India’s Big Government

by Vivek Kaul

  A question worth asking here is: What sort of a home can an individual earning a salary of Rs. 3.69 lakh per year actually afford? An annual income of Rs. 3.69 lakh translates into a monthly income of around Rs. 30,755.

  What sort of a home loan would a bank give against this amount? Typically, a bank works with the assumption that 40 per cent of the monthly income can go towards servicing an EMI and accordingly gives the loan.

  In this case, that amounts to around Rs. 12,300. An EMI of Rs. 12,300 at an interest rate of 10 per cent per annum and a tenure of 20 years would service a home loan of Rs. 12.75 lakh. Banks typically lend up to 80 per cent of the official value of the property. This means an official value of property of around Rs. 16 lakh (Rs. 12.75 lakh divided by 80 per cent). Please note that I have used the word ‘official’, because there is bound to be a black component as well.

  What this number tells us is that most of the salaried class in 2011-2012 were not in a position to buy a home to live in across large parts of the country. There is no reason to believe that things would have changed since then.

  The point is that the demand for real estate is in the below Rs. 20 lakh market price segment. But what is being built across large parts of the country is clearly above that price. This has again happened because a lot of black money has found its way into real estate all across India and, in the process, driven up real estate prices beyond what most people can afford.

  i)While the release of detailed income tax data is a good start, much more remains to be done. First and foremost, data from more years needs to be released. This means releasing data from prior to the assessment year 2012-2013. It also means releasing data from years after the assessment year 2012-2013. More data would help researchers spot trends over the years.xvi This has been a standard problem with Big Government over the years. It doesn’t like sharing data with its citizens. And even if it does, it does it in a format which is not user-friendly at all.

  Many ministries still scan and upload reports onto their websites. This means that the size of the files is simply too big to be downloaded on the slow internet connections that India has. The biggest such document that I have managed to download was a document from the Power Ministry’s website. The size of the document was more than 100 MB.

  The data on which all the above analysis is based was released by the Income Tax Department in the form of PDF files. While that is fine, data in the form of Excel files should also have been released. This makes the data machine-readable immediately and is of tremendous importance for researchers. Otherwise, a lot of time is uselessly spent in transferring data from the PDF files to an Excel file.

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  Black money has several negative effects. First and foremost, it leads to inequality. It shifts the burden of financing the government from those who can successfully evade taxes (read as businessmen, the self-employed, etc.) to those who cannot (read as salaried individuals, for whom income tax is deducted at source).

  Other than leading to inequality, this has other effects as well. As Kumar puts it: “This makes the latter [i.e., those who cannot avoid paying income tax] feel that injustice is being done to them, and [so] they ask for greater concessions.”569

  And how has this played out in the Indian context? As mentioned earlier, in the assessment year 2012-2013, only around 2.88 crore individuals filed income tax returns. Of this number, around 1.62 crore did not pay any income tax. Only the remaining 1.26 crore individuals paid some amount of tax.

  Of this number, around 1.11 crore paid a total amount of income tax of up to Rs. 1.5 lakh during the year. The average income tax paid by these individuals was at around Rs. 21,069. The interesting thing is that, even though the average income tax paid by these individuals was low, the total income tax paid added up to a substantial Rs. 23,446 crore. This was by far the highest amount paid by any category of taxpayers.

  The next highest amount of tax was collected from individuals who paid income tax in the range of Rs. 5.5 lakh to Rs. 9.5 lakh. Around 1.79 lakh individuals fell in this category and paid a total income tax of Rs. 12,580 crore. The average income tax paid worked out to around Rs. 7 lakh. While, at an average level, this was substantially higher than the income tax paid by those paying tax of up to Rs. 1.5 lakh, on the whole it was lower.

  What does this mean? This essentially means that, when it comes to personal income tax, there is a fortune waiting for the government at the bottom of the pyramid. The phrase ‘fortune at the bottom of the pyramid’ was coined by the late management guru CK Prahalad in a book of the same name.

