Post-Iran Crisis, India Faces Pressure to Address Tax Compliance Gaps Amid Sluggish Economic Growth

India's Tax-to-GDP Ratio Fails to Keep Pace with Economic Growth

Key Points:

• The tax-to-GDP ratio in India has remained stagnant for nearly 15 years, despite sustained economic growth.
• 6.5% nominal GDP growth over a prolonged period should have resulted in higher tax collections, but this has not occurred.
• Part-time member of the Prime Minister's Economic Advisory Council (PMEAC), Rakesh Mohan, attributes the weak tax buoyancy to compliance issues.

Analysis:

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Rakesh Mohan, a former Reserve Bank of India deputy governor and current President Emeritus at the Centre for Social and Economic Progress (CSEP), emphasizes the need for India to improve its tax-to-GDP ratio. He notes that sustained nominal GDP growth should have led to higher tax collections as more individuals move into higher tax brackets. However, the absence of a commensurate rise in overall tax collections suggests a structural disconnect between income growth and tax buoyancy.

Compliance Gaps Persist:

Mohan cites compliance issues as a key reason for the weak tax buoyancy, noting that gains in income tax collections have not been reflected proportionately in higher overall tax ratios. He suggests that the issue may be more pronounced on the direct tax side, although indirect tax leakages also remain a concern.

Improving Compliance:

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Mohan recommends that improving compliance become a key policy priority once macro uncertainties ease. He suggests that greater use of data and technology can help strengthen enforcement and widen the tax base. This can be achieved by tracking financial behaviour, such as loan transactions in real estate, to ensure corresponding income is properly reported and taxed.

External-Sector Pressures:

The call for stronger tax compliance comes amid emerging external-sector pressures driven by higher energy costs and geopolitical risks. Mohan notes that the current account deficit is expected to increase under such conditions, affecting the balance of payments through higher fuel import costs and potential risks to remittances coming from West Asia.