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For a long time it was assumed that economic inequality in India is low compared to countries with similar per capita income. This notion arose because inequality in India is measured mainly in terms of distribution of consumption expenditure, which is known to underestimate the extent of inequality. This arises from the fact that consumption distribution tend to exclude the consumption trends of the very rich and the very poor. The other reason why consumption distribution is likely to underestimate the extent of inequality is because ‘the poor are more likely to consume as much or even more than their income while the rich are more able to save’. However, even when seen by this measure, inequality has increased in the 2000s compared to the early 1990s. While information related to income distribution for the country as a whole is limited, latest available estimates too show that income inequality in India is not just high but has been increasing in the decade of the 2000s. Various other indicators, such as the share of wages in total income, wealth distribution or income tax data also show that inequality in India has increased significantly since 1991. In short, whether seen in terms of trends in consumption expenditure, income or wealth, it is now widely recognised that India is a high-inequality country, and among the most unequal in the world.

As is known, high and persistent economic inequality negatively impact the prospects of growth of an economy. More importantly, high inequality reduces access to basic services (such as health and education) of the vast mass of the population and further accentuates social and economic disparities.

International experience shows that policy interventions are critical for reducing inequality. And among various policy interventions, progressive taxation plays a vital role in tackling inequality. Direct taxes are considered to be progressive as they are linked to the tax-payee’s ability to pay and the average tax rate increases as the taxable income of the tax-payer increases. Indirect taxes, on the other hand, are considered regressive as the rich and the poor are subject to the same tax rate for similar goods they consume. Indirect taxes, therefore, impose a proportionately greater burden (in relation to their consumption or income) on the lower income groups than on the upper income groups. Therefore, for tackling inequality, the emphasis is on mobilising tax revenue through direct taxes. This is particularly important for India as India’s tax structure is extremely regressive.

In this context, the recent announcement by the Central Board of Direct Taxes of direct tax collection having reached record high in the financial year (FY) 2017-18, is indeed welcome. Direct taxes are collected mainly by the Centre, so the quantum of direct tax it collects plays an important role in determining the progressivity (or the lack of it) of India’s overall (taking Centre and all states) tax structure. In this respect, the increase in direct tax collection in FY 2017-18 to Rs. 10.3 lakh crores from Rs. 8.34 lakh crores in FY 2016-17 should be a cause for cheer. However, the picture appears less rosy if one looks at other indicators and not just absolute increases. Analysis of the data shows that the increase in direct tax collection (comprising personal income tax and corporate tax) in FY 2017-18 has been driven mainly by increase in personal income tax collection. Longer term trend of various tax heads as share of gross central tax revenue also points toward the lacklustre performance of corporate tax in direct tax mobilisation. Taking the period between FY 2009-10 (the year after the global crisis began) to the most recent financial year, shows that the share of corporate tax in gross central tax revenue has consistently declined from 39 per cent to 29 per cent in FY 2017-18. While the share of personal income tax in gross central tax revenue has increased during this period, it has not been very significant. As a result, the share of direct taxes in gross central tax revenue too has come down from 58.8 per cent in FY 2009-10 to 51.6 per cent in FY 2017-18. Clearly, the record high direct tax collection in FY 2017-18, has not reversed the process of India’s tax structure becoming increasingly regressive in the last few years.

What is even more striking is that the share of direct tax has declined even when direct tax compliance has improved over the last few years. This is largely got to do with the fact that the quantum of tax collected through indirect taxes has increased relatively more in the last few years, even surpassing direct tax collection in some years.

The regressive nature of India’s tax structure is further compounded by the fact that the share of taxes on fuel (petroleum products) too have been increasing over the years. Since fuel is a universal intermediate, any increase in its price, including because of higher taxes, adversely affects the lower income groups the most.

Obviously then, much more needs to be done to increase the share of progressive taxes for dealing with the challenge of increasing inequality in India. Although there is a lot of optimism in the official circle about the potential to improve direct tax compliance further, this optimism might be somewhat misplaced. As per a recently released report, the latest available data of the Labour Bureau shows that 82 per cent of male and 92 per cent of female workers in India earned less than Rs. 10,000 a month in 2015. The report also notes that the situation is not likely to have improved in the period since then. This clearly indicates that majority of the working population do not earn even half the income annually necessary to bring them in the income tax net. There would be another large chunk of the working population who earn between Rs. 10,000 to Rs. 20,000 per month, again not enough to be in the tax net. Therefore, it is not clear how many more individuals can be brought under the tax net. Under these circumstances, the focus of taxation should be on adopting measures to tax the rich and reduce tax evasion by them. This would help increase direct tax collection as well as reduce inequality.

 

The views expressed in this piece are those of the author, and don’t necessarily reflect the position of CBGA. You can reach Malini Chakravarty at malini@cbgaindia.org.