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Marginal Uptrend: Exploring Minimal Growth In Tax Payer Compliance – IMPRI Impact And Policy Research Institute

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Marginal Uptrend: Exploring Minimal Growth in Tax Payer Compliance

Arun Kumar

The income tax data released recently points to the highly skewed nature of income distribution in the country, with only about 0.68% people paying effective taxes.

The Central Board of Direct Taxes (CBDT) has released data on income tax payees for financial years 2013-14 to 2022-23. More detailed data about different categories of tax payees are available for the financial year 2020-21. This data can be used to get an idea of the income distribution of the top income earners in the country.

Few direct tax payers

Income tax is paid by a minuscule percent of the population. Official data shows that 7.4 crore individuals filed tax returns in FY2022-23 and 6.75 crore in FY2020-21. In this earlier year, there were also 2.1 crore people who did not file a tax return but paid Tax Deducted at Source (TDS). So, in FY2020-21, effectively there were 8.85 crore people in the tax net – which was 6.6% of the population. Since we do not have corresponding data on those not filing tax return but paying TDS for FY 2022-23, we do not yet know the total number of entities in the tax net in 2022-23.

Anyone paying income tax or filing a tax return has to have an income above the income tax exemption limit and therefore has to be among the top income earners in the country. What is their distribution?

The exemption limit for determining tax liability is now Rs 3 lakh but has been Rs 2.5 lakh, with some concessions for senior and super senior citizens. With a standard deduction of Rs 50,000 and rebate under Section 87A, till now an individual did not have to pay any tax up to a taxable income of Rs 5 lakh. Of India’s per capita annual income at current prices of Rs 1,50,007 in 2021-22, this is 333%. From the current financial year, tax will have to be paid at income of above Rs 7.5%, 414% of the likely per capita income of about Rs 1,81,000. So those in the tax net are in the tail of the income distribution.

With so much concession, for FY2020-21, out of 6.76 crore e-returns filed, 4.46 crore paid nil tax (67.3% of the total). The 2.1 crore who did not file a return but paid TDS must have had an income below Rs 2.5 lakh, otherwise they would have had to file a return. Adding these two numbers, effectively, 6.6 crore returns out of a total of 8.85 crore (73.4%) were filed by those with low incomes. 91 lakh (10.3% of those in the tax net) had taxable incomes above Rs 9.5 lakh and who can be called well-off in the Indian context. About 2.15 lakh declared income above Rs 1 crore and maybe characterised as wealthy.

In brief, people in top rung of the income ladder in the country were those who were in the income tax net (6.6% of the population) even if they did not pay income tax. Out of these, only 0.68% of the population were the really well off who effectively paid income tax. Further, 0.016% declared an income above Rs 1 crore and had a share of 38.6% of the taxable income.

Caveats

This picture of the well-off, characterised by those who effectively pay income tax, is incomplete. Two additional factors need to be taken into account. First, the rich families split up their incomes. This enables them to take advantage of concessions on each of the returns filed and each of the incomes may then fall in the lower income bracket on which a lower tax rate may apply. Second, the well-off resort to black income generation by not declaring their true income.

The first point implies that the 0.68% people who paid significant amounts of income tax belong to an even smaller percent of the families. So, the actual family income of the well-off is much higher. Since the poor face unemployment, under employment and joblessness, their family income is not much higher than what a poor individual earns. The implication is that the gap in family incomes between the well-off and the poor would turn out to be much larger than gap in incomes shown by the data on individuals paying tax.

Further, black incomes are generated by the well-off, who have substantial incomes. Those who have an income below the taxable limit don’t need to hide their income. They do not have to file a return or declare their income to the tax authorities. Those who have a taxable income of, say, up to Rs 9.5 lakh, need pay only a few percent of it as tax, if they take advantage of deductions under 80C, 80D, 80TTA, etc. So they will hardly benefit from hiding their income and will not be generators of black incomes.

It is the well-off, especially businessmen and professionals who declare a lower income to tax authorities so as to pay a smaller portion of their income as tax. Some of them completely escape the tax net by not filing a return or by showing an income below the taxable limit.