  In this book, Prahalad looked at the distribution of wealth and the capacity to generate income in the form of an economic pyramid. As he wrote: “At the top of the pyramid are the wealthy, with numerous opportunities for generating high levels of income. More than 4 billion people live at the bottom of the pyramid on less than $2 per day.”570

  Prahalad’s book was about these people, and he felt that the “dominant assumption is that the poor have no purchasing power and, therefore, do not represent a viable market”. This, he believed, was incorrect, and he went on to show through various examples that even those earning less than $2 per day could add up to a substantial market size.571

  Along similar lines, those paying an income tax of less than Rs. 1.5 lakh could also end up paying a substantial amount of income tax in total, even though the income tax that they individually pay is low.

  Hence, there is a lot of money that the government can collect at the lower end as personal income tax. Of course, if it goes around simplifying the entire Income Tax Act as well as the entire process of filing income tax returns, that would help.

  Having largely filed my own income tax returns for much of the last decade, I can safely say that the income tax returns forms are not user-friendly at all. Also, even the simplest income tax returns form (ITR 1-Sahaj) for the assessment year 2016-2017 has six worksheets built into the Excel sheet. Furthermore, some of the entries can confuse even someone adept at filing income tax returns.

  Getting back to the point, the fact is that there is a fortune that the government can make at the bottom of the income pyramid. In fact, this is a point that was made even in the Economic Survey of 2015-2016. Take a look at Figure 9.1.

  What does this tell us? It shows very clearly that the basic tax exemption limit, only above which income tax has to be paid, has risen at a much faster rate than the per capita income in India. As the Survey points out: “We can calculate, in some sense, the ‘missing taxpayers’ in India—not those who are evading taxes altogether or under-reporting taxes, but those who have legitimately gone under the tax radar due to ‘generous’ government policy.”

  So who are these missing taxpayers? These are those taxpayers who got left out because the basic exemption limit above which income tax has to be paid has been raised from the level of Rs. 1.5 lakh in 2008-2009. It currently stands at Rs. 2.5 lakh.

  Figure 9.1: The basic exemption limit and per capita income (in rupees and at current prices) between 1949-1950 and 2015-2016.

  Source: Economic Survey, 2015-2016.

  If this threshold had not been raised as rapidly as it had, the government’s income tax collections would have gone up tremendously.

  As the Economic Survey points out:

  We ask how many taxpayers there would have been in 2012-13 if the threshold had been maintained at Rs. 1,50,000 (the threshold limit in 2008-09). We find that there would have been an additional 1.65 crore units incorporated within the taxation system (an addition of about 39.5 per cent) and tax revenues would have been about Rs. 31,500 crore greater. India’s tax-GDP [ratio] would have increased by 0.32 per cent just by not having raised the threshold so generously.

  In fact, the Survey also points out that there is a lot that India can learn from China on this front. As it points out:

  [The] Chinese success in bringing more citizens into the individual income tax net owes to [the] setting [of] a reasonable threshold for
paying taxes and not changing it unduly. In contrast, in India, exemption thresholds for income taxes have been consistently raised. In fact, [as Figure 9.1] shows, thresholds have been raised much more rapidly than underlying income growth so that, today, the wedge between average income and the threshold has widened.

  The finance ministers who increased the tax exemption limit knew what they were doing. They were basically playing to the gallery and making the people who pay taxes feel better about the fact that they were paying taxes, by increasing the basic exemption limit at a faster pace than the increase in per capita income.

  But the loss of taxes on this front was more than made up for, first through a higher service tax rate and now through various cesses like the Swachh Bharat Cess and the Krishi Kalyan Cess. Indirect tax is essentially a tax on goods as well as services and not income or profits. It is just that, since these taxes are indirect, people don’t realise that they are paying them.

