Month: November 2016 | Page 3

10 November, 2016

Can India’s currency ban really curb the black economy?

On November 8, 2016, in a late-night TV broadcast to the nation, Indian prime minister Narendra Modi, demonetised Rs 500 and Rs 1,000 notes. As of the midnight of November 8, 2016, these notes have been rendered useless.

This decision of the Modi government came as a huge surprise to the media as well as the citizens, given that there were no news leaks before the announcement. Newsreports suggest that the Reserve Bank of India, the Indian central bank, was given close six months to prepare for this eventuality. The government had asked the central bank to print more Rs 50 and Rs 100 notes. Despite the long period taken to prepare for this decision, there were no news leaks.

Further, the Rs 500 and Rs 1,000 notes which have been demonetised, can be deposited in banks as well as post offices up until December 30, 2016. The money will be credited in the account of the individual depositing the money. The notes can also be exchanged up to Rs 4,000.

While Indian cities are full of bank branches, those living in rural areas will find exchanging the demonetised notes a little difficult. Only 27 per cent of Indian villages have a bank within 5 kilometres.

The idea behind this move as per the government is to curb “financing of terrorism through the proceeds of Fake Indian Currency Notes (FICN) and use of such funds for subversive activities such as espionage, smuggling of arms, drugs and other contrabands into India.”

It is also to hit those who have a massive amount of black money in the form of cash. Black money is essentially money that has been earned through corruption and legal activities, without any tax being paid on it. There are several estimates of the total amount of black money going around in the Indian economy. A World Bank estimate puts the size of the black economy at a little 23.2 per cent of the economy in 2007.

By making high denomination notes worthless overnight, the government hoped that those who have black money in this form, will not be able to convert this money into physical assets like gold. Newsreports suggest that jewellers across the country worked overtime through the night of November 8 and November 9, 2016, to help convert black money held in the form of Rs 500 and Rs 1,000 notes into gold.

Starting November 10, 2016, the government will introduce new Rs 500 and Rs 2,000 notes. Those who have black money in the form of the old Rs 500 and Rs 1,000 notes will try exchanging them with new notes. They can’t go to a bank and deposit all their black money given that it is likely to lead to questions from the income tax department.

Any other way of exchanging notes will take some doing, given that the old denomination notes form more than 86 per cent of notes in circulation by value. Hence, it will not be easy to exchange these notes without leaving audit trails for the income tax department. To incapacitate those who are holding a lot of black money in the form of cash seems to be the major idea behind the move.

Crisil Research expects income tax collections of the government to improve as money earlier unaccounted for, enters the banking system and eventually gets taxed. Inflation is also expected to come down in the short-term as cash transactions come down.

Another area which is likely to be impacted is real estate. A portion of the payment while buying a house in India is almost always made in the form of cash. With the high denomination notes, having been demonetised it will become very difficult to organise for this payment. Hence, prices are expected to fall. If prices do fall it will be make real estate affordable. At affordable prices, the demand for real estate is likely to go up. This is expected to create low-skilled and unskilled jobs, which the country badly needs, given that one million individuals enter the workforce every month.

Further, the retail as well as the luxury goods businesses where a bulk of transactions are carried out in cash is expected to be impacted negatively, as cash transactions will come down dramatically in the short-term.

In fact, during the period the old notes are withdrawn and new notes make it to the market, the cash transactions are likely to remain down. India is a country where a bulk of transactions are still carried out in cash. A 2012 estimate carried out by the The Fletcher School at the Tufts University estimated that 86.6 per cent of the transactions were carried out in cash. While this figure would have come down since then, it would still be at a very high level.

Another research paper titled The Cost of Cash in India points out that “the ratio of currency to GDP in India (12.2%) is higher than countries such as Russia (11.9%), Brazil (4.1%), and Mexico (5.7%)”. Hence, India is still largely a cash driven economy and given this, Modi government’s move is likely to cause a few problems in the short-term.

Also, if the Modi government is serious about tackling the black money menace, it shouldn’t just leave it at this. As the former RBI governor Raghuram Rajan said in this context: “I think there are ways around demonetization. It is not that easy to flush out the black money. Of course, a fair amount may be in the form of gold, therefore even harder to catch.”

