Are finance ministers in India relaxed enough to enjoy New Year’s Eve parties? Or are they too tense and worried thinking about the budget that they have to present in parliament in a few weeks’ time? However, it is quite likely that P. Chidambaram had a great time on December 31. While Delhi shivered in the abnormally cold winter, the booming Indian economy must have provided sufficient warmth to Chidambaram and his team in the finance ministry.

Indeed, Chidambaram has never had it so good during his long tenure as finance minister. The economy has been growing at a very rapid rate throughout the year. Moreover, we are also experiencing a surprising degree of price stability, with the rate of inflation currently under 4 per cent.

Above all, there has been a remarkable increase in the Central government’s tax revenues. The growth in direct tax revenues upto November has been as high as 42 per cent. While indirect tax revenues have not grown at quite the same rate, the growth in overall tax revenues has more than met the target specified in the budget speech last year. The ratio of tax revenue to gross domestic product is finally reaching respectability. This is no mean achievement in view of the fact that only a small number of Indian households pay direct taxes — an overwhelming majority of households have incomes falling below the exemption limit.

What must be particularly heartening for the finance minister is that this impressive performance has been achieved without any sudden imposition of draconian measures in the form of very high rates of tax. Tax rates have remained more or less stable for several years now. A part of the increase in tax revenues has been due to the sustained rise in income levels. Quite naturally, people pay more taxes when their incomes increase. Similarly, corporate income tax receipts go up with company profits. More goods and services are bought and sold and that too culminates in larger indirect tax receipts.

Of course, if this were the full story, then there would always be the fear that a sudden fall in fortunes for the economy — caused, for instance, by a bad monsoon or a global recession — would wipe out the gains completely. Fortunately, this is not the case. There have been two important structural changes as far as the country’s fiscal regime is concerned.

First, over the last few years, the government has managed to bring new activities within the scope of direct taxes. For instance, most service activities — starting from those provided by travel agents to insurance companies — now attract service tax. The importance of this cannot be overstated. The structure of the Indian economy has been changing quite rapidly, with the service sector expanding far more rapidly than other sectors. Unless the service sector was brought into the tax net, the government would have found it increasingly difficult to increase the tax to GDP ratio.

The second change has been the steep increase in tax compliance. Growing numbers of people are reporting larger fractions of their incomes to the government. This is not because Indians have suddenly become more honest. The credit for the increased tax compliance lies entirely with the tax authorities. The greater use of computers have allowed them to gather and organize information about tax payers. This has been supplemented by a whole host of new regulations, such as the use of PAN in many financial transactions and stipulations that tax be deducted at source in a larger number of cases.

Chidambaram seems so satisfied with the volume of the tax revenues that the Central government has collected that he has almost hinted at the possibility of reducing tax rates in the future. But, are we really overtaxed? Do we deserve some relief in the form of lower tax rates or should the government put the higher tax revenues to productive use?

There was a time when rich Indians faced really draconian rates of income tax. As far as I can remember, the highest marginal tax rate at one time was as high as 97.5 per cent. Quite naturally, only a handful declared incomes that attracted these rates of tax. The benefit from tax evasion was simply too high. “Honesty does not pay” must have been the motto of the vast bulk of the relatively well-off Indians. Despite these incredibly high tax rates, the government managed to collect a relatively small volume of tax revenue.

But, there has been a sea-change in tax regimes. Tax rates have been relatively stable. Once the exemption limit and all other tax concessions are taken into account, hardly anyone pays more than a third of his or her income in direct taxes. And this certainly cannot be construed as a punitive rate of taxation.

How do Indian tax rates compare with rates in other countries? Indeed, income tax rates are higher in several western European countries. For instance, highest marginal tax rate in the United Kingdom is 40 per cent, and this kicks in at relatively low levels of incomes. Even some university lecturers have to pay this rate on a small part of their incomes. Tax rates are significantly higher in Scandinavian countries.

However, international tax rate comparisons are fraught with difficulty. Citizens can well ask what they get from the government in return for the taxes collected from them. Only a handful of Scandinavian citizens would send their children to private schools. And even members of the royal families go to public hospitals because the public health system is so good.

Although the public healthcare system in other European countries does not quite match that in Scandinavian countries, it is vastly superior to what is available in India. While there are some excellent government schools in West Bengal, the total number of such schools in India obviously falls far short of requirements. So, compared to Europeans, Indians are forced to spend a significantly larger fraction of their incomes on health and children’s education. This needs to be taken into account in any comparison of tax rates across countries.

Of course, it is highly unlikely that Chidambaram will actually lower direct tax rates. And he should not for at least two reasons. First, it is politically difficult to raise income tax rates, even if this comes after a reduction. So, if some future government feels an economic need to restore rates to current levels, it may not have the political will to do so.

Second and perhaps more important, the government still needs a significant increase in overall revenues despite the comfortable levels of tax collection today. Investment in infrastructure has to be stepped up quite dramatically in order to meet the requirements of a growing economy. Government spending in the social sectors is still woefully inadequate for a country which portrays itself as one of the world leaders in the 21st century. These needs must take precedence over any tax cut.