Though indirect tax collections surpassing direct tax collections can be attributed to the COVID-19 pandemic, experts warn that the trend will be regressive should it continue.
According to data released by the Controller General of Accounts, the government has collected Rs 10.9 lakh crore through indirect taxes, a significant amount being contributed by taxes levied on petroleum products.
AK Bhattacharya, Editorial Director of the Business Standard, and Dinesh Kanabar, CEO of Dhruva Advisors believe that the government would not readily reduce the levies on petrol given its contribution to the government's coffers.
"I do not see this trend necessarily reversing. Petroleum has been a boon to the government. The prices of petroleum today are equal to what it was earlier when the price of petroleum globally was twice what it is today. The reduction in the prices has been substituted with the higher levies that the government is making. Which is one of the reasons why the government has got petroleum in the GST net. So, I really do not see this trend changing. I only see it going up, and up and up," Kanabar told BOOM.
Echoing Kanabar's thoughts, Bhattacharya said that the government prefers indirect taxes to direct taxes because they are less prone to leakage, brings in more money during times of inflation and the government can keep all of the cess without having the need to share it with states.
"It is a policy dilemma for the government. The government ideally should move more towards direct taxes and less towards indirect taxes. I think the attraction towards indirect taxes also comes because it is easy to collect, less leakage prone and because it is ad valorem. It can actually collect more," Bhattacharya said.
Edited excerpts of the interview follow
Why is this happening and what does this reflect?
AK Bhattacharya: To understand what is happening at present, we must go back in recent history. You must look at what was happening in 1990-91 which is just when the reforms had begun. It will be interesting for you to know that the direct taxes at that time as a percent of GDP in 1991 was just 2%. And indirect taxes as percent of GDP in 1991 was 8%. What has happened now is more or less the reverse in the sense that direct taxes are still around 4.5% of GDP but indirect taxes have gone crossed the share of GDP of direct taxes to 5.4%.
Now, this probably from an economist's point of view, this is a regressive movement. Because as we all know, direct taxes are more equitable. Taxes are paid depending on what you earn but whereas indirect taxes are not equitable. Whether you are living in Mumbai's high rise, or Mumbai's Chowpatty, or in a slum--you pay the same amount of tax on the petrol that you buy or the Colgate toothpaste that you buy.
This is why economists have traditionally frowned on the dominance of these indirect taxes. In my view, what is happening now in the pandemic year is actually more a reflection of the economic stress that the Indian economy is going through. In the sense that indirect taxes are continuing to be depressed but because the direct taxes are more depressed you are suddenly seeing that indirect taxes as a percent of GDP is more than direct taxes.
Individual income tax has actually done quite well but the corporation tax has not done quite well and largely because of reducing the corporation tax rate and also because companies have taken advantage of many of the exemptions and the pandemic facilities that the government has given. In my view what has happened in 2020-2021 is reflection of the pandemic, the stress and most importantly, the huge taxes that were levied on the petroleum products, which has given us this cue of where excise duty on petrol today would account for almost 2% of GDP. It is quite a remarkable thing that today you are paying a huge amount of taxes on petroleum products, which used to be less than a percent of GDP even five years ago. I think that is what has really happened in 2020-2021.
Mr Kanabar, how are you seeing these numbers and how does this contrast with maybe a developed country or any other tax system you are familiar with?
Dinesh Kanabar: So, first Govind. A factual correction. Individual taxes today actually are far more than corporate, not equal. So, at the highest level an individual pays 43% tax
GE: I was referring to the quantum of collection and not the percentage
DK: But when you look at corporates today, if you are a new manufacturing company you are subject to a 15% plus surcharge. Otherwise, you are 25%. If you are availing of exemptions, you are 35%. In the case of the individuals, you go all the way to 43%. This probably is not something that has been usual for the last 20 years; it used to be so in the past, but this is again something that is phenomenally new. That is one point that O would make.
I would agree with what Ashok is saying about the regressive nature of indirect taxes. There is also one another aspect of indirect taxes, which is that it is not susceptible or prone to leakage. It is easy to collect. I am not justifying it but trying to put a proposition that if you have a tax on petroleum products and that accounts for 2% of the GDP, there is hardly any leakage. The moment you buy, you have got to pay for it.
