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Rising Direct Tax-to-GDP Ratio in India: The Impact of Demonetisation and GST

India's direct tax-to-GDP ratio rising on better data from demonetisation and GST

In recent years, India has witnessed a significant rise in its direct tax-to-GDP ratio. This surge in direct taxes has outpaced the growth of the nominal GDP, indicating a positive trend for the country's economy. Finance ministry officials attribute this phenomenon to the combined effects of demonetisation, the implementation of the Goods and Services Tax (GST), and the relentless efforts of the tax departments to track down tax evaders.

The Growth of Direct Taxes

For the past two-and-a-half years, the Central government's tax collections have consistently outpaced the growth of the nominal GDP. This trend is the result of years of meticulous data analysis and coordination between various government initiatives, starting with demonetisation and continuing through the implementation of GST. This trend of taxes growing faster than GDP is expected to continue in the coming years.

Tax Growth vs. GDP Growth

Let's take a closer look at the numbers:

Year

Rate of Growth of Taxes (%)

Corporate Tax Growth

Growth in Income Tax

Tax Buoyancy

2021-2022

19.55

5.64

32.52

 

2022-2023

15.41

20.12

1.1

 

2023-2024

(Apr-Aug) 8.15

35.7

-

 

It is evident that the rise in direct taxes has consistently surpassed the growth of the nominal GDP for the third consecutive year. Notably, the growth in income tax has shown remarkable buoyancy.

Factors Driving the Rise in Direct Taxes

Several factors have contributed to the surge in direct taxes in India. Let's delve into each of these factors to gain a better understanding:

1. Demonetisation and Enhanced Data Analysis

In the aftermath of demonetisation, the income tax department compiled a comprehensive list of millions of new taxpayers. This data was then analyzed to identify common addresses, directors, and promoters among the newly registered companies. Surprisingly, many companies were found to be operating from a single-room address in cities like Kolkata or Jaipur, raising suspicions of tax evasion.

Over the past four years, the tax department has sent repeated notices to these suspicious entities. As a result, many of the new filers have voluntarily declared higher incomes, aware that the tax authorities are closely monitoring their activities.

2. Impact of GST on Tax Compliance

The implementation of GST was expected to have a positive impact on indirect taxes. With the Introduction of GST, companies found it beneficial to conduct transactions only with registered entities to avail of input tax credits. Consequently, more unregistered companies and those previously operating in the cash economy have registered and started paying taxes.

Notably, fiscal economist Govinda Rao highlighted that GST would lead to higher direct taxes as professionals previously operating in the cash economy would be compelled to disclose their previously undeclared incomes. This includes lawyers and doctors, among others. While these professionals may not declare their entire income, they are now declaring more than before due to increased scrutiny by tax authorities.

3. Reduction of Tax Exemptions

To boost tax collections, the Indian government has gradually reduced tax exemptions in recent years. For instance, the interest credited to the Employee Provident Fund (EPF) account was tax-free until the 2021-2022 fiscal year. However, a cap of Rs 2.5 lakh was introduced, leading to a slight increase in tax collections.

Furthermore, in the latest budget, tax exemptions on insurance policies issued after April 1, 2023, will only apply if the aggregate premium paid by an individual is less than Rs 5 lakh. Tax exemptions on debt mutual funds have also been eliminated. Although the full impact of these measures will be observed in the coming years, they are expected to contribute to incremental gains in tax revenue.

The Impact on India's Direct Tax-to-GDP Ratio

India's direct tax-to-GDP ratio has been gradually increasing, reaching a high of 5.97% in FY22 and 6.08% in the last fiscal year. While this is an improvement from the average of 5.5% observed from FY12 to FY21, it is still lower than the peak of 6.3% achieved in 2007-2008.

The key takeaway here is that reducing tax exemptions and improving tax administration play crucial roles in increasing tax revenue. However, the strongest catalyst for higher taxes is sustained economic growth. The record-high tax-to-GDP ratio in 2007-2008 can be attributed to three consecutive years of 8% real GDP growth preceding it.

In conclusion, India's direct tax-to-GDP ratio has been on the rise, surpassing the growth of the nominal GDP for several years. This positive trend can be attributed to the combined effects of demonetisation, the implementation of GST, and the persistent efforts of the tax departments to track down tax evaders. By leveraging enhanced data analysis, reducing tax exemptions, and promoting economic growth, India is poised to further improve its tax collections and strengthen its economy.

author

The Tax Heaven

Mr.Vishwas Agarwal✍📊, a seasoned Chartered Accountant 📈💼 and the co-founder & CEO of THE TAX HEAVEN, brings 10 years of expertise in financial management and taxation. Specializing in ITR filing 📑🗃, GST returns 📈💼, and income tax advisory. He offers astute financial guidance and compliance solutions to individuals and businesses alike. Their passion for simplifying complex financial concepts into actionable insights empowers readers with valuable knowledge for informed decision-making. Through insightful blog content, he aims to demystify financial complexities, offering practical advice and tips to navigate the intricate world of finance and taxation.

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