It is important that the government uses information technology to track down those who are earning money but not paying their share of taxes. As Rajan put it: “I would focus more on tracking data and better tax administration to get at where money is not being declared.”

Further, the government needs to quickly introduce electoral financing reform in the country.

The column originally appeared on BBC.com on November 10, 2016.

9 November, 2016

Will the Great Indian Real Estate Bubble Finally Burst? It’s for the Modi Govt to Decide

In a surprise late evening move yesterday, prime minister Narendra Modi told the nation in a TV address, that come midnight, Rs 500 and Rs 1,000 notes will no longer be legal tender.

As I explained in a column published earlier today, one reason for doing this is to tackle the menace of fake notes. The second reason for doing this is to tackle black money.

As I mentioned in the earlier column, the move seems to be inspired from the American dollar as well as the British pound. In the United States, the highest denomination bank note is $100. When it comes to the United Kingdom, the highest denomination bank note issued by the Bank of England is £ 50. In the United States as well as the United Kingdom, the highest denomination note is essentially 50 times the smallest denomination note of one dollar or one pound.

In India, up until now the highest denomination note was Rs. 1,000 and this was 1,000 times the smallest denomination note of Re 1, issued by the ministry of finance. When a currency has notes of higher denomination, it is easier to launder money i.e. store black money, as it takes less space and weighs less as well.

As Ritika Mankar Mukherjee and Sumit Shekhar of Ambit Capital wrote in a recent research note: “For instance, the weight of Rs 1 crore in the form of hard cash rises from 12kgs to 100kgs if the denomination of the sum is changed from 1,000-Rupee notes to 100-Rupee notes.”

Also, Rs 500 and Rs 1,000 form the bulk of the total amount currency notes in the Indian financial system. As per the Reserve Bank of India, the total amount of paper notes in circulation in 2015-2016 amounted to Rs 16.4 lakh crore. Of this, the high denomination notes of Rs 500 and Rs 1,000 amounted to Rs 14.2 lakh crore or a little over 86 per cent. The Rs 500 notes amounted to Rs 7.9 lakh crore whereas Rs 1,000 notes amounted to Rs 6.3 lakh crore.

This basically means that anyone who has black money stored in the form of currency notes is more than likely to have it in the form of Rs 500 and Rs 1,000 notes. Black money is basically money which has been earned and on which taxes have not been paid. As Mukherjee and Shekhar write: “Given that 48% and 39% of the total value of currency in India is in the form of Rs 500 and Rs 1000 notes respectively, discontinuing usage of either of these notes can increase the physical costs and risks of holding black money significantly.”

Given this, anyone who has these notes, must go deposit this money in a bank account or in a post office account. And if the money being deposited is black money then questions are likely to be asked by the income tax department. Hence, that is unlikely to happen, at least not in a direct way.

One repercussion of this move that is being widely talked about is that it will lead to a fall in real estate prices. Typically, real estate throughout the length and breadth of India is bought using black money. A significant part of the payment is made in cash. Either this is black money being used or it is white money being converted into black. Experts are of the view, that the Modi government’s crackdown on black money is likely to lead to real estate prices coming down significantly.

The logic is that with Rs 500 and Rs 1,000 no longer being legal tender, it will become difficult to make the black component of the payment using currency notes. With the cash component becoming difficult to pay, it is expected that the real estate companies and builders will have to cut prices.

Further, the government plans to launch new Rs 500 and Rs 2,000 notes. It will not be so straightforward to exchange the old Rs 500 and Rs 1,000 notes with these new notes, at least that is the feeling that currently prevails.

This is the logic being offered by experts who are forecasting a fall in real estate prices. As Yashwant Dalal, president of the Estate Agents Association of India told The Economic Times: “Property markets will see around 30% correction in prices…Apart from big property markets, tier II and III cities will be worst affected.” Property prices in tier II and tier III cities will fall more because the black component while buying a home is higher in these cities.

