The presentation of the Union Budget to Parliament is one of the most awaited and watched events of this season. Our democracy requires that not even a rupee be spent by the government unless we give our consent. This consent is given in the form of the passage of the Finance Bill by the Lok Sabha. Rajya Sabha’s approval is not needed for the Finance Bill. The Members of Parliament vote on the bill, and approve it on behalf of all of us, the citizens who are also taxpayers.
The expenditure of the government is ultimately borne by taxpayers. If it is running a fiscal deficit, then that is paid by borrowing, which is nothing but taxation on future, unborn taxpayers. The size of the deficit of the Union government has been rather large, because of the burden of extra spending due to the pandemic. As of this fiscal year, roughly Rs 21 lakh crore of spending is raised as tax revenue, and Rs 14 lakh crore is through borrowing. This excludes some non-tax revenue like privatisation, which is small in relative terms. So, the size of borrowing i.e., fresh loans, are two-thirds of revenues.
That borrowing is in the form of 10, or 20, or 30-year sovereign bonds, which must be repaid. But the repayment is from revenue raised by taxation. So that is why, deficit financing is nothing but future taxation. Can the revenue-raising capacity of the government not be more toward taxes on the current generation, and less toward borrowing? Excessive borrowing and high fiscal deficit become unsustainable and can lead to a debt trap or spiralling inflation.
How should more revenue be raised by a higher level of current taxes? Nobody likes to be taxed. So, the answer to this question depends on what is the “least bad” solution to the challenge of taxation. Firstly, it has to be efficient i.e., the cost of collecting taxes should not be more than what is collected. Secondly, the imposing of taxes should not alter taxpayer behaviour. For example, a steep tax on solar lamps will make people simply abstain from buying solar lamps, defeating the social objective of promoting renewable energy.
Thirdly, taxation should also be efficient in the sense that there should be less leakage and no room for tax evasion. Thankfully, digital trails of all banking transactions make it difficult to hide or evade taxes.
Finally, taxation also has to be fair. There are two notions of fairness, vertical and horizontal. Vertical fairness means that the rich should bear a higher burden than the poor (in relative and absolute terms). Our income tax system does follow this principle. But if a rich person is making all his income through capital gains and dividends, it is possible that he pays less taxes than someone who has only salaried income. So, we need to examine the violation of vertical fairness.
The other notion, i.e., horizontal fairness, means that if two people are making the same income, their tax burden should be the same. This latter notion is often violated. For instance, if one person gets all his income from agriculture and another gets her income from a salary, then the two are taxed very differently. This is a consequence of the fact that our Constitution prohibits income tax on agricultural income, and only the states have the right to tax that income.
One broad indicator of the fairness of taxation is the share of direct taxes in total taxes collected. About 30 years ago, the share of direct taxes, which included income tax and tax on capital gains, was merely 19%. Indirect taxes, which include excise duties (which later were subsumed as GST), sales tax, import duties, etc., made up the remaining 81%. The share of direct tax in total revenue is a sign of the maturity of the tax system.
By charging a higher tax rate on richer individuals, the direct tax system becomes more “progressive”. Even if we had a single flat tax rate, with just one slab for all, it would still mean richer individuals pay a more absolute amount. This is not as progressive as multiple slabs, with increasing marginal tax rates.
An indirect tax system is, however, regressive. That is because the tax paid depends on the price paid and not on the income of the buyer. So, the GST paid on a pack of biscuits is the same for a rich or a poor person. It will, however, pinch the poor person more, and hence is regressive.
To reduce the regressivity of GST, multiple slabs were created, with a low rate for essential items like food and medicines, a median rate for most goods, and a high rate for luxury goods. But this classification is arbitrary. A plain biscuit is classified as essential and a cream biscuit is a luxury. Chappals are essential and shoes are not. This can lead to too much power of discretion in the hands of the taxman, endless litigation, even harassment or corruption. Ideally, the GST rate should be uniform for all products, except perhaps only a tiny, excluded set. As of now, GST covers only about 40% of the GDP, with a vast number of goods and services excluded. And even among those which are included, there is a demand for lowering the rate from 18 to 12 or 5%.
The reality is that the share of indirect taxes, which had gone down from 81% in 1990-91 to 44% in 2014-15, has gone up again to around 55% now. Thus, our system has become more regressive. We need to have a higher share of direct taxes, from not just salaries but all sources of income. The share market rose by nearly 100% from the lows of March 2020, yet capital gains tax collection has not even risen by 20%. We are able to tax dividends since taxes can be deducted at source (TDS) at the company level, but taxing realised capital gains remains a challenge.
Similarly taxing other forms of wealth or inheritance is still a bridge too far. As a result, our system remains regressive, and the total tax-to-GDP ratio is barely 10.5%, among the lowest compared to peer economies. We need to move to a more fair, equitable and efficient tax system, with a greater share of direct taxes, and a lower dependence on deficit financing.
(The writer is an economist and Senior Fellow, Takshashila Institution) (Syndicate: The Billion Press)