India not really an outlier in terms of tax-to-GDP ratio
Contrary to popular perception, GST could boost overall tax revenues for India
* At first glance, India’s tax-to-GDP ratio appears lower than other economies; however, after adjusting for the level of economic development – measured by per capita income, India is not really an outlier.
* While the government has been talking about the revenue-neutral characteristic of the implemented GST model, evidence from other economies makes us believe that GST could actually boost tax revenues in India.
* Whether the probable increase in fiscal resources would boost economic activity is, however, questionable. Of the four possible scenarios we have built, the materialization of only one would be growth-supportive.
India’s low tax-to-GDP ratio is generally considered a dilemma for policy authorities, which is also seen as an obstacle to improve the quality and quantity of fiscal spending. A cursory look at India’s data vis-à-vis other economies (advanced or emerging) confirm this trouble. Nevertheless, careful investigations make us think otherwise.
In this note, we attempt to answer three key questions.
1) Is India really an outlier in terms of tax-to-GDP ratio?
Many market participants and policy makers are likely to nod affirmatively. However, our detailed empirical research and cross-sectional analysis shows that the answer is not straight forward. At first glance, India’s taxto-GDP ratio appears lower than other economies; however, after adjusting for the level of economic development – measured by per capita income, India is not an outlier. While the tax-to-GDP ratio of the central government is certainly lower, the tax-to-GDP ratio for the general government (central and state governments together) is in line with the level of economic development (per capita income).
2) Will GST be revenue neutral for India?
While the government has been talking about the revenue-neutral characteristic of the implemented GST model, evidence from other economies makes us believe otherwise. Our cross-country analysis of Australia, Canada, Malaysia and Singapore reveals that while indirect tax revenue increased post GST, total tax-to-GDP ratio (including direct taxes) was broadly unchanged to slightly lower, because GST was complemented with lower (personal or corporate) income tax rates. Hence, in all these four economies, GST was broadly revenue neutral. However, with no reduction in direct tax rates in India, GST is most likely to boost overall tax revenue.
3) Will higher tax revenue be growth boosting?
Not necessarily. There could be four possible scenarios, under which GST might boost the government’s tax collection. However, we believe only one could boost economic activity.
a) Most desirably, GST might help to increase reported GDP by increasing overall efficiency in the economy by decreasing trade turnaround time. If so, per capita income would also increase, leading to a structural increase in the government’s tax revenue. This would give more room to the government and allow durable gains in economic activity.
b) Secondly, higher tax kitty could simply be a wealth transfer from the private sector to the government. It implies that fiscal spending would rise at the cost of private spending. This would not necessarily be a growth booster; however, some sectors could benefit at the cost of others. For instance, defense, transport or rural sectors could benefit at the cost of urban discretionary spending or home improvement segment.
c) Thirdly, GST might lead to a reduction in money hoarding by making it difficult to evade taxes. Even so, such rise in tax collection does not necessarily imply higher economic activity (or higher per capita income) because it might be unfair to assume that evaded taxes were not utilized or were not adding to economic growth. One could argue that the velocity of undisclosed wealth could be much higher than the velocity of white/disclosed wealth. Further, even if GST shifts unorganized businesses into the organized sector, it would not necessarily lead to higher GDP, because an estimate of the unorganized economy is already included in GDP estimates.
d) Finally, there is a possibility that even if the government collects higher taxes, these might remain completely unspent and are actually utilized to narrow fiscal deficit. If so, this would be negative for the economy, as total spending will get hurt.
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