Demonetisation and Its impacts on Tax Revenues

On November 8, 2016, the Union Government had demonetised old Rs.500 and Rs. 1,000 notes from November 2016 on the recommendations of the RBI’s central board to eliminate unaccounted money and fake currency notes from the financial system. Here is an overview of what are possible implications of the demonetisation on government tax revenue and government revenue.

Impact of demonetisation on Government Tax revenue

The first clearly visible impact of demonetisation on government tax revenue was an increased tax base. As per the publically available data, India had only 55.9 million individual tax payers at the end of 2015-16. In 2016-17, the government added 9.1 million new taxpayers, which represented an 80% increase over the typical yearly increase. At the same time, it was revealed in May 2017, that number of people who had filed income tax returns also got increased by 9.5 million.

Though not very significant, yet this increase in tax base would certainly widen government’s direct tax revenue in coming years. India has been traditionally a country of mass under-reporting of Income and most important marker of the demonetisation would be the tax collections.  The finance minister also confirmed that due to demonetisation, the tax collection has witnessed a double digit growth.  As far as the indirect taxes are concerned, the excise duty got increased by 43.5%, service tax by 25.7% and custom duties by 5.6%. In addition, an increase has been witnessed in life insurance, tourism, petroleum consumption, flow of mutual fund investment etc. The demonetisation has also brought a large part of money into formal banking system. This had augmented the capacity of the banks to lend.

Impacts of Income Declaration Scheme (IDS) and Pradhan Mantri Gharib Kalyan Yojana (PMGKY)

Income Declaration Scheme (IDS) was launched in June 2016 and it provided a one-time opportunity to those who had not paid full taxes in the past. It had provided four-month window for declaring undisclosed income or black money. The scheme ended on 30 September 2016. CBDT received a total disclosure of Rs. 65,250 crore black money in the form of cash and other assets under the Income Disclosure Scheme. Further, the Pradhan Mantri Garib Kalyan Yojana (PMGKY) was notified along with other provisions of Taxation Laws (Second Amendment) Act, 2016 and came into effect from 17 December 2016. It remained open until March 31, 2017. PMGKY was Union Government’s second income disclosure scheme (IDS) to allow tax evaders to come clean with unaccounted wealth. It provided for 50 per cent tax and surcharge on declarations of unaccounted cash deposited in banks.

However, these two income disclosure schemes did not help in increasing the government revenue as expected.

Current Scenario: Low Tax Base is India’s Achilles Heel

In this year’s budget speech finance minister said that India is largely a tax non-complaint society with a predominance of cash transactions making it possible for the people to evade their taxes. The prevalence of the low taxpayer base has long been existing as a key drag on the finances of the government.

^^India’s tax revenue as a percentage is a meagre 16.7% in 2016 when compared to 25.4% in the US and 30.3% in Japan. Out of the 37 million people who filed income tax returns in 2015-16, only 5.2 million and 2.4 million have disclosed income between Rs5 lakh and Rs10 lakh; and over Rs10 lakh respectively. Out of this 7.6 million tax payers 5.6 million were in the salaried class. Hence, only 172,000 people in th entire country has shwed that their income has exceeded Rs 50 lakh. In comparison, the number of cars that sold in the last five years stands at 12.5 million and the number of Indians travelling abroad for business/pleasure in 2015 stood at 20 million.^^

What is India’s tax-GDP ratio conundrum?

India’s abysmally low tax to GDP ratio is a major reason for the widening of income inequality. While the average tax to GDP (%) of India remains in between the range of 16%-17%, the corresponding figures for OECD countries are much higher at around 34.3%. In emerging economies, it is even higher with South Korea (25.3%), Mexico (17.4%) and Turkey (30%) all having figures higher than India.

These countries have a good tax to GDP ratio because of their proportionally higher level of per capita incomes. India’s GDP per capita income still remains abysmally low at around $1,900 (nominally) and $6,700 (on a purchasing power parity basis). It is generally held that the low per capita income may explain a low tax-GDP ratio for a given country.

But in India, what remains conundrum is that post economic liberalisation in, India’s tax to GDP ratio first diminished and then remained stagnant since 1991 while GDP per capita has been increasing post economic liberalisation. So in India’s case, the GDP per capita income may increase over time but this may not necessarily increase the tax to GDP ratio will rise at the same rate or even incrementally.

This statistical anomaly is expected to get corrected if more people are brought under the tax net with unaccounted money being deposited in banks.

End Notes

Though the government justifies its demonetisation move with increase in taxpayers and tax revenue, critics however are pointing out the failure of the government to fulfil the other objectives of the demonetisation like curbing of black money, terror financing or counterfeit notes.

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