In case of income tax there is still this issue of leakage, people planning etc. That is one another aspect. In fact, increasingly over the last few years, every time there is a budget there is a rumour going around, and one of thing that is spoken about is banking transaction tax when you withdraw money you pay things like that. Again, none of these are equitable but then again, they do have this simplicity, therefore ease of collection and also a lower cost of collection. You have an entire administrative machinery to monitor income tax. On an excise duty or a GST on petroleum products you really do not need to have so many people out there, you are just able to monetise and make it. The cost of collection to the total amount collected is very very low.
I think increasingly, and again I totally agree with what Ashok mentioned that some of this is a phenomenon of COVID. The fact is that corporate profits last year were under pressure in many cases. Consumption was what it was, and again petroleum and all of that led to the percentage of GDP for indirect is much higher. And I do not see this trend necessarily reversing. Petroleum has been a boon to the government. The prices of petroleum today are equal to what it was earlier when the price of petroleum globally was twice what it is today. So really the reduction in the prices has been substituted with the higher levies that the government is making. Which is one of the reasons why the government has got petroleum in the GST net. So, I really do not see this trend changing. I only see it going up, and up and up.
When you say the trend going up, you mean to say that we will pay more indirect taxes rather than?
So, does that mean you see taxes going up on the goods and services we consume?
DK: The rate does not need to go up. I think the consumption itself is going up. As I see, when people are coming out and says that Mercedes launched Maybach in India and 50 got sold in a jiffy, a Lamborghini got sold in a jiffy, it is obviously out of tax paid money. But not much of it is going to really go back to the government in the form of direct taxes. We pay a lot more in indirect taxes. Because the moment you sell a car there are 20 other taxes that you are going to collect and then another is going to be petroleum
How does this compare with the tax system elsewhere in the world. One is whether the trend will change or not. The direction in which we are going is in consonance with what you see elsewhere
DK: In most developed countries, the percentage of direct taxes is much much higher but that is for a different reason. Take for example, the UK. The individual taxes are 45% and sort of kicks in fairly early. You look at all the Scandinavian countries-- you go up to 52 or 53%. But all these countries equally have social benefits etc. Comparing the two simply in terms of percentages may not be right. If you are going to pay a much higher right of direct taxes and therefore the direct tax collections go up, but the government has a healthcare or social security system which is of different order altogether ...then it is really very different. So, yes in developed countries direct taxes are much more than India but the two are not comparable.
So how do you see this? One is the argument on equity and creating an equitable environment and the other is that we have no choice but to depend on indirect tax as that is the simplest way to collect more taxes
AKB: Well, I think it is a dilemma, a policy dilemma for the government. The government ideally should move more towards direct taxes and less towards indirect taxes. But I agree with Dinesh that there will be an increase in indirect taxes because it is not only less leakage prone, but it has also got an obvious inflation induced buoyancy. Most of the indirect taxes are ad valorem taxes. Except on petroleum products and some products which means when prices go up from 10 to 15 automatically the excise collection or the GST collection goes up. So, if the inflation goes up the Government also makes merry out of that because they get more collection. So, I think the attraction towards indirect taxes also comes because it is easy to collect, less leakage prone and because it is ad valorem. It can actually collect more.
And the final point of why the government will prefer indirect taxes and I agree with him that indirect tax's share will go up because indirect taxes can afford the government to levy. A lot of the part of the levy in terms of cesses and surcharges which direct taxes also have it but less. Now, the beauty of the cesses and surcharges in indirect tax is that the Centre can keep the entire portion of the cess and surcharge instead of sharing with the states. If you look at the last 10 years of the cess surcharge component in overall indirect taxes you will be shocked to know how it has actually gone up and which has actually meant that the Centre has been able to pocket more of the increased revenue than it should have been shared with the states. So, for the variety of the 4 or 5 reasons that I gave, I agree with Dinesh that there will be a tendency to skew it further and indirect taxes are more and direct taxes are less.
Another reason why direct taxes will not see the kind of rise we should see is because I think the government is in a welfare mode right now. In the last three years, you will see that the tax coverage will come down substantially. In the sense, the number of people who are paying taxes, the individuals who are paying income taxes have actually come down in the last few years because the slabs have been raised, the exemption levels have been raised, similarly the rates for corporations have come down.
Now, I am not questioning the logic of it but I think in a country like India when you do these changes the net outcome of it is the distortion that we are seeing today where indirect taxes will be more and direct taxes will be less and probably, we will very soon reach the level we had in 1990-91 where 8% of GDP was indirect taxes and only 2% of GDP was direct taxes.