Further, as Anuj Puri, chairman and country head, JLL India, told Mint: “We have just witnessed a tremendous step towards increased transparency in the Indian real estate industry…The effects will be far-reaching and immediate, and shake up the sector in no uncertain way.” Rajiv Talwar, CEO of DLF, was a little more direct than Puri when he told The Economic Times: “There is bound to be a downward pressure on prices of everything including real estate.”

How do I see the situation? Given that I have been bearish on real estate for as long as I have been, it would be easy for me to say that prices will crash. But the past data (whatever limited data we have on real estate) doesn’t suggest the same.

So, my feeling is that real estate prices will fall, but whether they will crash or not, depends on how the government reacts to the situation. Allow me to explain.

This is something I had written in the last edition of The Vivek Kaul Letter, but it is worth repeating here. The current financial crisis that the world is dealing with, essentially started once the investment bank Lehman Brothers declared bankruptcy in mid-September 2008. Real estate prices fell across large parts of the world. But India beat the trend.

The question is why did this happen. Why did real estate prices in India not crash? How did India manage to beat a global trend? The answer lies in Figure 1.

Figure 1: Bank lending to commercial real estate (in Rs. Crore)

The Figure 1, plots the total loans given by banks to commercial real estate, essentially, builders or real estate companies, which make and sell homes, in the period following the start of the financial crisis in late 2008 and early 2009. In the aftermath of the financial crisis, real estate companies in India were also under a lot of pressure. Loans had to be repaid. At the same time the buyers had simply disappeared from the market.

To attract buyers, builders did start to cut prices. Nevertheless, that soon came to a stop. Look at Figure 1. There is a huge jump in lending between January 2009 and February 2009. In January 2009, the total bank lending to commercial real estate stood at Rs. 78,401 crore. At the end of February 2009, the total bank lending to commercial real estate stood at Rs. 90,765 crore. During the period of just one month, lending to real estate went up by Rs. 12,364 crore or 15.8 per cent.

This, when the total lending by banks (non-food credit) between January 2009 and February 2009 went up by Rs. 26,380 crore. Hence, lending to commercial real estate by banks, formed close to 47 per cent of the total lending carried out by banks during the month.

This was a huge anomaly. It is safe to say that this was a bank-sponsored bailout of the real estate sector. If this bailout had not been carried out real estate companies would have had to cut prices majorly to sell homes, to be able to earn enough money to repay the bank loans that they had taken on. Chances are they would have defaulted on some of these loans as well.

The Indian banks managed to avoid this scenario by lending fresh money to real estate companies. The fresh loans were used by the real estate companies to repay their old loans. If these fresh loans hadn’t come through then the real estate companies would have had to cut home prices, so as to be able to sell homes and earn enough money to repay those loans. And India’s real estate bubble would have ended in 2009.

Look at Figure 2. It basically plots the growth in bank lending to commercial real estate over the years. So, in June 2011, the growth rate was at 23.2 per cent. This means that the growth in bank lending to real estate companies between June 2010 and June 2011, stood at 23.2 per cent. All other data points have been plotted in a similar way.

Figure 2: Growth in lending to commercial real estate (in %)

It is clear from Figure 2 that the growth in bank lending to real estate companies simply exploded in the aftermath of the financial crisis. In fact, it just went up vertically. Zoom!

And this explains, why the real estate prices in India did not fall in the aftermath of the financial crisis. Further, this also tells us why India beat the global trend of falling real estate prices. Of course, perpetual reasons like black money finding its way into real estate, were also there.

Further, the law of demand does not work in the real estate market. In a normal market, when prices go up, people buy less of that thing. In the real estate market, as prices go up, more and more people enter the market (as is the case with the stock market as well). This is what happened post 2009 in India. Rising real estate prices brought the buyers back into the market and the real estate bubble got a new lease of life.

In fact, it is clear from Figure 2, that the growth in bank lending to real estate companies goes through some sort of a cycle. Are these lending cycles linked to the rate of increase of real estate prices? The trouble is that there is very little data available on real estate prices in India. One of the real estate indices that one can look at is the Reserve Bank of India (RBI)House Price Index. Look at Figure 3. It shows one- year returns in real estate per the RBI House Price Index, since June 2011.

