Need to raise India’s tax-to-GDP ratio

Source: The post there is a need to raise India’s tax-to-GDP ratio has been created, based on the article “Tax reform dilemmas” published in “Business Standard” on 30th August 2024

UPSC Syllabus Topic: GS Paper 3- Economy- mobilization of resources

Context: The article discusses the need to raise India’s tax-to-GDP ratio for economic growth. It highlights challenges in taxing agricultural income and personal income, and the need to reform property taxes and land revenue for sustainable revenue generation.

What is the Importance of Raising the Tax-to-GDP Ratio?

1. Raising the tax-to-GDP ratio is crucial for India to achieve its economic growth and developmental goals.
2. A higher tax-to-GDP ratio allows the government to increase spending on infrastructure, education, and healthcare, driving overall development.
3. Expanding the tax base through reforms in personal income tax and agricultural income taxation can enhance fiscal sustainability.
4. Improved property taxation, such as regular updates to property tax rates, can also contribute to a higher tax-to-GDP ratio, providing more resources for public services.

What are the Challenges of Raising the Tax-to-GDP Ratio?

1. Challenges in Taxing Agricultural Income
2. Constitutional Assignment: Taxation of agricultural income is assigned to state governments, many of which have been reluctant to impose these taxes.
3. Small Farm Sizes: The average size of farms and incomes in agriculture are small, leading to arguments that taxing them is not worth the fiscal and compliance costs.
4. Tax Complexity: Agriculture is considered a difficult sector to tax due to the varied income sources and small returns for administrative efforts.
5. Challenges in Reforming Personal Income Tax
6. High Exemption Threshold: The exemption threshold has historically been high, with the effective threshold ranging between 200% and 300% of per capita income.
7. Limited Taxpayer Base: Only 1-2% of citizens are taxpayers, leading to perceptions of an unfair tax burden on a small segment of the population.
8. Challenges in Reforming Property Tax
9. Static Rates: Property tax and stamp duty rates are often fixed and not regularly updated, failing to reflect changes in property values.
10. Public Resistance: Increases in property tax are often resisted due to perceptions of inadequate civic services.
11. Land Revenue: Few states collect significant revenue through land taxes, with less than 2% of their own tax revenue in many cases.

What Should be Done to Raise the Tax-to-GDP Ratio?

1. Tax Agricultural Income Above a Threshold: Implement taxation on agricultural incomes that exceed the exemption threshold, aligning them with other tax-paying sectors. This approach respects the small size of most agricultural holdings while targeting wealthier farmers to broaden the tax base.
2. Adjust Personal Income Tax Exemptions: Maintain the current exemption thresholds without increases to capture more taxpayers as per capita income grows. For example, the effective exemption threshold was 236% of per capita income in 2023-24, indicating a low proportion of taxable individuals.
3. Reform Property Taxes: Regularly update property tax rates and circle rates for stamp duties to reflect actual market values and inflation, ensuring revenue growth aligns with economic realities.
4. Digitize Land Records: Enhance the accuracy and efficiency of property tax collection by digitizing land records, making it easier to identify and tax all potential property owners.

Question for practice:

Examine the challenges and proposed solutions for raising India’s tax-to-GDP ratio.