A tax system based on consumption

Such a tax system can progressively allow the state to accrue income from higher consumers

Finance Minister Nirmala Sitharaman’s latest move to cut basic corporate tax to 22% from 30% for domestic companies that currently don’t avail any tax exemptions received a celebratory response from India Inc.

In the hope of boosting fresh investments in manufacturing amidst other sectors, the finance minister’s slashing of corporate income tax to 15% (from 25%) remains applicable for domestic companies to be incorporated on or after October 1, 2019, and those likely to commence their production on or before March 31, 2023.

While these steps may cyclically address a waning private investment sentiment, one significant opportunity cost surfacing from this is likely to affect the government’s fiscal deficit mark, and at the same time affect the tax-GDP ratio.

On closer observation, if we look at tax collective data over the last three years, the average income tax collected last year saw a declining trend even though the overall tax base has continued to widen from the imposition of ‘formalisation’ in business and tax regime.

Last October of 2018, e-filing of tax returns increased up to 70% while the average income tax paid by individuals actually came down by 32% (to Rs 27,083). In two years before that - in FY 2018 and 2017 - the e-return filing growth (year-on-year) went up by 24% and 29% respectively, and average income tax paid were Rs 44,000 and Rs 40,200, respectively.

One reason for this could be that the government - in its effort to get more people under the taxable base - is gradually increasing some individual (and corporate) tax exemptions which allow more people to report their incomes (and file e-returns) but subsequently end up paying average tax annually. This inversely affects the fiscal base, in terms of tax revenue, for the government.

With shrinking collections from tax revenues, and the corporate tax cuts announced now, the government may end up most likely making strategic cuts to its welfare-expenditure plans (or worse, delay disbursements to ministries) over coming months, in order to keep its fiscal deficit mark low.

This should make one wonder: to what extent will such drastic fiscal measures that the government is currently undertaking, actually address the ‘structural’ inequities driving the economic slowdown?

It isn’t as if wealth creation has disappeared in the country. In its 2018 Global Wealth Report, Credit Suisse reported how the richest 10% Indians own three-fourths of the nation’s wealth where the richest 1% own 51.5% of wealth, while bottom 60% owns less than 5%.

It is remarkable how in a democracy, the richest 1% have been able to consistently maintain their share of wealth year-on-year, while the majority remains meekly destitute.

Corporate tax cuts provide a sugar-rush to an economy. Investors feel happy, albeit more temporally in the short term, buying more stocks - giving stock traders and financial markets a happy face. This while some others invest big time in greater capital-intensive modes of production, which may drive nominal growth rates for a period, but may hardly do much to boost employment or create higher wage-paying opportunities.

At the same time, from the perspective of fiscal policy, a way to ensure fiscal consolidation (and keeping a buoyant tax-GDP ratio) while progressively creating a fairer wealth (and income) distribution may require a progressive consumption tax over time.

A consumption tax is seen as a tax imposed on consumption, as opposed to some other measure of ability to pay, most notably income.

Our data on consumption based surveys (even at household levels) and trends seen within them, has been observed as a principal method for understanding and analysing various kinds of inequities.

Transitional difficulties

The transitional difficulties, often associated in implementing such a system, are more likely in nations where consumption-based data and its sources are weak. A relatively more robust consumption-based household data allows any such transitional costs to be minimised. For a start, in a graduated implementation cycle, at least one can consider imposing a marginal consumption/spending tax side-by-side to existing income-taxes which can then be phased out over time.

Another advantage of a consumption-based tax system is one that may allow certain natural resources (like water) to be used in fixated quantum. A higher carbon-consumption tax may over time channelise resources towards ‘renewable’ or eco-sensitive modes of production which will take the policy-discourse away from providing any ‘subsidies’ on renewables but to encourage them through a consumption-based tax system.

As one of the fiscal measures, a consumption-based tax system can progressively allow the state to accrue income from higher consumers (those with a higher willingness to pay) and allow for a greater fiscal incentivisation of worker-productive sectors of occupation and production which would relate to agro-based industries and those part of a ‘farm-to-factory’ manufacturing supply chain.

Corporate tax cuts, thus, may do very little to subsequently boost labour productivity or tackle decline in real wages while further widening the fiscal deficit.

(The writer is Director, Centre for New Economics Studies, O P Jindal Global University, Sonepat, Haryana)