Context: The Economic Survey 2025 projects India’s FY 2025-26 GDP growth at 6.3-6.8%. For Viksit Bharat, India has to grow 8% for at least 10 years. As India's per capita income rises and its democratic processes deepen, an increase in tax collections is anticipated in the country.
Relevance of the Topic: Prelims: Key trends in Taxation in India
Why does Taxation become important in the present state of Indian Economy?
- Inadequate consumption-led growth: Indian consumers are not spending enough on goods and services. This has led to weak demand in the economy.
- Impact on Private investment: Dullness in demand has discouraged private firms from investing in creating new productive capacities.
- Constraints in exports-led growth:
- With Trump as the US President, US’s threat to impose tariffs can possibly lead to a global trade and currency war.
- With rising protectionism, threat of tariffs and competitive devaluations of currency, India cannot solely rely on exports-led growth.
- Necessity for government spending: With low private consumption expenditure and low private investment, the increase in government expenditure is the necessary condition for economic growth. But in order for the government to spend more, robust tax revenues are required.
Role of Taxation
- Reducing direct taxes like Income tax can increase disposable income for the tax payers and ensure household consumption expenditure.
- Rationalising indirect taxes, like rationalising Goods and Services tax (GST) will make goods and services more affordable and thus, boost consumption expenditure.
- Tax-incentives and favourable policies for export-oriented sectors and firms can enhance their global competitiveness, invest in innovation and expand their operations.
- Efficient tax collection and broadening the tax-base can provide the government with sufficient tax revenue to increase expenditure.
Scope of Taxation in India
1. Critical importance of tax revenues for Indian government:
- The Indian government has a very high dependence on tax revenues -close to 80%. Comparable economies such as Brazil, Mexico and China are much less dependent on tax revenues.
- Cutting tax rates or collecting less taxes will force the Indian government to borrow more money from the market, thus competing with private firms for investible funds. This will drive up interest rates for everyone in the economy.
2. Tax revenues as share of GDP:
- India ranks fairly low when total tax revenues as a share of total national GDP is concerned- well below 20%.
- Most developed countries in Europe manage to raise much higher levels of revenues as a proportion of GDP. This suggests that those countries are more efficient at raising revenues.
- India’s government, despite being desperately dependent on taxation for their expenditure, is not able to target as wide a tax base.
3. Tax revenues as a share of GDP versus GDP per capita:
- India fits into a broad pattern where the richer a country, the more capable its government is in raising taxes as a percentage of the overall GDP. So, India is behind China, which, in turn, is behind the US.
- Older, more established economies are more efficient in raising revenues.
4. Income Tax vs. Taxes on Goods & Services:
- Direct taxes such as personal incomes taxes are more progressive and just — i.e., the rich can be made to pay a higher rate of tax as against the poor.
- Indirect taxes such as the GST are regressive, since a poor person also pays at the same rate at which the rich pays.
- In India, both direct and indirect taxes roughly amount to around 7% (of the GDP) each.
- Richer developed countries use direct taxes more to raise much higher levels of taxation as against emerging economies such as China or Vietnam or India.
- Indian taxpayers should expect higher tax collections, especially from direct taxes such as personal income taxes, as India becomes richer and the Indian government becomes more efficient in collecting taxes.
5. Taxation in Electoral Democracies:
- The higher a rank for a country in electoral democracy, the more tax revenues its government is able to raise.
- So, India does better than Bangladesh while it is behind Brazil, the US and Germany on both electoral democracy index as well as tax revenue collection (as a % of GDP).
- As India improves its electoral democracy ranking, we can expect higher tax collection.
Conclusion
- While it is true that, due to repeated economic shocks as well as the government’s inability to successfully kick-start a virtuous cycle of economic growth in the country, there are concerns that the Indian government is overtaxing citizens.
- But, India’s tax revenues (as a percentage of GDP) is not as high as many of the developed countries, even though it funds a remarkably high proportion of central government’s spending. Moreover, as India becomes richer (in per capita income terms), and its democracy deepens, tax collection can be expected to go higher.