CHAPTER 07 Fiscal Capacity for the 21st Century
Fiscal Capacity for the 21st Century
- Fiscal capacity—spending and especially taxation—is key to long run economic development.
- Simple tax-GDP and spending-GDP ratios suggest that India under-taxes and under-spends relative to comparable countries.
- India does stand out in the number of individual income taxpayers, currently about 4 percent, far from our desirable estimate of about 23 percent.
- Controlling for the level of economic development, India neither under-taxes nor under-spends.
- Taxation is not just about financing public spending, it is the economic glue that binds citizens to the state in a necessary twoway relationship.
- tax paying and political participation as two important accountability mechanisms wielded by citizens.
- The precocious India phenomenon is that economic development lags political development.
- Citizens will be willing to pay their dues as taxes only if they feel that the state is adhering to its side of the contract by delivering essential services. In other words, tax and spending policy are related to actions by the state to increase its legitimacy. State and tax capacity are as much about state legitimacy as they are about technical details relating the design of policy and its implementation.
cross-country taxation and Expenditure patterns
- Centre has fewer policy levers at its disposal so that improving property taxation will require greater cooperation between all three levels of government.
- India appears to be an outlier: it taxes and spends less than OECD countries and less than its emerging market peers
- India’s spending to GDP ratio (as well as spending in human capital i.e. health and education) is lowest among BRICS and lower than both the OECD and EME averages.
- India’s tax to GDP ratio at 16.6 per cent also is well below the EME and OECD averages of about 21 per cent and 34 per cent, respectively.
- India’s spending and tax ratios are the lowest even among economies with comparable (PPP adjusted) per-capita GDP e.g. Vietnam, Bolivia and Uzbekistan.
- India’s share of income and property tax in GDP are also comparatively low (with the exception of China in case of direct taxation).
- it seems, India has made limited progress in increasing its tax and spending capacity
- .In comparison to the United States (which introduced income taxes over the first half of the 20th century) India’s tax to GDP ratio has increased at a much slower pace over the comparable time period following the introduction of income taxation.
- contrary to popular perception that India has low fiscal capacity, each of the charts show that India does not. It is close to the line of best fit (shown in red) in all the figures4.
- In case of direct tax and personal income tax, counter to conventional wisdom, India’s fiscal capacity seems to be significantly better than the average.
- controlling for both India is a significant negative outlier when it comes to the tax to GDP ratio and significantly so with respect to expenditures on health and education.
- India’s overall tax to GDP is about 5.4 percentage points less than that of comparable countries.
- legitimacy to redistribute is earned through a demonstrated record of effectiveness in delivering essential services.
- if the state’s role is predominantly redistribution, the middle class will seek to exit from the state.
- They will avoid or minimise paying taxes; they will cocoon themselves in gated communities;
- A state that prioritises or over-emphasises redistribution without providing basic public goods, risks unleashing this vicious spiral.
Number of Taxpayers: Is India an outlier?
- Especially in a country like India, indirect taxes are not immediate or direct enough to be perceived by citizens as their contributions to the state. For that reason, the implementation of the GST – while highly desirable and necessary – will have a limited impact in furthering the broader objective of citizen participation, state building, and democratic accountability
- countries with a higher share of income taxes in total tax collections tend to have more accountable governments.
- In India today, roughly 5.5 percent of earning individuals are in the tax net.
- India currently has amongst the lowest number of taxpayers (as a ratio of voting age population).
- Controlling for the level of democracy, India’s ratio of taxpayers to voting age population is significantly less than that of comparable countries
- while at present about 4 per cent of citizens who vote pay taxes, the percentage should be about 23.
conclusIon: MovIng to a BEttEr EquIlIBrIuM on taxatIon and spEndIng
Four points seem relevant here.
- First, the government’s spending priorities must include essential services that all citizens consume: public infrastructure, law and order, less pollution and congestion, etc.
- Second, reducing corruption— fiendishly difficult as it is—must be a high priority not just because of its economic costs but also because it undermines legitimacy.
- Third, subsidies to the well-off need to be scaled back
- Fourth, property taxation needs to be developed. .Property taxes are especially desirable because they are progressive, buoyant (at least in the Indian
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