NIPFP estimates need careful interpretation
India’s tax-to-GDP ratio is currently at around 17%, so if this is raised by three-fourths—a news report in The Hindu says the National Institute of Public Finance and Policy (NIPFP) has estimated the black economy equals 75% of GDP—India’s taxes rise by R12.5 lakh crore. In which case, bye bye fiscal deficit, hello prosperity ... Since the reported NIPFP numbers recall the black money estimates put out by the likes of Baba Ramdev—he talked of ‘stocks’ while NIPFP talks of ‘flows’, but large flows give rise to large stocks—it is important to step back and get some perspective. This is also why it is critical the finance ministry make public not just the NIPFP study, but also the others commissioned by it such as the one by the National Institute of Financial Management (NIFM)—one estimate by NIFM, FE had reported, had put the estimated size of the black economy at 17%. It is important to look at the number correctly. If India’s GDP is 100 and the black economy is 75, the actual size of the black economy is not 75%, it is a much lower 43%. There is then the issue of what GDP is. Since the full report is not accessible, we have only the newspaper article to go by. Black money generated by real estate deals is black if not taxed, but if taxes are not paid on resale of existing property, it doesn’t really come into the calculation of GDP since this is a capital gains transaction, not a value addition one—only new real estate comes into calculation of GDP. An unaccounted income figure of over 10% of the GDP coming from the mining sector seems high by any standards, even if you take into account illegal mining—the sector’s share in the GDP is just around 2%.
There is also the issue of whether a sector is black if it is informal? Agriculture, which comprised 13.9% of GDP in FY14, is not taxed, but is it necessarily black? Ditto for SMEs that don’t pay tax. The questions are important since, if it is true that 43% of India’s economy is black, the issue is of being able to tax it. Certainly the taxman needs to be more vigilant and use all that information gathering being done for years on expenditure in hotels, on cars, on travel and so on. Probably more important is the ability to create value chains that make it impossible to evade taxes. That is what the VAT did to a certain extent, that is what GST will do, and that is what making e-filing compulsory for service taxes did—once firms get tax credits only if their suppliers are also paying taxes, there is an automatic incentive for everyone to pay taxes. Equally, the taxman needs to increasingly think of the advantages of flatter tax structures to prevent tax arbitrage—some of the highest personal income tax evasion is in the R10-20 lakh annual income range. If absurd laws, on labour for instance, encourage firms to remain in the informal sector, rationalising these laws will encourage more formalisation of the economy. That is, getting the informal economy into the formal network goes beyond just the taxman; and getting more people to pay taxes goes beyond conventional thinking on tax policy.