What are the factors responsible for the narrow tax base in India? Explain in brief.

Question

Ghissu Editorial · Accepted Answer

India's tax base is narrow because of high exemption thresholds, numerous concessions, a large informal cash economy, untaxed agricultural income and weak tax administration. Only about 4% of the voting-age population pays taxes, and Andhra Pradesh's 2021-22 CAG audit found revenue losses of over ₹1,800 crore.

**Introduction**

India’s narrow tax base constrains fiscal capacity despite growth, impacting states like ==Andhra Pradesh⟦3⟧⟦2⟧⟦1⟧== where resource mobilisation influences development and equity. Expanding the tax base is crucial for financing welfare and infrastructure, especially in regions with significant social needs.

**Institutional Design and Capacity Constraints**

SKETCH: fishbone | Factors Narrowing India’s Tax Base  
effect: Narrow Tax Base in India  
- Institutional Design  
- Implementation Challenges  
- Informal Economy  
- Legal and Compliance Issues

1. **High Exemption Thresholds**: Making income up to ₹12 lakh⟦4⟧ effectively tax-free under the new regime excludes many taxpayers, shrinking the tax base and reducing direct tax revenues despite rising incomes.

2. **Tax Administration Gaps**: The ==Andhra Pradesh CAG audit (2021-22)== found ₹1,806 crore revenue losses in tax and land departments due to enforcement weaknesses and underassessment, highlighting institutional inefficiencies.

**Implementation Challenges**

4. **Informal Economy and Revenue Shortfalls**: Large informal sector and cash transactions cause evasion; ==Andhra Pradesh Mining Revenue⟦5⟧== shows 16% shortfalls and data gaps, reflecting difficulties in formalising economic activities.

5. **Low Taxpayer Penetration**: Only 4% of voting-age Indians pay taxes, far below the 23% expected based on political development, limiting revenue mobilisation and fiscal capacity.

**Policy and Structural Barriers**

8. **Excessive Reliance on Indirect Taxes**: Heavy dependence on indirect taxes reduces progressivity and voluntary compliance, weakening the link between taxpayers and the state.

**Way Forward**

9. **Tax Reforms and Digitalisation**: Initiatives like Transparent Taxation⟦6⟧ – Honouring the Honest and SPICe+⟦7⟧ improve transparency, reduce compliance costs, and enhance data analytics to capture informal incomes.

10. **Local Government Empowerment**: Enhancing local taxation powers and property tax collection, including in ==Andhra Pradesh==, can boost subnational revenues and fiscal decentralisation.

**Conclusion**

Addressing institutional, structural, and enforcement issues with targeted reforms and empowering local governments is key to broadening India’s tax base and supporting inclusive, sustainable growth.

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