Budget 2022: How to raise revenue with right tax policies

As the focus shifts to the forthcoming budget, one of the key areas of attention is to generate enough revenue to accelerate fiscal spending and boost economic recovery, particularly by reviving low consumption demand – which is expected to remain much below the FY19 level, as per the first advance estimates. The RBI had warned about the “demand shock” to the economy from the second wave, something that the first wave did and the third wave from the Omicron may do.

Low revenue remains a big concern for years. The revenue deficit breached 3% of the GDP mark to reach 3.3% in FY20, climbed up to 7.5% in FY21 and is expected to be 5.1% in FY22 – as against less than 3% during the previous five fiscals of FY15 to FY19.

This is primarily because of a series of economic shocks and misadventures in the past few years. First came the twin shocks of demonetisation (FY17) and GST (FY18) and then the corporate tax was cut in FY20, all of this before the pandemic hit – contradicting the government’s claims of expansion in tax base, higher tax efficiency and higher growth impetus through these ‘reforms’. The last budget document says gross tax receipt fell from 11.2% of the GDP in both FY17 and FY18 to 10.9% in FY19, then to 9.9% in FY20 and 9.8% in FY21. It is expected to be 9.9% in FY22(BE).

While the reasons for stagnation or lower tax revenue are obvious and known, the Centre has neither acknowledged nor took steps to reverse the trend. There are a few simple and logical steps to reverse it:

More tax on rich, less on poor

One of the cardinal principles of taxation is the ability-to-pay. That is tax incidence should be more (rich) on those who can pay more and less on those who can pay less (poor).

Ignoring this, the Centre cut corporate tax drastically in September 2019 (₹1.45 lakh crore) amidst severe resource crunch. It had a foreseeable impact in FY20 and corporate tax collection dropped by 16%, from ₹6.6 lakh crore in FY19 to ₹5.6 lakh crore in FY20. It dragged down the gross tax revenue from 10.9% of the GDP in FY19 to 9.9% in FY20. This trend is expected to continue with corporate tax budgeted to yield ₹5.5 lakh crore – less than FY20 – and the tax-to-GDP to 9.9% in FY22(BE).

In fact, in FY21, corporate tax fell below income tax (non-corporate entities) in FY21 for the first time in the new GDP series of 2011-12 base.

This is what industry body ASSOCHAM sought to correct in its pre-budget memorandum, pointing out that after the corporate tax cut, income tax on individuals (non-corporate) had gone up to 43% in certain cases, while corporate tax remained very low – 15% for new manufacturing company and 22% in other cases without tax exemptions and deductions. It argued that “firms/limited liability partnerships should not be required to pay tax at higher rate than corporates as most small and medium businesses are organised as firms, LLPs and proprietorship”.

The same argument holds for salaried class too, who, even after foregoing deductions and rebates are required to pay 30% for income above ₹15 lakh. Adding multitude of cess and surcharge the effective tax rate go further up.

Budget documents have been highlighting another anomaly with corporate tax structure without attracting attention or corrective measures: corporates with higher profits pay effectively less tax than those with lower profits. The last budget showed, the effective tax rate for companies with profit before tax (PBT) of more than ₹500 crore was 25.9%, while that for those with a PBT of ₹1-10 crore was 26.6% and ₹10-50 crore was 27.6%. This was for FY19. The budget document didn’t provide the data for FY20.

Such anomalies need to go to raise higher tax revenue. It is grossly misleading to argue that corporate tax fell because companies fell on bad times. Or that high corporate tax is bad for growth and lower tax would lead to more investment and job creations. The US Congress report and the RBI report showed the hollowness of such claims after the US cut corporate tax in 2017 and India did in 2020.

Similarly, there is a sound case for imposing wealth tax which India abolished in 2016.

The extraordinary surge in both income and wealth of the top 10% after the reforms and liberalisation of the economy in 1980s and 1990s, and the surge in billionaires’ wealth during the pandemic-induced economic ruin highlight why wealth tax is imperative, logical and wise.

The latest World Inequality Report 2022 makes the need of wealth tax even more compelling after mapping the surge of income and wealth to the top at the cost of the vast majority worldwide, including India. It says even a modest 1% wealth tax on $1-10 million, which progressively goes up to 3.5% for individuals owning $100 billion, would raise 1.6% of global income – or $2 trillion of the estimated global income of $122 trillion in 2021.

India is home to 1% of the global rich – about 700,000 dollar-millionaires – and their cumulative wealth was around $594 billion in 2020, as per the Credit Suisse. Even a small wealth tax will raise a tidy sum to provide direct income support to the millions who have lost jobs and incomes, including those running MSEs, to enable them to rebuild their lives and productively contribute to economic growth.

