As the Ministry of Finance hunkers down and begins preparing Budget 2025, calls have resurfaced for reducing the tax burden on salaried taxpayers. Unfortunately, this is unlikely to happen any time soon for three reasons.
First, the Narendra Modi government’s past tax reforms—the introduction of Goods and Services Tax (GST) and corporate tax cuts—haven’t really panned out as it hoped. Second, as a result of this, the government’s dependence on income tax has grown to levels not seen in at least 25 years.
Third, the nature of income tax itself, at least when it comes to salaried taxpayers. While corporate taxes are paid on profits, once all expenses are deducted, and the GST is paid only if a person buys something, a large chunk of income tax is deducted from your salary even before you get it, in the form of tax deducted at source (TDS).
This makes income tax such a steady and reliable revenue stream, and an increasingly vital one, that the government simply cannot afford to do anything that would curtail it.
Also read: Top & bottom of the income pyramid pose different tax problems. New govt must choose reform
GST didn’t bring the expected revenue
Let’s start with GST, the Modi government’s first major tax reform in 2017. The idea of GST is sound and essential for a country looking to attract both domestic and foreign investment. A single, unified tax rate nationwide for any given commodity or service is a basic prerequisite for modern large businesses to consider investing.
The problem with GST, however, was its implementation. And this is not just about the multiplicity of rate slabs, though that certainly needs urgent improvement. GST’s problems also arose from the extraordinary promises the Centre made to the states to encourage them to adopt it in the first place.
The Centre sweetened the GST pot for the states by promising them five years of compensation for any shortfall in revenue they faced due to the implementation of GST. At the core of this promise was the assumption that states would have seen an incredible 14 percent growth in their tax revenues every year, and so if GST resulted in a shortfall in this, they would be compensated.
In other words, states were assured a 14 percent growth in their tax revenues every year, a growth rate far in excess of what most of their past performances should have justified. But they needed to be brought on board, and this promise was essential in encouraging them, so the Centre went ahead with it.
Former chief economic advisor (CEA) Arvind Subramanian and his colleagues, in an EPW paper published a few months ago, calculated that this compensation cost the Centre tax revenues amounting to 1 percent of GDP every year. Incidentally, Subramanian was the CEA when GST was born.
What the economists also found was that GST revenues, once refunds were netted out, have only now reached pre-GST levels. One reason for this is that, between 2017 and 2019, the GST Council went on a rate-cutting spree. The average GST rate fell to 11.6 percent, according to the Reserve Bank of India (RBI), a far cry from the 15.5 percent revenue neutral rate Subramanian had suggested in the run-up to GST. Of course, revenues would suffer.
Also, keep in mind that GST is an ad valorem tax, so the higher the rate of inflation and the rise in prices, the higher the GST collections. Yet even this bump has not really helped.
So, what was widely expected to lead to a surge in tax revenues for the Centre has so far fallen flat on that front. Not really a failure, but GST hasn’t been a bonanza either.
Also read: Indian taxpayers are ‘dragged’ into paying higher income tax. Govt must factor in inflation
Similar story with corporate tax cuts
In 2019, the government implemented its second significant taxation reform—the cutting of corporate tax rates. The hope was that this would encourage companies to invest and expand their business in India, which would eventually lead to higher corporate tax revenues for the Centre.
The reality, however, has turned out very differently. Private sector investments, while growing, are tepid and nowhere near the level the Indian economy needs. On the other hand, corporate tax’s share in the overall tax collections has fallen—from 34.6 percent in 2014-15 to 26.4 percent in 2023-24.
Things are looking even worse this year, with corporate tax revenues for April-October 2024 accounting for just 24 percent of total tax collections, as economist and ThePrint columnist Radhika Pandey found. In fact, corporate tax revenues have grown only 1.2 percent this financial year, compared to the 12 percent growth estimated in the July budget.
Now, one could argue that this lower tax collection from companies is because profits have been shrinking. But the thing is, they haven’t been. An analysis by Motilal Oswal Financial Services found that corporate profits as a proportion of GDP surged to a 15-year high in 2023-24. The first two quarters of this financial year have seen profits slip, but that’s too recent to be a factor.
This is something the government needs to examine. Why is it that, despite making profits, corporate tax collections are not contributing as much to the total tax kitty as they used to.
Intertwined with all this, as both possible cause and definite effect, is the government’s increased reliance on income tax to shore up its revenues. Income tax accounted for 30 percent of total tax revenues in 2023-24, up steadily from 21.5 percent in 2014-15. This year, that number is so far 30.7 percent. This is the highest it has been since at least 2000-01.
Some of this higher share can be explained by the robust growth in income tax collections. If the government is collecting more from income tax, naturally its share in total taxes would go up. But a large part of the explanation is also because of the relatively poor performances of corporate tax and GST collections.
With the economy slowing and the private sector not really stepping up, the next budget will likely see the government again promising a sizable amount of capital expenditure. If it wants to stick to its commitment to reduce the fiscal deficit, it simply can’t afford to make any substantial cuts to income tax. Sorry, folks!
TCA Sharad Raghavan is Deputy Editor – Economy at ThePrint. He tweets @SharadRaghavan. Views are personal.
(Edited by Prashant)