Crossing the Kautilya-Rekha of Taxation

Crossing the Kautilya-Rekha of Taxation — Surajit Das  

The share of total
expenditure by the Central and the State governments taken together in India is
around 27 per cent of GDP. 
In other words, more or less 27 per cent of money
value of currently produced final goods and services within a year are produced
for or purchased by the government of India. This means that the participation
of government in aggregate level of activity in India is only slightly above
one-fourth as compared to that to be more than fifty per cent in Euro area. It
is a matter of common sense to understand that the governments with 25 per cent
presence in the economy would not be comparable with governments with more than
50 per cent participation in the level of activity – larger governments are
normally expected to be more important, powerful and capable on an average.

As far as the World
Economic Outlook database of International Monetary Fund (IMF) for the years
2010-2012 is concerned, the average size of governments in advanced economies
has been 43 per cent of GDP, in European Union 49 per cent, in Latin America
and Caribbean 34 per cent, in Middle East and North Africa 32 per cent and in
Sub-Saharan Africa 30 per cent of GDP. The developing Asia including India has
the lowest size of the government with only 24 per cent of GDP. Out of 189
countries, for which data is available, India ranks 125thvis-à-vis the
government expenditure to GDP ratio. Clearly, for stronger and more effective
government, we must try to step up our government expenditure as proportion to
GDP in India. There are two ways to finance the government expenditures: a) by
mobilizing revenue (mainly by taxation) and b) by incurring deficits (financed
mainly by borrowing from the domestic financial market in Indian context). The
combined fiscal deficit as percentage of GDP is not less in India when compared
to that in most of the other countries around the World. Even if the fiscal
deficit goes up by 1-2 percentage points of GDP, there is no harm. However, our
main problem lies in the arena of revenue mobilization.

India ranks 163rd
out of total 189 countries vis-à-vis revenue collection of government as
proportion to GDP. The average revenue GDP ratio of combined (Centre and
States) government during 2010-2013 has been only 19 per cent on an average in
India. This ratio has been 46 per cent in Euro area, 36 per cent on an average
in the advanced countries, 37 per cent in Middle East and North Africa, 31 per
cent in Latin America and Caribbean and 27 per cent even in the Sub-Saharan Africa
during the same time period. Even in Developing Asia, this ratio has been more
than 21 per cent according to the World Economic Outlook database of IMF. As
far as our Indian Public Finance database of Ministry of Finance is concerned, the
combined tax revenue as proportion to GDP stands slightly higher than 16 per
cent on an average during 2009-10 to 2011-12 (Revised Estimate). The rest 3 per
cent is combined non-tax revenue. Given limited possibilities of non-tax
revenue mobilization, it is obvious that, without significant improvement in
tax-GDP ratio, it is not possible to improve the presence of government in the
economy substantially. In 3rd Century BC, Kautilya apparently
suggested in his Arthashastra that the tax-rate of one-sixth (i.e. 16.7 per
cent) is the key tax-rate applicable to domestic trade and economic activities
(Reference: On the Manu-Kautilya norms of taxation: An interpretation using
Laffer curve analytics by D.K.Srivastava; NIPFP working paper 172, 1999).

If we look at the
direct tax revenue of the Central government (the bottom green panel) as
proportion to GDP during last 12 years, we see that there has been significant
improvement particularly during high growth period of 2002-03 to 2007-08 from
3.1 per cent to 6.4 per cent of GDP. Then it stagnated at around 5.6 per cent
of GDP. However, profit as percentage of net value added in organised
manufacturing in India also increased from 24 per cent in 2001-02 to 62 per
cent in 2007-08 and then stagnated at around 56 per cent of net value added (Source:
Annual Survey of Industries). Clearly, profitability increased at a faster rate
than increase in direct taxes on income of the rich and profit of the
corporates. The indirect tax revenue of Central government has come down as
proportion of GDP following the financial crisis of US in 2008 primarily due to
excise duty cuts to revive the economy. The direct tax revenue of States are
negligible and indirect own tax revenue of the States remained more or less
constant as proportion to GDP during the last decade.

In 1989-90, the tax-GDP
ratio was 15.5 per cent in India. The tax-GDP ratio came down to less than 13 per cent in 1998-99 mainly due to the reduction in customs
duty as part of the so called ‘structural adjustment’ programme. Then the ratio
improved continuously and crossed the 17 per cent mark (read Kautilya-rekha)
for the first time in the history of independent India in 2006-07 and 2007-08. Then
it came down to 15.5 per cent again during 2009-10 and after some recovery it
has reached 16.5 per cent according to the revised estimate of 2011-12. During
this high growth period, when profit rate as proportion of net value added in
organised manufacturing became more than 50 per cent from less than 25 per
cent, the profit tax rate has been actually reduced from 35.88 per cent to 32.5
per cent between 2004-05 and 2011-12. The effective tax rates have always been
much lower than the statutory rates and big companies with more than Rs.100
crore profit paid taxes at the lowest effective rate (Reference: Revenue
foregone statement of union budget of various years). Even if the same
corporate tax rate of 35.88 per cent would have prevailed and the tax would
have been collected at that rate, we would have got more than 2 per cent of GDP
amount of extra revenue (see table:1 below) every year.

       The above table (Table:2)
tells us that we could have touched 25 per cent mark i.e. one fourth of GDP
during 2007-08 and 2008-09 rather than struggling to cross even the
Kautilya-rekha. Some people have argued that without this kind of tax
expenditures or indirect subsidies, the profitability or the rate of growth
would not have been that high, which in turn, may have had affected the revenue
negatively. Even if we believe in this argument, that explains only the tip of
the iceberg. Even if we allow for reduction in direct tax rates, direct tax
revenue of the Central government should have been higher by 1.5-2 per cent of
GDP. Including direct taxes and indirect taxes, the revenue of Central
government would have been higher by 6-8.5 per cent of GDP (See the last column
of Table:2). Given present level of fiscal deficit, the government expenditure
in India could have easily become comparable with that in Latin America and
Caribbean and it could have crossed at least Middle-East, North Africa and
Sub-Saharan African averages. Given political will, the government could have easily
stepped up health and education spending to 3 and 6 per cent of GDP
respectively as per the promises made by the incumbent UPA Government in
National Common Minimum Programme (NCMP). But, we missed the bus and got stuck
within the vicious Kautilya-rekha.
Surajit Das is an Assistant Professor in JNU.