Figure 3: Real estate returns (in %)

What is clear from Figure 3 is that the annual real estate returns have come down over the years. Now what happens when we plot Figure 2 and Figure 3 together. Look at Figure 4.

Figure 4: Comparison n

The Figure 4 shows that every time the real estate prices start to correct (i.e. the rate of growth in real estate prices starts to fall), lending from banks to real estate companies starts to pick up. Of course, the mapping isn’t exactly one to one. But there is a clear correlation.

There are two possible reasons for this. One is that banks do not want real estate prices to fall. This is because they feel that if real estate prices fall, the real estate companies won’t be able to repay their loans. Given this banks give fresh loans to real estate companies, so that they don’t have to cut their prices. This keeps the real estate bubble going.

The second possible reason is that the government (I don’t mean just the current government here but any government) does not want real estate prices to fall. This stems from the fact that the ill-gotten wealth of politicians is largely invested in real estate and they work towards protecting its value. Also, real estate builders are major financiers of political parties at local and state levels.

How is all this relevant in the current context? Real estate prices will start falling for sure. The trouble is that this is also likely to lead to default of bank loans from real estate companies. As of August 2016, the total lending carried out by banks to real estate companies stood at Rs 1,81,700 crore. If home loan borrowers also start to default, then there will be a bigger problem.

In this scenario, will banks come to the rescue of real estate companies again? Will public sector banks be forced to give fresh loans to real estate companies? On these questions, your guess is as good as mine. I don’t have clear cut answers to these questions. If banks do give fresh loans to real estate companies, as they have done in the past, then the real estate prices may not fall by as much as they are currently expected to. Nevertheless, it is safe to say, that whether real estate prices will crash, is actually in the hands of the Modi government.

Also, it is worth pointing out here that public sector banks are currently in a mess because of corporates defaulting on loans. Will they be able to take on real estate companies defaulting on their loans as well? What will the government do in this situation?

To conclude, I must say this that if the Modi government does allow real estate prices to come down dramatically, it will improve the affordability of homes. This will allow many people who cannot currently buy homes to buy homes. Also, lower prices will spur demand, which is currently more or less dead. Higher demand will lead to the creation of many low-skilled and unskilled jobs, which the country badly needs, with one million individuals entering the workforce every month. It will also lead to a multiplier effect in industries which directly depend on real estate for their demand.

All I can say with confidence right now is: Watch this space.

The column originally appeared in Vivek Kaul’s Diary on November 9, 2016.

9 November, 2016

Why Mumbaikars bought gold all night long on a weekday

gold Gold is money.

It has always been money.

Nobody knows this better than us Indians. Our love for the yellow metal comes out in the way we hoard it. And this faith in gold was at display all night long yesterday in Mumbai.

The question is what brought out Mumbaikars to buy gold on a non-festive day? The answer is Narendra Modi.

In a late evening TV address to the nation prime minister Narendra Modi banned the use of Rs 500 and Rs 1,000 as legal tender. This essentially made a little more than 86 per cent of notes practically useless overnight.

Anyone who has Rs 500 and Rs 1,000 notes can deposit them in his or her bank account or post office account, up until December 30, 2016. This money will be
credited into the bank or post office account.

Nevertheless, these notes can be exchanged only up to a total of Rs 4,000 as cash. This limit has been set for a period of 15 days and it will be reviewed after that. People who have always declared their income and paid taxes on time, have nothing to worry about. All they need to do is just go to a bank or post office and deposit the Rs 500 and Rs 1000 notes they have. The money will be credited into their accounts, which they can later withdraw through ATMs/cheques.

Nevertheless, this move of the Modi government, has created trouble for those who have black money in the form of cash or notes. Black money is essentially unaccounted money which has been earned but on which tax has not been paid. If the holders of black money were to deposit it in their bank account, it would probably lead to questions from the income tax department regarding the origin of the money.

If they were to continue to keep it under their mattresses, the money would become useless overnight. Hence, the next best thing to do was to convert that money into a physical asset, which would continue to hold value. Of course, physical assets like land or flats or paintings cannot be bought overnight.

