The income tax debate: some proposals govt can ponder

Vinod Vyasulu/ Deccan Herald |

The Budget to be presented on February 1 has some unique features. It is the first to be presented in the beginning of February, rather than at the end, so that there is time to pass the appropriation bills in time to begin spending from April 1, the first day of the new financial year. It is also the first one in Independent India that includes within it the railway budget, which will no longer be presented separately, unlike in the past.

Another interesting aspect is that it is being presented in the post demonetisation economy. Demonetisation was meant to flush out counterfeit notes and black money. Once implemented, the objective became a ‘less cash’ economy. Citizens, desperate to complete transactions, began to use e-wallets etc to get their work done.

Companies dealing in these products have got a boost, as has the digital infrastructure based on the Unified Payments Interface, with the union government launching its own app, the BHIM. Major banks also have their own versions, and the whole system is interoperable and seamless — a major technological advance by any standard.

What does this mean for the Budget? The government’s position is simple: after some initial inconvenience, the economy will be back on a stable growth path. The Opposition, on the other hand, talks of a recession that this shock has pushed the economy into.

Banks are reducing the interest rate. There are demands for tax cuts to help the economy back on to the growth path. Ruchir Sharma of Morgan Stanley, has been making a case for a drastic cut in income tax rates, from the current 30-odd per cent to between 15% and 20%. This, he says, is essential because with the US expected to tax rates, India must remain competitive.

There is little doubt that the economy after November 8 has slowed down. If income tax rates are cut, government revenues will also drop. True, there has been an increase in tax collections in the recent figures released by the finance minister. One reason for this could lie in the fact that the government permitted those who owed income tax payments, could use the demonetised notes to make these payments in cash. This is another blow on the honest tax payer, but that is another story.

Those who demand tax cuts argue that the result will be more money in the hands of ‘consumers’ who will then buy commodities that will boost demand. It will enable companies to increase investment, and thus boost growth. This will stimulate the economy, and more than make up for the ‘lost’ revenues via the buoyancy effect on tax collection. This increased revenue can then be used for the social sector like education and health.

Apart from the inequality increasing effects of such a policy, I argue that this is not likely to happen. As for investment, it is driven by public investment; private investment piggy backs on public investment. With lower tax revenues, governments will have no option but to reduce investment expenditures. Thus, rather than a stimulus, recession could well continue.

To avoid this, an increase in tax revenues, for the current level of government services, is essential. This is not the time for tax cuts. In fact, there is a case for both widening the tax base, and increasing the tax rates. The impact on investment is not likely to be high as investments do not depend on tax rates alone, and all the efforts of the government to improve the ease of doing business could well be far more important.

How then can tax revenues be raised? For one, there should be no change in the threshold level for exemption from income tax. The current levels are high enough. But one can play with the tax brackets. Up to Rs 5 lakh, the rate could be just 2%. From Rs 5 lakh to Rs 8 lakh, it could be 10%. From Rs 10 lakh to Rs 15 lakh it could be 15%. From Rs 15 lakh to Rs 25 lakh it could be 30%. And above Rs 25 lakh per annum it to could be 40%. Income above Rs 2 crore a year could be taxed at 50%.

Scrap cesses

All cesses and surcharges must be scrapped. And exemptions like for provident fund and insurance should be withdrawn for incomes above Rs 15 lakh. All exemptions should be withdrawn for income above Rs 2 crore.

What this will do is to give relief to a very large number of people at the lower income level. Those who have permanent jobs, or who have electoral cards, should be encouraged to get PAN numbers. Every citizen, whether or not she pays income tax, should be encouraged to file returns.

From the next financial year onwards, those who have filed nil returns in the past year, should get a deduction of Rs 1,000 from their income tax. This is an incentive to people to file income tax returns.

With the technology now available to the income tax authorities, this will lead to better compliance in future years. The same rates should apply for corporate taxes. The favourable treatment given to unearned incomes like capital gains should be given up. Capital gains should be treated like any other income.

Estate duties must be introduced. Research has shown that the great source of inequality is the inherited wealth. Not taxing estates is a feudal practice, not a capitalist one. As an aspiring capitalist economy, we should encourage entrepreneurship, not inheritance.

These suggestions, though they will benefit a large number of those who pay taxes today, are likely to be unpopular. Nevertheless, they merit serious debate. The irony lies in the fact that demands for tax cuts are supported by those who will not benefit from them. But do they understand the issues clearly enough?

(The writer is with the Jindal School of Government and Policy, O.P. Jindal Global (Institution of Eminence Deemed To Be University), Sonipat, Haryana)