Why India’s Tax Net Is Still Too Narrow: The Failure to Broaden the Base

Taxation forms the backbone of any modern economy, ensuring that governments can fund welfare, infrastructure, and national development. In India, however, a long-standing challenge persists: despite rapid economic growth and rising incomes, the country’s tax net remains narrow. A significant portion of India’s working population does not contribute to direct taxes, leaving the burden disproportionately on salaried individuals and a small segment of businesses. This imbalance highlights the urgent need for tax reforms in India that can effectively broaden the base and create a more equitable system.

The Current State of India’s Tax Net

India has a population of over 1.4 billion people, but only around 7–8 crore individuals (less than 6% of the population) file income tax returns regularly. Even fewer actually pay income tax after deductions and exemptions. This is strikingly low when compared with developed economies, where tax compliance is far higher.

The tax-to-GDP ratio—a key measure of how effectively a government collects revenue—stands at about 11–12% for India. This is lower than many emerging economies and far behind OECD countries, where the average ratio is closer to 34%. Such figures indicate that India is not utilizing its full potential in terms of revenue generation. Despite several attempts at tax reforms in India, the results have not been sufficient to widen the tax base.

Why Is the Tax Net Still Narrow?

1. High Dependence on Indirect Taxes

While GST has streamlined indirect taxation, it continues to form a bulk of government revenue. Direct tax collections, particularly income tax, lag behind. This over-reliance on indirect taxes makes the system regressive, with the poor often bearing a disproportionate share of the burden.

2. Agricultural Income Exemption

Agricultural income is entirely exempt from taxation in India, regardless of scale. While the exemption protects small farmers, it also creates loopholes where wealthy individuals misuse agricultural income classification to avoid taxes. Without targeted tax reforms in India, this exemption continues to shrink the base.

3. Informal Economy and Cash Transactions

India’s large informal sector remains outside the tax system. Millions of small businesses and self-employed individuals operate in cash, keeping their incomes invisible. Despite digitalization and demonetization efforts, informal practices remain deeply entrenched.

4. Complex Tax Structure and Compliance Burden

Taxpayers often find compliance tedious and confusing. Filing returns, claiming deductions, and understanding changing rules discourage many from voluntary compliance. While technology-driven tax reforms in India have simplified filing to some extent, complexity still deters widespread participation.

5. Weak Enforcement Against Evasion

Tax evasion is rampant, from underreporting income to manipulating books. While authorities have introduced data analytics and AI-based tools to detect anomalies, enforcement is still inconsistent.

Past Efforts: Reforms That Tried but Fell Short

Over the years, several tax reforms in India have aimed to address the issue:

• Voluntary Disclosure Schemes (VDS): These encouraged people to declare undisclosed income. However, they provided only temporary boosts and failed to instill long-term compliance.

• Demonetization (2016): Designed to curb black money, it temporarily increased tax filings but did not create lasting habits.

• Introduction of GST (2017): A landmark reform in indirect taxation, it aimed to unify the market and improve compliance. While GST collections have improved, the reform did little to expand the direct tax net.

• Faceless Assessments: Introduced to reduce harassment and discretion, these are steps in the right direction but are still in early stages of efficiency.

These initiatives show intent but highlight that tax reforms in India often focus more on compliance technology rather than restructuring the system to ensure inclusivity.

What Broadening the Tax Base Really Requires

For meaningful change, tax reforms in India must move beyond short-term fixes. Here are some essential strategies:

1. Expand Direct Tax Coverage

India’s personal income tax structure should be designed to include a larger segment of earners while protecting low-income groups. Simplified slabs and fewer exemptions can reduce loopholes and encourage compliance.

2. Rationalize Agricultural Taxation

Instead of a blanket exemption, agricultural income could be taxed progressively above a certain threshold. This ensures that small farmers are protected while high-income agriculturists contribute fairly.

3. Formalize the Informal Sector

Digital payments, UPI adoption, and e-invoicing are positive steps, but enforcement and incentives are needed to push small businesses into the formal system. A wider rollout of tax reforms in India targeting MSMEs could substantially increase compliance.

4. Simplify Compliance

Filing returns must be made as seamless as possible. Pre-filled returns, automated reconciliation, and intuitive portals can make compliance effortless for taxpayers.

5. Strengthen Tax Administration

Using AI, big data, and better enforcement mechanisms, authorities can detect evasion more effectively. Transparent processes and reduced harassment will also encourage more people to file honestly.

6. Public Awareness and Trust

People are more likely to pay taxes if they see tangible benefits in return—better roads, healthcare, education, and social security. Transparency in how tax revenues are spent is a crucial part of building trust in the system.

Why Widening the Tax Net Matters

A broader tax base does more than just increase government revenue. It:

• Reduces dependence on indirect taxes, making the system fairer.

• Strengthens fiscal stability, allowing for more public investment in infrastructure and welfare.

• Encourages equity, as more citizens contribute their fair share.

• Lowers the tax burden on honest taxpayers, especially salaried individuals who currently shoulder a disproportionate share.

Without significant tax reforms in India, the country risks continuing with a lopsided system that overburdens a small fraction of the population while letting many high earners slip through the cracks.

Conclusion

India’s narrow tax base is not merely a statistic; it reflects deep-rooted structural challenges in the country’s economy and governance. While technology-driven measures and past reforms have made incremental progress, they are far from enough. The future of tax reforms in India lies in expanding the direct tax base, rationalizing exemptions, simplifying compliance, and building a culture of trust between the government and citizens.

A truly reformed tax system can unlock India’s economic potential, reduce inequality, and place the nation on a stronger path toward sustainable growth. Broadening the tax net is not just a fiscal necessity—it is a moral and social imperative.