Finance minister Arun Jaitley has made light of the demonetization impact on GDP – HSBC has just lowered its FY17 estimate to 6.3% as compared to FY16’s 7.6% growth – by highlighting the fact that April to December tax collections at both the central and state government levels have been quite robust. A report in The Times of India suggests VAT collections grew 26% in Maharashtra in November and 17% in December – only 3 of 17 states for whom the data is available, Times reported, showed a decline in VAT collections; even West Bengal, which saw an 8% fall in December reported a 10.8% rise in November. An official release shows April-December direct taxes for the centre rose 12% and indirect taxes 25% – while direct taxes are in line with the FY17 budget targets, indirect taxes grew at more than double the budgeted 10.8%. That is great news in an economy where a rise in government spending is critical for making up the continued slowing in investment growth – also, there are going to be significant shortfalls in divestment and telecom revenues, so a high tax mop-up is critical.
In the long run, Jaitley is right, there is a correlation between GDP growth and tax growth – between FY09 and FY17, GDP grew 2.72 times and central taxes 2.69 times. Even this, though, may not hold if there is an increase in formalization of the economy or a greater drive to capture untapped sections. Which is why, in the 2000s, as more and more segments of the economy were being made to pay service tax, the buoyancy was as high as 8.7 times – but, over time, this fell to 2.37 in the 2010s. In the case of corporate taxes, buoyancy has plummeted from 2.96 to 0.69; but for excise, it has jumped from 0.25 to 1.37.
In the short-run, the relationships fluctuate a lot more. Between FY01 and FY02, GDP growth rose from 7.6% to 8.2% while personal income tax growth plunged from 23.8% to 0.8%; between FY08 and FY09, GDP growth slowed from 16.1% to 12.9% while personal tax growth plunged from 36.7% to 3.3% – neither of these are results you’d expect in the normal course. In the case of service taxes, when GDP growth fell from 12.2 in 1999-00 to 7.6% in FY01, growth in service tax collections almost trebled, from 8.7% to 22.8%; but while GDP growth rose from 12.9% to 15.1% between FY09 and FY10, service tax growth fell from 18.8% to minus 4.1%.
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This unpredictable pattern is also evident in the April-December data put out by Jaitley, even though the overall number shows a buoyant trend. So, while personal income tax grew 10.7% versus the FY17 budget’s estimated 9% for the full FY17, excise duties rose 43% versus the projected 12.2% and service taxes grew 23.9% versus the projected 10% – surely a 43% hike in excise revenues, levied on the top-line of firms, is not in keeping with corporate tax growth of a mere 10.7% even if you account for the impact of price changes? While demonetization clearly cannot be judged by what happens to taxes in the short-run, its success has to be gauged over the medium term, and in terms of how many more taxpayers are brought into the net and how fast tax-to-GDP level rises. Between 1990-91 and 2016-17, India’s tax-GDP ratio has risen only from 9.8 to 10.7, after falling to 8.4 in 1999-00 – for an economy where the share of the black economy has fallen dramatically, that’s a poor show.