DK: I will just supplement the point that Ashok made. He made an interesting observation about ad valorem nature. Now, look at what is predicted over the next one year. A) we are likely to have a consumption boom because of the lockdown and people wanting now to go out and buy. And inflation which is supposed to be hyperinflation, we do not know where this will go up. Therefore, even at constant rates the amount of indirect taxes will go up, I totally agree with that
If you were to look forward, as an individual I am paying income tax which is at a certain level. But I am also seeing in a depressed environment, let us say the prices of the goods and services that I consume are likely to go up. It is very likely that income is stagnant or maybe coming down or lost. So how is this likely to play out as you look ahead. Let me begin with you Mr Kanabar.
DK: So, two parts. History has always shown that whenever the rate of direct taxes goes significantly higher there is a tendency to plan, tendency to try and find legal ways of putting the tax levels down. I have seen this personally quite a bit that people who are very happy paying 35% rate of tax, try to plan around that such that 43 could actually become 20. So, due to aggressive interpretation and planning such that you convert your income into capital gains but try to bring your tax down. Whereas at 35 people were reasonably comfortable to say that if that is what the Government is doing, we are ok with it. That is number one
Number two, there has been a lot of unearned money that has come in the recent past on account of stock exchange. The amount of money that has been pumped in the system, as you are seeing, is enormous. And I do not see that really going down. So, the money available to people for disposable-I am not talking of the middle and the lower level-at a higher level will continue to rise. Inflation will continue to dip into the savings and whatever else. I will be very interested in hearing Ashok's view on whether in the next two years our savings ratio going down significantly will continue to go down even more. I think so, but I will be very interested in hearing his thoughts.
AKB: I think going forward you will have a major dilemma in the policy options that the government has in terms of what kind of taxation it should do. I personally feel that we are both an under taxed and under-governed country. At our level of incomes, the kind of exemptions and the kind of slabs that are already in place probably need a further review. Having said that I am not saying that we should be a high tax country — taxes can be better governed. At the same time if you tax less, it is not necessary that you will see an increase in the savings rate.
Just to answer Dinesh's question. Because if you are, let us say, in a low tax to GDP syndrome, the international experience has also not necessarily seen a higher savings rate. What can lead to higher savings is probably the availability of those saving instruments and a more developed market for such savings. For example, if international pension market guys could come to India, I am quite sure that India's savings rate could see the kind of benefit that we have not seen so far. So, it is a complex problem and I think we have to deal with this problem. Taxes will be pinching us but for a developing economy taxes will pinch the people of the country.
The problem is that the perception of service that a taxpayer gets from the government and the tax that he pays, that gap is quite huge and that gap also needs to be reduced. If that gap is reduced, I have a feeling that we are at that stage of the economy where we can be taxed a little more.
Where are we and should we worry, as we look ahead, about equity and equitableness. And if we are saying that we are likely to see even more emphasis on indirect taxes, does that mean we are going to enhance inequity or maybe not care about it all?
AKB: It is not a question of inequity. It is a question of you to have a simple, transparent tax framework also. Now what is happening right now is, because you have inverted GST structure you are seeing demands for reducing GST rates for various items. Unless you simplify the tax structure, unless you make the GST structure less inverted, I do not think you will be able to solve this problem of equity and making sure that the people who should be paying should pay the tax and it is not that everybody irrespective of the income should pay the same tax at the indirect tax level.
That is going to deepen the inequities and inequality among the people. You cannot expect a person who is having a car and buying toothpaste is paying the same tax and therefore the preponderance of indirect taxes must come down.
We started by saying that we are seeing these unusual trends in tax collection…...Is this something that we should be worried about, not concerned, or mildly worried as we look ahead?
DK: Two quick points. I am actually experiencing people wanting to migrate out of the country. And that is not necessarily on account of the high rate of taxes. There is also one point that Ashok made earlier. Are you getting equity value for money where taxes are being collected? Is the service from the Government commensurate and second is the tax harassment? And I think that is very important.
The other point that I would like to mention is, Ashok made a point about inverted duty. And I think somewhere in the line that the government seems to be missing out on this entire zeal of trying to say AtmaNirbhar Bharat and sort of manufacture in India is to rationalise the rate and see what can be done to give impetus to manufacturing.