Less dependency on indirect tax like GST

The other structural regressive character of the Indian tax system is high reliance on indirect tax. In the OECD countries, the average direct tax collection stands at 67.3% of the total tax collection, while in India, it is 38.3%.

High indirect tax, like the GST, is bad because it doesn’t distinguish between the rich and poor (capacity to pay) as all are required to pay at the same rate. Such is the Centre’s reliance on the GST that it disregards processes and systems it has put in place to raise tax rates. In November 2021, the Department of Revenue unilaterally notified raising the GST on textile – a labour intensive industry that generates more jobs and hence should be encouraged at the time of extreme job crisis – from 5% to 12%. This was also to come into effect from January 1, 2022. The right place for such a decision is the GST Council, not a government department. When the GST Council met on December 31, 2021, many states strongly opposed the move, forcing the Centre to roll it back. But how long such a rise would be kept in abeyance is not known.

As the Fortune article ‘Why high GST collection is bad taxation and bad economics’ argued, the hype over high GST collection is misplaced. Not only it shifts attention away from falling direct tax (including corporate tax) but puts a high burden on the poor by way of ever rising oil taxes when international crude price remains relatively low for years and consumption demand has fallen below FY20 level. The Petroleum Planning and Analysis Cell (PPAC) data shows, the Centre has collected ₹19.6 lakh crore from various oil taxes from FY15 to Q1 of FY22, of which excise and cess alone amount to ₹17.4 lakh crore. Its study had shown that the poor are burdened far more than the rich when oil prices go up.

Disuse of tools to check tax evasion, tax havens and shell companies

Tax evasion is rampant in India and is known for decades.

For example, very few noticed the recent pronouncement of the Central Board of Indirect Taxes and Customs (CBIC) which said tax officers would give “reasonable time” to businesses to explain mismatch in their claims for input tax credit (ITC) and actual GST payment before initiating recovery action. A recent change in the GST law allowed them to begin direct recovery action from January 1, 2022.

Why does the mismatch occur – over-stating ITC claims and under-reporting tax – when filing vouchers for transactions is mandatory and claims are to be processed for accuracy and claim settlement automatically? Quite obviously, more than 4 years after the GST was introduced is still a work-in-progress with several key implementation mechanism not yet in place. The businesses still file summary self-assessed returns, GSTR-3B, which was a temporary arrangement before the GSTR-3 (summary of outward supplies, input credit claims) was rolled out. How many years will that take?

Are the vouchers being verified automatically for checking correctness of ITC claims? Are businesses filing GST tax audit reports? The CBIC’s directive raises many disturbing questions about the GST regime than the benevolence it supposed to show.

There are many such instances of disuse of tax evasion tools.

The Centre has laid a great emphasis on FDI since 2015. Official documents show more than 80% of FDI inflow and outflows are through well-known tax havens. How much of such fund movement is just for tax evasion and round-tripping? There is no assessment even after multiple investigations world over – Paradise Papers, Panama Papers, Pandora Papers, The Silicon Six – have shown how big corporations evade tax by profits-shifting to tax havens for which they use opaque shell companies. In the case of India, the Pandora Papers showed businessmen running away to foreign countries with bank loans and stashing millions in tax havens while pleading bankruptcy and zero net worth in courts not to pay legitimate dues of others.

It is to stop such blatant tax evasion and money laundering that it is critical for India to undo all its Double Taxation Avoidance Treaties (DTATs) with tax havens (which charge zero or near zero tax and hence it is illogical to have such treaties in the first place) and revisit the renegotiated treaties with Mauritius and Singapore and Cyprus, which leave many loopholes unplugged. It is not yet clear if another tool, General Anti-Avoidance Rules (GAAR), framed in 2012 and was to be enforced for the first time in FY22, is being scrupulously followed.

There are other taxation issues too that incentivise tax evasion.

For example, exemption to agricultural income has allowed non-agri businesses to claim large agricultural incomes to evade tax. The Tax Administration Reform Commission (TARC) report of 2014 had suggested that agricultural income above ₹50 lakh should be taxed to save small and marginal farmers. No attention has been paid to it. Similarly, self-assessment tax paid by businesses is a known source of tax evasion which has not been addressed. The issue was flagged by former Finance Minister Arun Jaitley in 2019 and yet the Presumptive Income Scheme (PIS) continues.

The budget is a good time to change the illogical and inverse tax system to raise enough tax revenue for its fiscal spending.

If this is done, there would be another significant gain.

As two earlier Fortune India articles “Why profitable strategic PSU CEL’s sale leaves scientists aghast” and “Disinvestment strategy: Centre's love; CAG's hate!” explained, the Centre continues its policy of selling public assets, particularly profit-making and strategically important PSUs like the Central Electronics Limited (CEL) and bleed the cash-rich PSUs to finance its disinvestment drive. That could be prevented.