But there are no such problems in buying gold. It is practically available everywhere in the city. All one needs to do is to step out and buy it. And this precisely what Mumbaikars who had black money in the form of cash did late last night.

They exchanged their Rs 500 and Rs 1,000 notes for gold and ensured that their black money continued to hold value. Also, no identification documents need to be shown for gold purchases of up to Rs 2 lakh. This makes converting black money into gold an easy proposition. Further, those with black money always have the option of buying gold from multiple jewellers in order to avoid showing identification documents. Hence, people were essentially busy converting their black money into gold.

As per the government notification Rs 500 and Rs 1,000 were not supposed to be a legal tender post-midnight. But the city jewellers seemed to have overlooked this technicality and carried on with brisk business late into the night. This was a good opportunity for them to earn some money, in what has been an otherwise slow year for them.

Of course, the money that they earned during the night and all the Rs 500 and Rs 1,000 notes that they managed to accumulate, must be deposited into their bank accounts, to make sure that it continues to hold value. If they don’t do that they will essentially end up holding worthless pieces of paper.

And once the money is deposited into a bank account, it will essentially mean that the black money of Mumbaikars will be converted into white money of the jewellers on which an income tax will have to be paid. This in a rather circuitous way will be a good thing to happen.

The column originally appeared in the Midday on November 9, 2016

9 November, 2016

Why Modi Just Banned Rs. 500 and Rs. 1,000 Notes

narendra_modi

It was sometime in April 1999. The summer was at its peak in Ranchi, the city I was born and brought up in.

I was writing my final year graduation exams in Mathematics. The examination centre was a rather non-descript college, whose name I don’t remember now.

On the first day of examination there were power cuts. The examination centre did not have any power-backup. Thankfully, I had a sort of a premonition of this and was wearing a pyjama-kurta on that day. This is something I can distinctly remember.

Everyone around me was sweating profusely. The sweating was not just because of the power cut. The question paper was totally bizarre. The questions that had been asked had never been asked before.

As anyone who has done his graduation from an Indian university would know, students essentially prepare in two ways. One, is that they look at question papers of previous years and mug up the answers to the questions asked. The other is preparation through guess papers.

Local publishers publish what they think are questions that are likely to be asked in the exam. Typically, these guess papers are ghost written by university professors looking to make some money on the side.

Sometimes, the professor who is writing the guess paper also ends up setting the question paper. And in this case, students who have prepared using the guess paper hit the jackpot.

But sometimes that is not the case. And something similar happened that morning in April 1999. The questions were neither from the guess paper nor had they been asked in the previous years.

It would be safe to say that 90 per cent of my class was caught unprepared. And some of them were totally screwed. As often happens in these cases, the universal opinion after the exam was that the questions were totally out of syllabus.

Something similar, happened on November 8, 2016. When everyone was preparing to discuss the American presidential results, prime minister Narendra Modi dropped a bombshell. The government of India decided to ban Rs. 500 and Rs. 1,000 notes with effect from midnight of November 8, 2016. In question paper terms, this was something which was totally out of the syllabus. No one was expecting it. And the media, as usual, did not come to know about it, until the prime minister started addressing the nation on TV.

The banned notes can be deposited at “bank or post office accounts from 10th November till close of banking hours on 30th December 2016 without any limit”.

At the same time, notes of only up to Rs. 4,000 can be exchanged. This limit will be applicable for the next fifteen days and will be reviewed after that.

What is the logic behind this? As per the government “Fake Indian Currency Notes (FICN) in circulation in these denominations are comparatively larger as compared to those in other denominations.”

The government is planning to introduce new notes of Rs. 500 as well as Rs. 2,000. As it said in a press release: “New Series bank notes of Rs. 500 and Rs. 2,000 denominations will be introduced for circulation from 10th November, 2016. Infusion of Rs. 2,000 bank notes will be monitored and regulated by RBI.”

The question is why is the government doing this? There is an answer based on economic theory. And there is an answer based on politics. I will try and give both the answers here. First, let’s look at the answer based on economic theory.