  Even when they realise that they are paying these taxes, they don’t keep track of the total amount of indirect tax they have paid during the course of the year. After all, what one doesn’t know about doesn’t really hurt. And given this, it is easier to increase the rates of indirect taxes than those of direct taxes.

  Another good metric to track here is to look at the ratio of the basic exemption limit to the per capita income that prevailed at any point of time. Take a look at Table 9.5.

  Table 9.5: The basic exemption limit over the years.

  * Calculated using GDP at factor cost at current prices.

  Source: A part of the exemption limit data has been taken from Trend and Pattern of Personal Income Taxation in India. Available at http://shodhganga.inflibnet.ac.in/bitstream/10603/855/9/09_chapter%203.pdf

  In 1961-1962, an individual had to pay income tax only if his income was 7.4 times the basic exemption limit. What this did was that it left a large section of the population out of the tax bracket. As can be seen from Table 9.5, the ratio has come down over the years. In 2005-2006, it fell to an all-time low level of 1.6. The ratio started to rise again after that, and in 2013-2014, it stood at 2.9. (I haven’t gone beyond 2013-2014 because, in January 2015, India moved to a new method of calculating the GDP, and the back series for that hadn’t been generated at the time of writing this.)

  What this tells us is that, to get more people into the tax bracket, a lower tax exemption limit is needed. This limit can be set at two times the per capita income to get a larger section of the population to start to pay taxes. Looking at the current per capita income, this limit could have been set at around Rs. 2 lakh. Furthermore, the government should mandate that those earning between Rs. 2 lakh and Rs. 2.5 lakh have to pay income tax at the rate of 5 per cent.

  More than raising income tax for the government, this would bring more people under the tax bracket. This means that, as and when these individuals move to higher tax-paying brackets, they are likely to continue paying income tax, once they have been initiated into the process. Also, more people would get onto the digital bandwagon, with the need to get a Permanent Account Number, a bank account, etc.

  While this might make sense theoretically, it would be politically difficult for the government to lower the basic exemption limit. This is something that has never happened before. The way around this is to not increase the current basic exemption limit of Rs. 2.5 lakh for at least the next five years.

  This would ensure that, as inflation plays its part and incomes go up, more people would come under the tax bracket. Around 2020, the government can look at creating a new tax slab, starting at Rs. 2,50,000 and up to some basic level (depending on how the inflation pans out until then) with an income tax rate of 5 per cent.

  In fact, as of early August 2016, 23.6 crore bank accounts had been opened under the Jan Dhan Yojana. This means that more people have bank accounts now than in the past. Hence, in the years to come, more and more salaries will get paid into bank accounts. This means that taxing them will not be difficult.

  Of course, as always, this means that the burden of financing the government will be more on the salaried class, which can’t get away from paying their taxes, unlike others.

  Also, at the cost of sounding repetitive, if the government wants to reap this fortune at the bottom of the pyramid, a simplification of the Income Tax Act is the need of the hour. In fact, the original Direct Taxes Code of 2009, which was to replace the Income Tax Act, fits the bill of a simpler tax law very well. But that is unlikely to happen, given that in October 2015, the Narendra Modi government set up a ten-member committee to overhaul the provisions of the Income Tax Act.572

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  As mentioned earlier, the evasion of taxes, leading to the generation of black money, has a negative impact on the economy on several fronts. As Ruchir Sharma writes in The Rise and Fall of Nations: “Researchers at the Organisation for Economic Cooperation and Development have found that countries with large black economies also tend to be the most unequal…. Jobs in the black economy are often poorly paid [and] with no benefits.”573

  Furthermore, those at the top who do not pay income tax become a sort of a role model for others. In the budget speech he made on February 28, 2013, the then Finance Minister, P Chidambaram, had said: “There are 42,800 persons – let me repeat, only 42,800 persons – who admitted to a taxable income exceeding Rs. 1 crore per year.” This statement caused a lot of hungama at that point of time. In April 2016, the top Finance Ministry bureaucrat Hasmukh Adhia made a similar sort of statement when he said: “There are only 1.5 lakh individuals whose total income would be above Rs. 50 lakh.”574

