December 05, 2019

Fiscal Modernisation: Lessons for India from the World

This paper charts how western economies raised income tax over time in order to identify learnings for India. It draws on Piketty and Qian’s paper where they argue that western countries fiscally modernised between 1914 and 1950 by raising their income tax contribution from less than 1% of gross domestic product (GDP) to 4-5% of GDP. We study how income tax in four major countries evolved from being a tax on elites to a more broad-based tax and analyse the lessons for India. India has a low income tax-to-GDP ratio with less than 3-4% of the population paying income tax.


We conclude with three specific policy takeaways regarding taxation: a) India needs a simple income tax structure with moderate marginal tax rates; b) a hike in exemption levels should not be out of sync with per capita income growth; c) the tax system must shun ad-hoc incentives that introduce unnecessary complexities.


Beyond these specific taxation measures, we argue that the political legitimacy to tax needs to be built through strengthening state capacity in the delivery of public goods. This will incentivise voluntary payment of income taxes. The capacity of the tax administration will also have to be built up.

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