budget

Updated: Jul 09, 2019 08:35 IST

Demonetisation in 2016 and the implementation of Goods and Services Tax (GST) in 2017 can be listed as the two biggest economic policy decisions of the first Narendra Modi government. There was significant disruption to economic activity in the aftermath of both. The economic pain was justified in the name of there being future gains, especially on the revenue generation front.

Individuals who held unaccounted cash were forced to deposit them in banks during demonetisation. This brought them on the radar of income tax authorities, the government said. GST, by forcing a formalisation of the economy, was expected to reduce commercial transactions which used to happen outside the erstwhile indirect tax regime. This would boost indirect tax collections, the government argued. Have these policies lived up to their promises?

The key metric to judge whether a policy is revenue enhancing (or not) is tax buoyancy. This measures growth in tax collections for a given amount of GDP growth. It can be calculated by dividing the annual growth in gross taxes by annual growth in nominal GDP. A higher tax buoyancy number indicates that either the nature of growth is more revenue generating or the tax-net is more effective at dealing with tax evasion. The reverse can be inferred if the tax-buoyancy number goes down.

Because budget numbers also contain projections of tax collections and nominal GDP along with past statistics, they give us an idea of not just past tax buoyancy but also what the government expects it to be.

The 2018-19 Budget assumed the highest tax buoyancy since 2005-06, the earliest year for which these statistics can be calculated using the 2011-12 GDP series. This suggests that the government expected demonetisation and GST to yield significant revenue benefits. This number is expected to be significantly lower according to revised estimates (RE) for 2018-19. It could actually end up being even lower than what the RE figures tell us (more on this later). It has also been revised further downwards for the 2019-20 budget estimates (BE), which suggests that the government too is rationalising its expectations about collecting more in taxes for a given rate of growth.

How did this come about? The government hopes to collect more in direct taxes (income tax and corporate tax) in 2018-19 than what it initially expected. This reflects in the fact that 2018-19 RE figures for direct taxes are higher than the BE numbers.

However there has been a big shortfall in indirect tax collections, primarily on account of shortfall in GST collections. The 2018-19 RE number for GST collection is 13% less than the 2018-19 BE value.

To be sure, provisional estimates from the ministry of finance until March 2019 show that both income tax and GST collections in 2018-19 are significantly lower than what the RE numbers given in this year’s budget tell us. If the provisional numbers were to remain unchanged, tax buoyancy for 2018-19 could turn out to be even lower.

What’s even more revealing about the long-term revenue generation hopes from demonetisation and GST is that the assumed tax buoyancy in 2019-20 BE figures is even lower than the 2018-19 RE figures.

It is actually the tax buoyancy of direct taxes which has suffered a big fall between 2018-19 RE and 2019-20 BE figures, while indirect tax buoyancy is expected to improve slightly.

How does one explain the fall in tax buoyancy? Either the nature of economic growth in India has become less revenue generating in nature or claims of better tax compliance have not materialised. Both of them are opposite to what the government has been claiming. It could also be the case that the government’s decision to increase exemption limit on interest paid for housing loans have led to a loss of future income tax revenue. To be sure, this year’s budget has also increased income taxes on the super-rich and enhanced duties on petroleum products by Rs 2/litre.

There is another possibility, which has got more to do with the GDP than taxes. If the official statistics have been overestimating GDP growth, which many academics including Arvind Subramanian, a former chief economic advisor to the Narendra Modi government, have been arguing, then the tax buoyancy numbers would naturally be lower. Tax payers after all pay taxes on actual incomes rather than what the Central Statistical Office thinks incomes are.