What Jaitley is doing to meet the Rs 1,05,000 crore tax collection gap

Fostering Public Leadership - World Economic Forum - India Economic Summit 2010In the Mid Year Economic Analysis released in December 2014 it was estimated that the government will run short of the projected tax revenues by Rs 1,05,084 crore. As I have suggested in the past, this means that the government will have to slash its expenditure big time, in order to meet the fiscal deficit target of 4.1% of the GDP that it had set for itself when it presented the budget in July 2014.
deeper reading of a newsreport in The Economic Times suggests that this will now partly happen on its own. The government expenditure is essentially categorized into two categories-plan and non-plan. Plan expenditure is essentially money that goes towards creation of productive assets through schemes and programmes sponsored by the central government.
Non-plan expenditure on the other hand is an outcome of planned expenditure. For example, the government constructs a highway using money categorised as a plan expenditure. But the money that goes towards the maintenance of that highway is non-plan expenditure. Interest payments on debt, pensions, salaries, subsidies and maintenance expenditure are all non-plan expenditure.
Data released by the Controller General of Accounts(CGA) suggests that during the first nine months of the financial year the period between April and December 2014, the government spent Rs 3,52,631 crore or 61.3% of the Rs 5,75,000 crore plan expenditure that the government had budgeted for.
A government rule does not allow it to spend more than 33% of the plan expenditure in one quarter. At the same time the government cannot spend more than 15% of the plan expenditure in March. 

Given this, how do the numbers stack up? 33% of Rs 5,75,000 crore, the budgeted plan expenditure for the year, amounts to Rs 1,89,750 crore. The government has already spent Rs 3,52,631 crore between April and December 2014. Hence, for the current financial year as a whole, it cannot spend more than Rs 5,42,381 crore (Rs 3,52,631 crore plus Rs 1,89,750 crore).
This means that the government will automatically end up not spending Rs 32,619 crore. In fact, the 33%/15% rule applies at the ministry, department as well as scheme level. Given this, the actual number can be slightly different from the overall number arrived at.
What this means is that the government will have to further slash plan expenditure in order to meet the tax gap of Rs 1,05,084 crore. This shouldn’t come as a surprise given that in the last two financial years, this is exactly what the government did.
The plan expenditure target of the government during the last financial year was at Rs 5,55,322 crore. The actual plan expenditure came in at Rs 4,75,532 crore, which was close to Rs 80,000 crore or 14.4% lower. This is how the fiscal deficit of 4.6% of GDP was achieved.
A similar strategy was followed in 2012-2013 as well. In 2012-2013, Rs 5,21,025 crore was budgeted towards plan expenditure. The final expenditure came in 20.6% lower at Rs 4,13,625 crore.
The Economic Times suggests that the plan expenditure this time around will be Rs 80,000 crore lower. The paper goes on to suggest that this will be Santa’s late gift to finance minister Arun Jaitley.
This can hardly be the case given that plan expenditure is asset creating. In an environment where private investment continues to remain slow, if the government expenditure is also cut dramatically, it can’t be good for the economy. But given that the government’s revenue projections have gone dramatically wrong there is nothing much it can do other than slashing plan expenditure, given that non plan expenditure cannot be easily slashed.
The bigger problem here remains that India’s tax collections are very low in comparison to its gross domestic product. Analysts Ritika Mankar Mukherjee and Sumit Shekhar of Ambit Capital in a recent report titled 
Modi’s ambitions will reshape India’s fiscal construct show that India’s tax collections are abysmally low as a proportion of its GDP. The next exhibit shows that clearly. 

Exhibit 1:India’s tax-to-GDP ratio remains
abysmally low at 11% as per FY15 Budget Estimates

Source: CEIC, Ambit Capital research, Note: Data is presented on financial year basis

At the same time, as the next exhibit shows, the tax to GDP ratio of India is lower than that of other emerging markets 

Exhibit 2: India’s tax GDP ratio is lower
than that of most emerging market peers

Source: World Bank, Ambit Capital research, Note: Data is presented on calendar year basis

Given this, it is very important that the government figure out ways of improving its tax collections. This is especially important in light of the fact that the government seems to have huge plans for spending money on improving India’s pathetic public infrastructure. 
As the Ambit Capital analysts point out: “India’s tax-to-GDP ratio has been range bound between 8% and 12% over the past two decades. Furthermore, a comparison with peers as well as with developed countries like the UK points to the vast tax revenue-generating potential in India which suffers from large-scale tax evasion.” 
The Ambit analysts also feel that boosting India’s tax-to-GDP ratio will be one of the major things that the Narendra Modi government will do over its term. As they point out: “Our discussions with well-placed policy experts suggest that enhancing India’s abysmally low tax-to-GDP ratio is likely to be one of the primary objectives that Modi will pursue over his five-year term.” 
One way of improving the tax-to-GDP ratio is to go about reducing the total amount of black money in the Indian financial system in a systematic way. While the government has made a lot of noise about bringing about all the black money that has left the Indian shores, it hasn’t had much to say about the black money floating around in India, which would be significantly easier to recover. Going after the black money in India would be the quickest way to significantly improve the country’s abysmally low tax-to-GDP ratio. 
The other major area that needs to be looked at are the tax rates and exemptions that come with them. As Swaminathan Aiyar pointed out in a recent column in The Times of India: “Currently , India has among the highest tax rates in Asia, but also hordes of exceptions.” 
Along with the budget every year, the government releases the revenue foregone number. This number for the last financial year 2013-2014 was estimated to be at Rs 5,72,923.3 crore. “The estimates and projections are intended to indicate the potential revenue gain that would be realised by removing exemptions, deductions, weighted deductions and similar measures,” the statement of revenue foregone points out. 
In the table that follows it can be clearly seen that the Indian corporates benefit the most out of all the exemptions and deductions available under the various tax laws in this country. The businesses benefit the most with corporate income tax, excise duty and customs duty foregone, forming a bulk of the revenue foregone by the government. 



(in Rs crore)



Corporate Income Tax



Personal Income Tax



Excise Duty



Customs Duty





Source: Annual budget

The revenue foregone number is based on certain assumptions. As the statement points out ” The estimates are based on a short-term impact analysis. They are developed assuming that the underlying tax base would not be affected by removal of such measures….The cost of each tax concession is determined separately, assuming that all other tax provisions remain unchanged. Many of the tax concessions do, however, interact with each other. Therefore, the interactive impact of tax incentives could turn out to be different from the revenue foregone calculated by adding up the estimates and projections for each provision.” 
Nevertheless, it is too big an amount to be ignored. In fact, the number is bigger than the projected fiscal deficit of Rs 5,31,177 crore for this financial year. Given this, the government needs to go through these exemptions carefully and figure out whether they are really needed. 
Of course, this exercise may not be possible to carry out before the budget, but it needs to be taken up seriously. Lower tax rates along with fewer deductions and exemptions should go a long way in improving India’s tax-to-GDP ratio.

(The article originally appeared on www.equitymaster.com as a part of The Daily Reckoning on Feb 6, 2015)