The move seems to be inspired from the American dollar as well as the British pound. In the United States, the highest denomination bank note is $100. When it comes to the United Kingdom, the highest denomination bank note issued by the Bank of England is £ 50. In the United States as well as the United Kingdom, the highest denomination note is essentially 50 times the smallest denomination note of one dollar or one pound.

In India, up until now the highest denomination note was Rs. 1,000 and this was 1000 times the smallest denomination note of Re 1, issued by the ministry of finance. When a currency has notes of higher denomination, it is easier to launder money i.e. store black money.

To give you an example, with Rs. 1,000 notes in circulation it takes lesser space to store black money in comparison to a situation when the highest denomination note is Rs. 100. At the same time, it also makes it a little more difficult to bribe anybody. Further, if the highest denomination note is Rs. 100, then cash transactions in black will become difficult.

That’s one point. The second point here is that with Rs. 500 and Rs. 1,000 notes being banned, the people who have black money in the form of cash will have to come forward and declare it with the banks. At least, that is the theoretical assumption.

The trouble here is that no one really knows as to how much black money is stored in the form of cash and how much has been stored in the form of physical assets like land, flats, gold etc. Hence, the move is likely to inconvenience those people who have black money in the form of cash. From my conversations with a couple of CAs, I can say that people who have cash, are worried.

Of course, the flip side to this argument is that new higher denomination notes of Rs. 500 and Rs. 2,000 are being introduced. But to get these new notes, those who have black money in the form of cash will have to deposit the banned Rs. 500 and Rs. 1,000 notes in the banking system. And if they do that, this is likely to generate some interesting data for the government. Or they will have to figure out other interesting ways to ensure that their black money in the form of cash continues to hold value.

Also, these new notes are likely to take some time to move through the system and get to a situation where they start being used to hoard black money all over again. So, that I guess was the economic logic behind the government’s decision to ban Rs. 500 and Rs. 1,000 notes.

And what about the political logic? Tackling India’s black money problem has been a pet agenda for the Bhartiya Janata Party as well as Narendra Modi. While, efforts have been made in the past to tackle this problem, the results at best have been mediocre.

By taking the decision to ban Rs. 500 and Rs. 1000 notes, Modi has managed to give a new lease of life to the black money issue. This projects Modi as a strong leader who is willing to take strong decisions which can be unpopular with a certain section of the population. And the electorates just love strong leaders.

The decision goes against the trading community which sits on a lot of the black money in India. At the same time, it is also a major financier of Modi’s Bhartiya Janata Party at the state as well as the local levels.

This decision goes against this community and at the same time projects Modi as a leader who is willing to take decisions even if they go against a section of his supporters. Also, by banning Rs. 500 and Rs. 1,000 notes overnight, Modi did not give those who have black money in the form of cash, to be able to do something about it.

The interesting thing is that this decision has come nearly midway through Modi’s five-year term and at a time when the assembly elections are due in Uttar Pradesh.

The column was originally published in Vivek Kaul’s Diary on November 9, 2016

7 November, 2016

Who Really Pays Income Tax in India?

In late October, the Ministry of Finance released detailed income tax data for the assessment years 2013-2014 and 2014-2015. The income tax returns for the income earned during the financial years 2012-2013 and 2013-2014 were filed during the assessment years 2013-2014 and 2014-2015, respectively. In late April, earlier this year, the government had released income tax data for the assessment year 2012-2013.

Some interesting conclusions can be made based on this data. In the last two columns, I looked at this data and I continue to do the same here. In this column, we try and look at the effective rate of income tax paid by the various type of taxpayers. Look at Figure 1.

Figure 1:

Assessment Year	Total gross income declared (in Rs. Crore)	Total tax payable (in Rs. Crore)	Effective rate of income tax
2012-2013	21,17,236	3,57,405	16.9%
2013-2014	24,31,697	3,93,918	16.2%
2014-2015	26,93,032	4,46,719	16.6%

Source: Author calculations based on Ministry of Finance data.

The Figure 1 gives us details of the overall income declared by Indian taxpayers and the total income tax collected against it. As we can see the effective rate of income tax is between 16-17 per cent for the assessment years under consideration. The effective rate of income tax is essentially the total income tax payable divided by the total gross income declared by the various taxpayers.

