When the country’s economy picks up pace, the taxes coming into the government’s account start increasing even faster. The government did not impose any new taxes or increase any rates, yet more money started coming into the treasury than before. This is not surprising but a natural way of the economy which is called tax buoyancy.
When people’s income increases they spend more. When there is more expenditure, activity in the market increases. The business of companies increases, their profits increase and along with all this, taxes also automatically start increasing, that too faster than the pace of the economy. In simple words, if GDP increases by 10% and tax collection increases by 15% then tax buoyancy is 1.5. This is not just a figure but an important measure of the economic health of the country which tells how much the government’s earnings can increase on its own without putting any burden on anyone.
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What is Tax Buoyancy?
Tax buoyancy works on a simple formula: divide the percentage increase in taxes by the percentage increase in GDP. The number that comes is the tax buoyancy. If it is more than 1, it means taxes are growing faster than GDP. If it is 1, then both are moving equally and if it is less than 1, then the tax lagged behind despite the increase in GDP.
Like GDP increased by 10% and income tax increased by 18%. So the tax buoyancy of income tax will be 18 ÷ 10 = 1.8 i.e. for every 1% increase in GDP, income tax increases by 1.8%.
Why do taxes increase faster when GDP increases?
The biggest reason behind this is the slab system of income tax. As someone’s income increases, he moves into a higher tax slab and starts paying taxes at a higher rate. Therefore, even if the income increases slightly, the tax increases significantly. Same thing happens in GST also. When people have more money in their pockets, they spend more, buy more goods and GST on it automatically increases. Corporate tax also increases only when companies earn more profits, that is, the pace of the economy directly determines the pace of tax collection.
Buoyancy and elasticity
Tax buoyancy and tax elasticity are often confused but they are different. The entire increase in taxes is counted in buoyancy whether it is the natural growth of the economy, the government has increased the rates or implemented a new system like GST. Elasticity only looks at the growth that comes from the economy growing without any new laws or rate changes.
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Condition of Tax Buoyancy in India
After the implementation of GST in 2017, India’s tax buoyancy improved significantly. Large scale businesses came into the formal economy, compliance increased and tracking became easier due to digital payments. The tax buoyancy of direct tax in FY2024 was around 1.4, which is a strong message. However, a major challenge still remains is the informal sector. A large part of the country is still out of the tax net. Unless the tax base, i.e. the number of people and businesses paying taxes, increases, the full potential of buoyancy cannot be realised.
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