of the GDP. Its share of GDP would have risen during the pandemic, which disproportionately hit the unorganised sector. The GDP was Rs 1,98,00,914 crore in FY 2020-21, the Covid year. So, Rs 1,08,90,000 crore should have been captured in the tax net from the organised sector. Some more should have come from the few well-off businesses in the unorganised sector.

Detailed data for FY 2020-21 shows that the taxable income declared by all return filers was Rs 69,59,552.48 crore. This is about 35.15% of the GDP and about 63.9% of what should have been shown as declared incomes by the organised sector. On this declared income, the tax collected was Rs 9,47,176 crore. The tax to GDP ratio was a very low 4.78%. If black income generation were taken into account, it would be even lower.

In FY2021-22, GDP recovered from its low during the pandemic, and became Rs 2,36,64,637 crore. The direct tax collection increased to Rs 14,12,422 crore, so that the direct tax to GDP ratio rose to 5.97%. In 2018-19, this figure was even higher at 6.02%. But, even this figure is low compared to many developing economies.

The government claims that more and more people are filing tax returns and presents this as an indication of better tax compliance and a reduction in the black economy. According to the data just released, the number of people paying direct taxes has risen from 7,42,49,558 in FY2016-17 to 9,37,76,869 in FY2021-22. This is impressive, but the catch is that most of the people entering the tax net declare nil income or a low income, as pointed out above.

A reduction in black income generation would have meant that many more of the individuals with high incomes would have come into the tax net, and the direct tax to GDP ratio should have risen sharply instead of hovering between 5.5% and 6% since 2014-15.

The increase in the number of tax returns is due to the constancy of the income at which a tax return needs to be filed remaining unchanged at Rs 2.5 lakh, while incomes have risen due to inflation. The per capita net national income, which tells us how much an average citizen is earning, is 30.1% higher in 2022-23 than it was in 2019-20.

Thus, someone with an income of Rs 2 lakh in FY2019-20, pre pandemic, would be earning Rs 2.6 lakh in FY2022-23. In 2019-20, she would not have had to file a tax return while in 2022-23 she would have to file a return. Thus, the number of tax return filers would automatically rise. But the tax they pay would not rise, so their entry into the tax net does not impact the tax to GDP ratio.

Conclusion

The income tax data released recently points to the highly skewed nature of income distribution in the country with only about 0.68% people paying effective taxes. The percentage of families they belong to would be even smaller. If tax manipulations by the wealthy and black income generation are taken into account, then the income distribution becomes even more skewed. Finally, the increase in the number of tax filers is due to inflation but this has hardly led to an increase in the direct tax to GDP ratio since most new entrants in the tax net file either nil return or are exempt from tax. So, tax compliance in the country has hardly changed.

Arun Kumar is the author of Understanding Black Economy and Black Money in India.