Things get interesting when we start breaking down this overall data. Look at Figure 2, which has the details regarding the income declared by individuals.

Figure 2:

Assessment Year	Total gross income declared (in Rs. Crore)	Total tax payable (in Rs. Crore)	Effective rate of income tax
2012-2013	12,14,289	1,12,112	9.2%
2013-2014	15,12,433	1,39,500	9.2%
2014-2015	18,41,782	1,91,208	10.4%

Source: Author calculations based on Ministry of Finance data.

The effective rate of income tax paid by individuals in the assessment years under consideration are in the range of 9.2 per cent and 10.4 per cent. A major reason for this lies in the fact that a bulk of individuals who file income tax returns and declare their income, do not pay any income tax. Look at Figure 3.

Figure 3:

Assessment year	Proportion of individuals filing income tax returns who also pay income tax
2012-2013	43.5%
2013-2014	49.6%
2014-2015	52.3%

Source: Author calculations based on Ministry of Finance data.

The Figure 3 shows the proportion of individuals filing income returns also paying an income tax. In the assessment year 52.3 per cent of individuals filing income tax returns also paid taxes. While this had improved since assessment year 2012-2013, still close to half of those who filed their income tax return, did not pay any income tax.

A lower effective rate of income tax in the range of 9.2-10.4 per cent can also be explained through the spate of exemptions and deductions that are available to individuals filing income tax returns.

In fact, the data released by the income tax department does not give a split of the total taxes payable on the salaried income of individuals in comparison to the total taxes payable on business income of individuals. This would have made for a very interesting comparison. My guess is that the effective rate of income tax on business income of individuals who have been even lower than 9.2-10.4 per cent, given all the expenses they can deduct to arrive at their taxable income.

While, the effective rate of income tax of individuals in the assessment years under consideration has been in the range of 9.2-10.4 per cent, the overall effective rate has been higher than 16 per cent. So, the question is who is paying up?

The total amount of tax that needs to be paid by Hindu Undivided Families is too small. Nevertheless, their effective rate of income tax is even lower than that of the individuals. In the assessment year 2014-2015, against a total gross income of Rs 32,218 crore, taxes of Rs 2,845 crore needed to be paid. This works to an effective rate of income tax of 8.8 per cent.

Getting back to the question of how is the overall effective rate of income tax higher than 16 per cent, when that effective rate of income tax of individuals in the assessment year 2014-2015, was just higher than 10 per cent. Look at Figure 4. It shows the details regarding the income tax paid by the companies.

Figure 4:

Assessment Year	Total gross income declared (in Rs. Crore)	Total tax collected (in Rs. Crore)	Effective rate of income tax
2012-2013	7,87,091	2,21,470	28.1%
2013-2014	8,05,289	2,28,242	28.3%
2014-2015	7,32,453	2,26,490	30.9%

Source: Author calculations based on Ministry of Finance data.

What the Figure 4 tells us is that companies pay a significant of the income tax collected in India. And the effective rate of their income tax as can be seen from the above table is significantly higher than that of individuals.

What is interesting is that the total amount of tax paid by companies has remained more or less constant in the time under consideration, though the effective rate of tax has increased to 30.9 per cent. At the same time, the total amount of income tax collected from individuals has been growing at a rapid pace (as can be seen from Figure 1).

Further, an effective rate of income tax of close to 31 per cent for companies is not in line with the effective rate of income tax declared in the statement of revenue foregone published along with the budget every year.

For 2013-2014 (the tax return on the income earned during this financial year was filed in the assessment year 2014-2015), the effective rate of income tax was a much lower 23.2 per cent. I don’t have an explanation for this anomaly.

Nevertheless, even an effective rate of 23.2 per cent, is significantly higher than an effective rate of 10.4 per cent for individuals. Lest individuals feel that they are getting away with a lower effective rate of income tax, that is not the case. What the government loses out on a lower effective rate of income tax, it more than makes up for through the service tax and other indirect taxes.

For starters, try looking at your restaurant bill for once.

The column originally appeared in Vivek Kaul’s Diary on November 7, 2016