Budget 2013: Dear FM, Indians aren't undertaxed; govt is a wastrel

One of the big myths the Left likes to foster is that Indians pay very little tax. Faced with a difficult fiscal situation, it's a myth Finance Minister P Chidambaram has been willing to buy into.

A few days ago, Chidambaram talked about administering "bitter medicine" to the economy - and presumably taxpayers - to "restore the health of the economy" so that "next year we can look forward to much higher growth."

Indians are not under-taxed. The problem is with what the government does with the money it gets as taxes. AFP

Last year, when he was not finance minister, he talked about raising taxes. He said: "We must raise the tax revenue to defend (the expected aggregate decline in resources). I know many people won't like this. But I think I can summon the courage to make the statement... you must be prepared to pay higher tax rates, especially the rich must be prepared to pay higher tax."

Both are flawed assumptions. It is not the economy that needs to swallow bitter medicine, but politicians. In fact, the long-suffering Indian taxpayer has been gnashing his teeth in impotence as government has wasted his money in getting itself re-elected and for voter inducements. This year the government will spend Rs 1,70,000 crore in fuel subsidies, and another Rs 60,000 crore in fertiliser subsidies. Money will be spent in bailing out Air India, banks and oil companies.

All this is money that could have gone to the poor, but politicians refuse to take this bitter medicine.

A report in Economic Times in December had this to say: "Who has to take the medicine, and who is to administer it? Since it is the finance minister who says this, it is easily assumed that economic agents have to take the medicine and the government would administer it, in the form of tough policy. However, the constituent components of the nation that require real bitter medicine are the political parties and politicians. They and the manner in which they have arranged the affairs of the nation have let the people down. If growth today stands hobbled, and prices stay high, unreformed politics is to blame."

But the Left will still argue: Indians pay too little taxes. Look at the tax-GDP ratio, and the big concessions given to the rich.

The Left, of course, does not know its backside from its elbow, since it is fundamentally anti-rich. There are three reasons why the Indian tax-GDP ratio-around 18 percent of GDP in 2009 - is "low" compared to, say, a Sweden or Europe or even the US.

First, a poor country cannot, by definition, have a high tax-GDP ratio since you can't tax the poor. If India's povertywallahs are so sure that 30-40 percent of our people are below the poverty line, as they repeatedly insist, by the same token this means so many people cannot pay taxes, and the rest have to shoulder the burden on their behalf.

Second, even if you had higher tax rates, tax compliance will be lower in a low-trust society like India. People willingly contribute more when they know their money will go to the right people, or to one of their own. Denmark or Sweden or much of Europe pays 40-50 percent of GDP in taxes because they are small, culturally united societies. In more diverse US, the tax-GDP ratio is just about 27 percent.

Third, in high-corruption countries (which is what India is), people pay taxes to private agents. Whether it is bribes paid to get basic government services, or paying protection money to thugs, Indians actually pay more taxes than the official figures suggest since rule of law is practically unenforceable in India in this phase of our development.

In fact, the evidence is that Indians pay much more in taxes that the official figures suggest. Parthasarathi Shome, a professor at Icrier in Delhi and the man who has made suggestions to create a stable tax environment for foreigners, says the right way to calculate the tax-GDP ratio in India is to exclude the absolutely poor from the GDP base.

Writing in Business Standard, Shome says: "In international circles, a common theme is India's low tax effort. Is this true? We must consider India's subsistence population who cannot be taxed. Ideally, therefore, subsistence incomes should be removed from GDP when calculating tax/GDP. Doing that would yield the correct 'effective' tax effort."

According to Shome's calculations, in 2005, India's official tax-GDP ratio was 16.55 percent. But if the GDP base is reduced by excluding the earnings of the poor, this ratio improves to 19.71 percent. For 2007-09, we would thus end up with a tax-GDP ratio in the range of 21-22 percent. Very high for a poor country.

Contrast this with China's ratio of 17 percent, Malaysia's 15.5 percent, and Singapore's 14.2 percent - all growth tigers, and much richer than us, and the conclusion is inescapable: India continues to be an overtaxed nation for its stage of development.

In fact, the government's anxiety to extract more from India's rich is going to boomerang, since the rich - defined here not as billionaires, but India's 32 million taxpayers - are already shouldering a big burden.

TN Ninan, writing in Business Standard, has these interesting statistical tit-bits that paint a completely different picture of the undertaxed Indian. He suggests that a small proportion of Indians bear the overwhelming share of tax contributions. According to his figures, "a mere 400,000 taxpayers, with income of more than Rs 20 lakh, accounted for 63 percent of income tax collected."

This does not mean there is no evasion. But Ninan's numbers show that only 1.4 million people declared taxable incomes above Rs 10 lakh per annum when there were 5.2 million people who owned mutual funds. The taxman could presumably unearth some unwilling taxpayers here, but it's more than likely that many of these mutual fund holders are senior citizens or minors or spouses, who anyway may not have their own sources of income. Indians often invest in the names of their elders, spouses and children.

The point is simple: Indians are not under-taxed. The problem is with what the government does with the money it gets as taxes. This is where the bitter medicine needs to be administered - on wasteful expenditure

We don't need more taxes. We need to eliminate subsidies on energy pricing, and focus on delivering a bigger bang for the buck when we spend money on the poor.

Maybe direct cash transfers will help here, but the way the government is rushing into it in order to benefit electorally from it, one cannot have great confidence that it will do its homework well.

If one considers the fact that UPA-1's NREGA vote-winner is still to be fixed nearly seven years after launch, one can only shudder at the prospect of Chidambaram approaching the taxpayer like Shylock eyeing the Merchant of Venice's fleshy parts.