Vivek Kaul's Diary
By Vivek Kaul

Demonetisation Barely Made Any Difference to Tax Collections

07 August 2017

Since November 8, 2016, the Narendra Modi government has made many attempts to pass off demonetisation as a success. In the first series of attempts they tried to offer logic and economic theory in order to defend demonetisation. And in the more recent months, they have offered data.

The latest such data being offered to show demonetisation as a success is that it has led to an increase in the taxbase in the country. Sushil Chandra, the chairman of the Central Board of Direct Taxes said something to that effect in late July 2017.

On August 4, 2017, Santosh Gangwar, the minister of state for finance, said something similar in a reply to a question in Lok Sabha. The question put to the department of revenue, ministry of finance, was: "Whether the number of Income Tax payers has increased in the country after demonetisation?"

Gangwar said: "The number of income tax payers has increased after demonetization. During the period of 09.11.2016 to 31.03.2017, 1.96 crore returns were filed as compared to 1.63 crore returns filed during corresponding period of FY 2015-16."

This statement doesn't really tell us much. Yes, the number people filing returns between November 9, 2016 and March 31, 2017, was higher than in comparison to the corresponding period between November 2015 and March 2016. But Gangwar hasn't given us the number of returns filed during the same period in earlier years, in order to be able to make a fair comparison.

Having said that he has given us the size of the taxbase for the last three years. Before we get into the details it is important to define what the term taxbase actually means. The meaning of the term has been changed a few times by the Central Board of Direct Taxes, over the last few years.

As per the annual report of the ministry of finance for 2015-2016, the latest annual report which is publicly available: "The definition of "Tax base"... has undergone change. Tax base as on 1 st April of the financial year is now taken as number of persons who have either filed Income Tax Returns (ITRs), or in whose case tax has reportedly been paid or deducted, in any of the three consecutive financial years, previous to the reference year." Table 1 shows us the taxbase for the last three financial years.

In 2016-2017, the taxbase grew by 10.7 per cent in comparison to 2015-2016. In 2015-2016, the taxbase had grown by 8 per cent in comparison to 2014-2015. Hence, the taxbase has increased at faster pace, thanks to demonetisation. But the difference in growth rates pre and post demonetisation isn't really huge. If this is all the difference that demonetisation made on the taxbase, then it is really worth asking, whether it was worth all the trouble.

Also, there is another way of analysing that needs to be looked at here. Ultimately, the idea behind increasing the taxbase is to ensure that there is an increase in the total direct taxes collected by the government as a proportion of the total size of the economy (i.e. the tax to the gross domestic product(GDP) ratio should go up). If tax collections as a proportion of the GDP are not going up along with the taxbase, then it means that only more tax returns are being filed. And that basically means that the chartered accountants(CAs) are making more money and nothing else. (This is one of the unwritten rules in life, whatever happens the CA makes more money).

Let's see how things look on that front. How do things look when we look at the total corporation tax plus the income tax collected as a proportion of the GDP, over the last few years? (I have ignored wealth tax here simply because it was abolished from 2015-2016 onwards and including it wouldn't make for the right comparison). Take a look at Figure 1.

Figure 1

What does Figure 1 tell us? It tells us that as far as corporation tax plus income tax as a proportion of GDP is concerned, the income tax department is just about trying to play catch up. This ratio was much higher up until 2013-2014, without any demonetisation being carried out.

How do things look if we were to look at just income tax as a proportion of the GDP? Take a look at Figure 2.

Figure 2

What does Figure 2 tell us? The income tax to GDP ratio in 2016-2017 has seen a jump of 23 basis points to 2.33 per cent in comparison to 2015-2016. The question is at what cost? Demonetisation cost India at least 100 basis points of economic growth. Also, it is worth remembering here that the jump in income tax came about because of the two income tax amnesty schemes were run by the government in 2016-2017. If we were to leave these schemes out, the income tax to GDP ratio would have been more or less the same as earlier years. The government won't have access to these amnesty schemes during the current financial year and it will impact its tax collections.

For the year 2017-2018, the projections made by the government stand as follows. The corporation tax plus income tax to GDP ratio is expected to come in at 5.82 per cent. The income tax to GDP ratio is expected to come in at 2.62 per cent of GDP. Looking at past data, these are fairly optimistic projections. Also, with the economy slowing down, there is bound to be some impact on the taxes collected by the government. Having said that, it is too early in the year to figure out if these projections will turn out to be right or not.

To conclude, demonetisation has led to a minuscule increase in tax collections when it comes to income tax. But overall direct tax collections have more or less stayed the same as in previous years. Also, all this it has come at the cost of a major destruction of large sections of the economy, particularly the informal sector.

Given this, trying to project demonetisation as a major success on the tax front is basically a marketing spin and nothing else. But then that is the speciality of the Modi government. As Evan Davis writes in Post Truth-Why We Have Reached Peak Bullshit and What We Can Do About It: "A fact is reported, the fact is true, a legitimate interpretation is placed on that fact - but then it is puffed up to a magnitude well beyond anything it deserves."

This is exactly how things have played out as far as the issue of higher taxes and higher taxbase because of demonetisation, is concerned.

Vivek Kaul is the Editor of the Diary and The Vivek Kaul Letter. Vivek is a writer who has worked at senior positions with the Daily News and Analysis (DNA) and The Economic Times, in the past. He is the author of the Easy Money trilogy. The latest book in the trilogy Easy Money: The Greatest Ponzi Scheme Ever and How It Is Set to Destroy the Global Financial System was published in March 2015. The books were bestsellers on Amazon. His writing has also appeared in The Times of India, The Hindu, The Hindu Business Line, Business World, Business Today, India Today, Business Standard, Forbes India, Deccan Chronicle, The Asian Age, Mutual Fund Insight, Wealth Insight, Swarajya, Bangalore Mirror among others.

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