The healthy rise in the Union government’s direct tax collections over the last few years has led to celebrations within the finance ministry. This is understandable. According to an analysis by the Central Board of Direct Taxes (CBDT), the share of direct taxes in gross domestic product (GDP) in 2023-24 rose to a 24-year high of 6.64 per cent. In 2000-01, this number was about half, at 3.25 per cent.
An equally important development during this period, not captured by the CBDT analysis for obvious reasons, was the decline in the share of indirect taxes in GDP. From 5.62 per cent of GDP in 2000-01, the share of indirect taxes fell to 5.11 per cent in 2023-24.
The Union government’s gross tax collection efforts, therefore, rose from 8.8 per cent of GDP in 2000-01 to 11.7 per cent in 2023-24. Not only did gross tax collections maintain a steady growth rate in this period, but their composition also got better, with direct taxes accounting for 57 per cent of gross collections last year, up from about 36 per cent in 2000-01. This is a healthy sign as the Centre is relying more on direct taxes, which are more equitable, and less on indirect taxes.
Raising the share of direct taxes in the Centre’s gross tax collections was a big challenge when economic reforms were launched in 1991. Gross tax collections in 1990-91 were estimated at a shade lower than 10 per cent of GDP, of which direct taxes accounted for only 1.9 per cent and the share of indirect taxes was over 8 per cent. By the end of that decade, overall gross tax collections fell to 8.8 per cent of GDP, but the share of direct taxes rose by over 70 per cent, while that of indirect taxes fell by about 30 per cent. A healthy correction in the mix of direct and indirect taxes had begun taking place in the 1990s, even as the overall tax collection efforts had weakened.
But the story of the Centre’s tax collection efforts alone is not enough to understand the larger implications of its fiscal performance over the last few decades. Bigger changes have taken place in other areas, which cannot be ignored and whose analysis can help in making the fiscal policy more responsible and purposeful in the days to come.
The Centre’s bigger achievement on the fiscal front is in the way its expenditure has been brought down even while its quality has got better over the years. The Centre’s annual expenditure at over 18 per cent of GDP was quite substantial in 1990-91. Over the last 34 years, this share has declined to about 15 per cent of GDP. The ability to have squeezed government expenditure even as the size of the economy kept rising has not received adequate appreciation. The credit for this containment should go to all the governments that ruled from New Delhi during this period. Barring some crisis-led increases during a few of the years under Atal Bihari Vajpayee, Manmohan Singh and Narendra Modi, the broad trend in government expenditure has been one of a steady decline.
Not all governments, however, can take credit for achieving an improvement in the quality of that expenditure. In 1990-91, the share of capital expenditure was relatively high at over 5.5 per cent of GDP and revenue expenditure accounted for 12.8 per cent of GDP. Worryingly, capital expenditure saw a steady fall over the next three decades and by 2019-20, its share in GDP fell to as low as 1.67 per cent of GDP. Indeed, the gradual reduction in the fiscal deficit during this period was achieved through a mix of expenditure reduction and tax revenue growth.
The Covid crisis in 2020 and the Modi government’s emphasis on infrastructure creation led to a sharp rise in capital expenditure in the years after 2019-20. From 1.67 per cent in 2019-20, capital expenditure rose to 3.2 per cent of GDP in 2023-24. If the fiscal deficit was brought down to 5.6 per cent in 2023-24, it was more because of a cut in revenue expenditure—from 15.5 per cent in 2020-21 to 11.8 per cent of GDP in 2023-24—than because of growth in tax collections.
Lower revenue expenditure was possible because of the brakes applied on subsidies, after they had hovered around 2 per cent of GDP from 1990-91 to 2007-08 and had even exceeded that level for most of the second term of the United Progressive Alliance government. The Modi government’s track record has been creditable. Barring the Covid year of 2020-21, when subsidy expenditure rose to a record level of 3.8 per cent of GDP, the outgo on subsidies has seen a southward turn, reaching a level of 1.5 per cent of GDP in 2023-24.
What becomes clear from the Centre’s fiscal performance in the last 34 years is that the strategy of keeping a check on expenditure has its limitations. The demand for higher capital expenditure in the coming years will keep rising. While tax collections have grown at a decent pace, this growth is not enough to meet the demand for more resources or to achieve the goal of reducing the fiscal deficit to the desired level.
A fact that is often overlooked is that the Centre’s net gain from higher gross tax collections has been much less than the increase in its gross tax revenue. The Centre’s gross tax collections grew from 8.8 per cent of GDP in 2000-01 to 11.73 per cent in 2023-24. But in the same period, the Centre’s net tax revenue (minus devolution to the states) rose at a slower pace, from 6.39 per cent to 7.88 per cent of GDP. With successive Finance Commissions recommending higher devolution of gross taxes collected by the Centre to the states, the net gain for the Centre has been less than what it was 24 years ago. It is likely that the states’ share in Central taxes will only go up in the coming years.
Yet, there will be no let-up in the demand for the Centre to raise its expenditure on infrastructure creation and on managing climate transition responsibilities, which will create new challenges for revenue mobilisation. Taxes from the petroleum sector account for about 12 per cent of the Centre’s gross tax revenue. Finding alternative sources of revenue would pose fresh challenges, as the reduced reliance on fossil fuels would result in a drop in tax revenue from this sector. The Centre’s fiscal challenge will become more formidable.
With such fiscal pressures on the Centre’s finances, it is necessary for the finance ministry to explore non-tax areas to raise revenue. In this regard, non-tax revenues and disinvestment are two relatively easy targets that the Centre must examine. The Centre’s efforts at collecting non-tax revenues have been sub-optimal. Last year, they were estimated at 1.36 per cent of GDP, down from a record high of 2.93 per cent in 2001-02.
Another area of policy attention should be to revive the disinvestment of government equity in state-controlled enterprises, where the government’s performance last year was poor at only 0.17 per cent of GDP. Higher public sector dividends should not lull anyone into complacency on the disinvestment front as the Centre’s equity infusion into public sector enterprises has been rising rapidly in recent years.
The big advantage of both non-tax revenue and disinvestment receipt is that neither is to be shared with the states. The Centre can take full credit for such receipts and will no longer need to rely only on revenue expenditure containment or tax revenue growth to meet its goals of fiscal responsibility.
AK Bhattacharya @AshokAkaybee is the Editorial Director, Business Standard. Views are personal.