Prof D Mukhopadhyay
Tax buoyancy is a measure of how responsive Government tax revenues are to changes in GDP. In simplicity, it measures how much tax revenue is generated for every unit of growth in GDP. Tax buoyancy is a crucial metric for any economy as it reflects the ability of the tax system to generate additional revenue without any changes in the tax rates. It represents the relationship between variations in the Government’s tax income change and the potential in GDP. Tax buoyancy is influenced by several factors, such as the volume of the tax base, efficiency of the tax authorities, rationale and transparency of the tax rates. Tax buoyancy has been observed to have been consistently low in recent years. According to the Economic Survey of India Report 2020-21, the tax buoyancy of the country’s direct taxes was only 0.73 in FY 2020-21, while the tax buoyancy of indirect taxes was negative (-0.88) in the same year. The said report highlights that India’s tax buoyancy has remained low, averaging only 0.5 over the last decade, which is lower than the historical average of 1.2. In addition, buoyancy has been negative for two consecutive years, indicating a decline in tax revenue despite economic growth. This indicates that the tax system is not generating the desired revenue growth, despite a rise in GDP.
The low tax buoyancy may be attributed to factors such as the informal economy, tax evasion, and weak enforcement of tax laws. One of the major reasons for low tax buoyancy is the significant size of the informal economy in India. The informal economy accounts for a significant portion of the country’s economic activities but, due to its unregulated nature, it remains outside the tax net. The informal sector includes small traders, farmers, and self-employed individuals who do not maintain proper records or pay taxes. Tax evasion is another factor that contributes to low tax buoyancy. Tax evasion occurs when individuals or businesses deliberately under-report their income or avoid paying taxes altogether. Weak enforcement of tax laws is a significant factor in India’s low tax buoyancy. When a tax is buoyant, its revenue increases without increasing the tax rate. There is a symbiotic relation between the Government’s tax revenue earnings and economic growth. The Tax-to-GDP Ratio(TGR), which is a measure of the size of the tax revenue in relation to the size of the economy, has been stagnant at around 10-11% in the last decade, which is significantly lower than the average TDR of other emerging economies such as Brazil, Russia, China and South Africa (BRICS), which is around 20%. One of the primary reasons for the decline in tax buoyancy is the slowdown in the economy. India’s GDP growth rate has been decelerating in the last few years, which has resulted in lower tax revenues. The COVID-19 pandemic has further exacerbated the situation, with the economy contracting by 7.7% in FY 2020-21. This has led to a sharp decline in tax revenue growth . Further, the decline in tax buoyancy is due to inefficiency of the tax administration system. Researchers very often criticize the tax administration system for being complex, cumbersome and opaque. As a consequence, tax evasion is widespread and the tax collection machinery is not teethed adequately to deal with both the cases of indirect and direct taxes.
To improve tax buoyancy, the Government needs to take a multi-pronged approach that includes policy reforms, improved tax administration and greater use of technology. Tax reforms can be introduced to simplify the tax levy, collection and administration system. This can be achieved by reducing tax rates, increasing the tax base, and rationalizing tax exemptions and deductions. Simplifying the tax system would encourage more people to pay taxes. Formalization of the informal sector could be another initiative to greater tax buoyancy as it would increase the tax payers’ base . Use of technology can ensure cost effective tax collection and monitoring, improve compliance, thereby reducing the scope for tax evasion. To simplify the tax levy and reducing tax rates to encourage compliance may help in raising tax buoyancy. The introduction of the Goods and Services Tax (GST) Act , 2017 was a step in the right direction, as it replaced multiple indirect taxes with a single tax, making compliance easier. However, the GST rates are still high, and several compliance issues need to be addressed. The Government may also consider reducing direct tax rates, such as income tax, to encourage compliance. Moreover, Federal Government should expedite Direct Tax reforms in ways similar to the indirect tax reforms taken place by the enacting the GST Act, 2017. Direct Tax Reforms through enactment of the Direct Tax Code has been pending almost two decades. A large portion of the Indian economy operates in the informal sector, where tax evasion is rampant, which warrants formalizing the informal sector to improve tax collections. Besides, Government may introduce measures to address tax disputes and litigation. The high tax rates in India have led to a proliferation of tax disputes and litigation, leading to delayed tax collections. The Government may consider introducing measures, to reduce tax disputes, such as improving tax administration and dispute resolution mechanisms. The introduction of alternative dispute resolution mechanisms, such as mediation and arbitration, can also reduce litigation.
Improving tax buoyancy is crucial for achieving target economic growth and to financing the development agenda. In order to improve tax buoyancy, structural reforms, such as improving the ease of doing business, encouraging investments, and promoting exports. An increase in public expenditure on infrastructure and social welfare can create jobs and stimulate economic activity, besides, rationalizing tax rate, particularly corporate tax rates, as the Indian tax rates are among the highest in the world, which discourages investment. However, any tax rate cuts should be balanced with measures to improve tax compliance and prevent tax evasion. Tax evasion is a major problem in India, and improving tax compliance is essential to improving tax buoyancy. Under the given circumstances, it should adopt measures to prevent tax evasion through technology to monitor transactions, increase penalties for non-compliance and improve the efficiency of tax administration.
Buoyancy in indirect tax has recently been noticed but there are several challenges that need to be addressed. According to the World Bank, India ranks 115th out of 190 countries in terms of ease of paying taxes. It may be mentioned that the Goods and Services Tax (GST) was introduced in India in July, 2017, replacing various indirect taxes levied by the Centre the Provincial States. The implementation of GST has brought in many benefits, including the removal of multiple taxes, reduction of tax evasion, and improvement in the ease of doing business. However, the GST system has been facing various challenges since the point of implementation, including a drop in revenue collection. One of the ways to improve tax buoyancy and address these challenges is restoration of the mandatory GST audits by the practising Chartered Accountants (CAs) and Cost and Management Accountants (CMAs). GST audits are conducted to ensure that the taxpayers comply with the GST laws and regulations. The audits involve an examination and assessment of the books of accounts, records, and other relevant documents maintained by the taxpayers. The audits provide a comprehensive analysis of the taxpayer’s financial position and help in identifying any discrepancies or violations of the GST Laws. However, in 2020, the Government of India made GST Audits optional for taxpayers with an annual turnover of up to Rs 5 crore. This move was aimed at reducing the compliance burden on small taxpayers and improving the ease of doing business and it has been observed that, the optional nature of GST audits has led to a decrease in the number of audits conducted, it has adversely affected the revenue collection. The Government has been struggling to meet its revenue targets, and restoration of mandatory GST audits could provide a solution. The CAs and CMAs are highly trained professionals who possess the necessary expertise, knowledge and skill to conduct GST audits. The restoration of mandatory GST audits by CAs and CMAs would ensure a more rigorous and effective audit process, leading to improved compliance and revenue collection and it would be a significant step towards improving tax buoyancy as the audits provide a more rigorous, effective and critical process of examination of records and documemnt leading to improved compliance and revenue collection. Therefore, it is recommended that the Government may consider restoring mandatory GST audits remaining in place since the inception of the GST Act 2017. The Government needs to strengthen the enforcement of both indirect and direct tax laws by improving the capacity and effectiveness of the tax administration system. This can be achieved by investing in training and development of tax officials, increasing the use of data analytics and technology, and ensuring transparency and accountability in tax administration. Finally, enactment of the Direct Tax Code should be effected as fast as possible in order to simply direct tax levying, collection and dispute settlement issues and, over all, efficiency in direct tax administration to increase direct tax buoyancy in particular and tax buoyancy in general.
(The author is Professor of Management (Finance) and Director, ISEAM, Bangalore)
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