Muted tax growth spells trouble for govt
The Centre’s muted tax collection numbers have gotten lost in the euphoria around the better-than-expected GDP numbers in the first quarter of the current financial year. While the GDP numbers are giving a rosy picture of the economy, tax collection numbers should make the government a little worried. More worrisome is that the corporate tax revenue in Q1 of FY24 showed a 10% contraction compared to last year. This is despite the fact that listed companies witnessed a healthy operating profit growth of over 30% in Q1. The overall tax collection during the April-July period also showed signs of fatigue, with gross tax revenue growing by a paltry 2.8% against the government’s full-year target of 10%. If the situation persists, the government might find many of its financial ratios, including fiscal deficit as a percentage of GDP, going off the target.
One possible explanation for the muted tax revenue growth is the slow growth in the nominal GDP. While the real GDP grew at 7.8% in the first quarter, the nominal GDP grew at only 8%, indicating very low inflation levels. This may sound unreal as retail inflation has been going up in the last couple of months, but the truth is that wholesale inflation has been in the negative zone since the beginning of FY24. While calculating nominal GDP, a large part of the inflation is accounted for by wholesale inflation.
The practice in the tax system is to levy tax on nominal income, that is, an increase in income due to a price rise. So, the higher the inflation, the higher the tax collection. But in the current situation, wholesale inflation is negative, neutralising the impact of retail inflation. So, tax collection is lower. But this does not yet explain the fall in corporate tax collection despite healthy profit growth shown by listed companies. The possible reason could be that a large number of smaller businesses might be forced to work on very thin profit margins as larger players keep consolidating their markets.
The contraction in corporate tax collection coupled with an underwhelming private investment scenario may spell trouble for the government. In the absence of healthy private investment, the government needs more taxes to keep investing in infra and asset creation. But if tax collections remain muted, the government may fail on many fronts, including keeping the government capex high and maintaining a healthy fiscal position.