All these factors lead to the official data underestimating the skewedness of income distribution in the economy.

Has compliance increased

The organised sector has higher incomes and contributes most to direct taxes. It produces 55% of the GDP. Its share of GDP would have risen during the pandemic, which disproportionately hit the unorganised sector. The GDP was Rs 1,98,00,914 crore in FY 2020-21, the Covid year. So, Rs 1,08,90,000 crore should have been captured in the tax net from the organised sector. Some more should have come from the few well-off businesses in the unorganised sector.

Detailed data for FY 2020-21 shows that the taxable income declared by all return filers was Rs 69,59,552.48 crore. This is about 35.15% of the GDP and about 63.9% of what should have been shown as declared incomes by the organised sector. On this declared income, the tax collected was Rs 9,47,176 crore. The tax to GDP ratio was a very low 4.78%. If black income generation were taken into account, it would be even lower.

In FY2021-22, GDP recovered from its low during the pandemic, and became Rs 2,36,64,637 crore. The direct tax collection increased to Rs 14,12,422 crore, so that the direct tax to GDP ratio rose to 5.97%. In 2018-19, this figure was even higher at 6.02%. But, even this figure is low compared to many developing economies.

The government claims that more and more people are filing tax returns and presents this as an indication of better tax compliance and a reduction in the black economy. According to the data just released, the number of people paying direct taxes has risen from 7,42,49,558 in FY2016-17 to 9,37,76,869 in FY2021-22. This is impressive, but the catch is that most of the people entering the tax net declare nil income or a low income, as pointed out above.

A reduction in black income generation would have meant that many more of the individuals with high incomes would have come into the tax net, and the direct tax to GDP ratio should have risen sharply instead of hovering between 5.5% and 6% since 2014-15.

The increase in the number of tax returns is due to the constancy of the income at which a tax return needs to be filed remaining unchanged at Rs 2.5 lakh, while incomes have risen due to inflation. The per capita net national income, which tells us how much an average citizen is earning, is 30.1% higher in 2022-23 than it was in 2019-20.

Thus, someone with an income of Rs 2 lakh in FY2019-20, pre pandemic, would be earning Rs 2.6 lakh in FY2022-23. In 2019-20, she would not have had to file a tax return while in 2022-23 she would have to file a return. Thus, the number of tax return filers would automatically rise. But the tax they pay would not rise, so their entry into the tax net does not impact the tax to GDP ratio.

Conclusion

The income tax data released recently points to the highly skewed nature of income distribution in the country with only about 0.68% people paying effective taxes. The percentage of families they belong to would be even smaller. If tax manipulations by the wealthy and black income generation are taken into account, then the income distribution becomes even more skewed. Finally, the increase in the number of tax filers is due to inflation but this has hardly led to an increase in the direct tax to GDP ratio since most new entrants in the tax net file either nil return or are exempt from tax. So, tax compliance in the country has hardly changed.

Arun Kumar is a retired professor of economics at the Jawaharlal Nehru University. He is the author of Demonetization and Black Economy and Indian Economy’s Greatest Crisis: Impact of the Coronavirus and the Road Ahead.

The article was first published in The Wire as Income Tax Data Reveals That Increase in Compliance Is Marginal on November 24, 2023.

Disclaimer: All views expressed in the article belong solely to the author and not necessarily to the organisation.

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Acknowledgement: This article was posted by Aasthaba Jadeja , a research intern at IMPRI.

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  • IMPRI

    IMPRI, a startup research think tank, is a platform for pro-active, independent, non-partisan and policy-based research. It contributes to debates and deliberations for action-based solutions to a host of strategic issues. IMPRI is committed to democracy, mobilization and community building.

  • Arun Kumar

    Arun Kumar, Malcolm S Adiseshiah Chair Professor, Institute of Social Sciences, New Delhi and author of ‘Indian Economy’s Greatest Crisis: Impact of the Coronavirus and the Road Ahead‘.

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