The DeMon is in the Details

It is true that Demonetisation had an impact on direct tax revenues. It was a negative impact.

The Narendra Modi government has unleashed a whole host of numbers on us, the citizens of this country, to prove how demonetisation has led to a huge increase in the number of returns filed. Different numbers have been offered by the prime minister, the finance minister, the finance ministry and the chief economic adviser to the finance ministry. Recently, there was even a clarification put out by the finance ministry regarding how to read these numbers.

This piece is not about how to read the different numbers put out by the government. For that you can read this excellent piece by James Wilson. I try and answer a different question here: Has this increase in the number of tax returns being filed ultimately led to a substantial difference in the total amount of direct taxes being collected by the central government as a proportion of the size of the Indian economy?

If it hasn’t, then the increase in the total number of returns being filed has basically meant more work and more money for the chartered accountants, and nothing else.

So, let’s take a look at Figure 1, which maps the direct taxes collected by the central government as a proportion of size of the Indian economy — that is, its gross domestic product or GDP. Direct taxes essentially consist of corporation tax, personal income tax, income tax paid by firms other than companies, security transaction tax, hotel receipts tax, etc. Corporation tax and personal income tax form a bulk of direct taxes.

The exercise has been carried out for the financial years between 2011-2012 and 2016-2017. This has been done because the GDP data is available only from 2011-2012 onwards. Also, while carrying out the calculations wealth tax has been ignored because it was abolished in the budget speech the finance minister Arun Jaitley gave on February 28, 2015. (To be honest, the collections were so small that even if they had been included, it wouldn’t have made any difference to the overall result.)

Figure 1:

(Source for Direct Taxes data: Indiabudget.nic.in Source: Press Information Bureau, April 4, 2017. Source for GDP data: Reserve Bank of India)

Now what does Figure 1 tell us? There has been a slight improvement in the direct taxes to GDP ratio between 2015-2016 and 2016-2017. But at 5.58 per cent of the GDP, it is still trying to play catch up with the earlier years.

Also, it is worth reminding the readers here that in 2016-2017, the government got a declaration of  Rs 65,250 crore through the Income Declaration Scheme, a voluntary income disclosure scheme. If we adjust for the taxes collected under this scheme, the direct taxes to GDP ratio falls to 5.48 per cent. This scheme was launched before demonetisation happened. This changes things. And this is how the real scenario looks like (See Figure 2).

Figure 2:

What Figure 2 tells us is that demonetisation basically led to a slowdown in the economy where lesser tax was paid than in the past. The direct taxes to GDP ratio of 5.63 per cent was achieved in 2013-2014 without demonetisation.

Also, how do things look if we ignore corporation tax (i.e. corporate income tax) and look at the remaining direct taxes. This primarily comprises of personal income tax. Let’s take a look at Figure 3, which plots the ratio of direct taxes other than corporation tax as a proportion of the GDP.

Figure 3:

(Source for Direct Taxes data: Indiabudget.nic.in. Source for GDP data: Reserve Bank of India)

Figure 3 tells us that the direct taxes other than corporation tax as a proportion of GDP has jumped by 23 basis points to 2.33 per cent in 2016-2017, in comparison to 2015-2016. One basis point is one hundredth of a percentage.

Again, the question to ask here is: Has this jump happened because of demonetisation? It has happened primarily because of the money collected as taxes and fines under the Income Disclosure Scheme. Once the tax collected under the Income Declaration Scheme is adjusted for, the ratio falls to 2.23 per cent of the GDP. And this is how Figure 3 now looks like (See Figure 4).

Figure 4:

How do things look if we were to simply look at the corporation tax to GDP ratio? Take a look at Figure 5.

Figure 5:

As can be seen from Figure 5, the corporation tax to GDP ratio has been falling for a while, and it continued to fall in 2016-2017 as well.

All this analysis was for 2016-2017. How do things look in the current financial year i.e. 2017-2018? We do not have the GDP data for that, so calculating the direct taxes to GDP ratio is not possible. Nevertheless, there are other ways to analyse this issue.

A press release put out by the ministry of finance on August 9, 2017, states the following:

The Direct Tax collections up to July,2017 [i.e. between April 2017 and July 2017] in the Current Financial Year 2017-18 continue to register steady growth. Direct Tax collection during the said period, net of refunds, stands at Rs. 1.90 lakh crore which is 19.1% higher than the net collections for the corresponding period of last year.

Basically, direct tax collections have grown by 19.1 per cent during the first four months of this financial year in comparison to the same period in the last financial year. Hence, has demonetisation led to an increase in collection of direct taxes?

A press release put out by the ministry of finance on August 9, 2016, had this to say:

The figures for direct tax collections up to July, 2016 show that net revenue collections are at Rs.1.59 lakh crore which is 24.01% more than the net collections for the corresponding period last year.

Hence, in the period between April to July 2016, the direct tax collections had grown by 24 per cent, without the demonetisation of currency which was carried out in November 2016. What this tells us is that direct tax collections grew faster before demonetisation than they are growing after demonetisation.

Personal income tax collections have grown by 15.7 per cent during the first four months of this financial year. They had grown by 46.6 per cent during the first four months of the previous financial year.

So the point is that as far as the actual direct tax collections are concerned, demonetisation has clearly had a negative impact. This also explains why the government media releases tend to focus on the number of returns filed and not the tax that is being collected. More returns being filed without any increase in taxes collected simply means more work and more money for chartered accountants — and nothing else.

One argument that can be made here is that as the income earned by those who are filing returns now (but not paying taxes) goes up, they will pay taxes as well. But this argument rests on the assumption that the minimum taxable limit to pay income tax will continue to remain where it is and will not be increased in the years to come. If one looks at the history of income tax, this has clearly not been the case. The minimum taxable limit keeps going up every few years and at a rate faster than the growth in per capita income.

Of course, given that we live in an era of post-truth, all this data and analysis doesn’t really matter. What matters is who is presenting the data, even if it is incomplete and leads to wrong inferences being made. As Evan Davis writes in Post Truth—Why We Have Reached Peak Bullshit and What We Can Do About It:

[The] argument that who you are matters more than the substantive point you are making is especially true about politicians. Voters focus on character rather than policy partly because they are better able to judge character and are relatively uninformed on policy… So, for a politician, having a good reputation is worth a hundred quick victories in specific arguments.

The moral of the story is that it doesn’t matter if the right data is not being presented, because people will believe what is being presented.

About the author

Vivek Kaul

Vivek Kaul is a writer who has worked at senior positions with the Daily News and Analysis (DNA) and The Economic Times. His latest book India’s Big Government—The Intrusive State and How It Is Hurting Us, has just been published. He is also the author of the Easy Money trilogy.