  These low numbers obviously result in lower taxes for the government. They hurt in another way as well. As Sharma puts it: “Tax dodging at the top creates a strong disincentive for any citizen to pay up.” And this perpetuates tax evasion.575

  Furthermore, the income of those who evade tax goes up. But their consumption does not go up proportionately, given that they tend to save more of this black money. As Kumar writes in The Black Economy in India: “The tax evaders, who only spend a small amount of their income in increased consumption, save most of it and end up reducing demand in the system. In the net, demand does not go up, so that incomes remain unchanged in spite of tax evasion. So, even though the individual feels that she/he has a higher income due to evasion, businessmen as a class have less income.”

  A lot of the black money makes its way into real estate and gold. Why is real estate the ideal conduit for channelising black money? As Kumar writes: “The reason is that it is hard to value it. Hence, in a property transaction, if a certain value is declared by the buyer/seller, it is tough for anyone to prove that the price paid was different.”576

  In a country like India, home building is not a bad thing. The construction of homes has linkages to 250 other industries.577 As Keith Wardrip, Laura Williams and Suzanne Hague write in a research paper titled ‘The Role of Affordable Housing in Creating Jobs and Stimulating Local Economic Development: A Review of the Literature’:

  During the construction of affordable housing — or any kind of housing, for that matter — the local economy benefits directly from the funds spent on materials, labour, and the like. If the builder is purchasing windows and doors from a local supplier, the supplier may have to spend money on materials and hire additional help to complete the order – examples of indirect effects. Finally, the construction workers, glass cutters and landscapers are likely to spend a portion of their wages at the local grocery store or shopping mall, which illustrates induced effects.

  The trouble, though, is that much of the housing that has been built in India is lying unoccupied. As mentioned earlier in the chapter, more than a crore homes are lying unoccupied across the big cities in India. Despite this, the rental yield in India is between 2-3 per cent. Now, imagine if these homes were available for renting. The rents would have crashed even further.

  Actually, even lower rents can be achieved by reforming the rental laws in the
country, which are currently totally loaded against the landlords. This has led to a situation wherein people buy homes and keep them locked. If these homes were easily available for renting, the demand for owning homes would fall, because renting a home would become an even more attractive option.

  Once the idea of easily renting a home becomes an attractive option, the fascination for owning a home will come down. Once this fascination comes down, the demand for homes will come down. Once demand for owning homes (i.e., real estate) comes down, its viability as a conduit for black money would also come down.

  Also, currently, a lot of the black money (or even the white money, for that matter) that goes into real estate ends up as dead capital once the landlord decides to keep the home locked. Furthermore, as Sharma writes: “A house will provide a home to one family but will not provide a steady boost to economic output or increase productivity.”

  The point being that the money that goes towards buying a home in which no one lives could easily instead have gone towards something else where it could have been put to better use.

  On a similar note, the black money that goes into gold also hurts the Indian economy. It needs to be mentioned here that India produces very little gold of its own (in fact, almost next to nothing). Thus, gold needs to be imported. When gold is imported, foreign exchange gets used up. When the demand for gold is particularly high, the demand for dollars, which are used to buy the gold, also goes up. Importers of gold essentially sell rupees to buy dollars. In this process, the value of the rupee depreciates against the dollar.

  A weaker rupee then pushes up India’s oil bill, given that India imports 80 per cent of the oil it consumes. Over and above this, the government subsidises products like kerosene and cooking gas. In fact, it earlier used to subsidise diesel as well.

  A weaker rupee means that the oil-marketing companies which buy oil need more rupees to buy the dollars necessary to buy oil. This means that the cost at which they buy oil goes up. Hence, they need to sell oil products at a higher price in order to ensure that they make a profit. But the government doesn’t allow them to sell kerosene and cooking gas (and even diesel in the past) at a price at which they would make a profit.