Highest tax rates kick in too fast, need changing
Though Arun Jaitley, the front-runner for the finance minister’s job, has paid fulsome praise to yoga guru Ramdev, he would be well advised to junk the latter’s view on replacing income taxes with a banking transaction tax. Given that over R1,000 lakh crore—10 times India’s GDP—is transacted electronically through banks every year, a 2% tax would add to more than the total taxes collected across the country by both the Centre and the states. The problem with this, however, is that transaction taxes are cascading in nature and will, over a period, simply encourage people to move back to the cash economy—in other words, they will negate much of the tax reforms made since 1991.
Indeed, the BJP’s better bet would be go back to its original plan of reducing the tax burden on the middle class—this will not only put more money in their pocket, it will go a long way in encouraging tax compliance. With a per capita income of R74,920, levying a tax after an income of just R2 lakh makes it clear the tax is kicking in way too fast, more so given the average family size of 5 persons. With the top rate of 30% kicking in at just R10 lakh, this means a family with an income just 2.5 times more than the per capita income attracts the highest tax rate—this multiple is many times higher in most countries and is the reason for India’s low tax compliance in lower income brackets. Which is why the Parliamentary Standing Committee under the BJP’s Yashwant Sinha, for instance, was in favour of zero taxation till R3 lakh and imposing the 30% tax bracket only for incomes over R20 lakh—the 2009 Direct Taxes Code wanted to introduce the top rate for incomes of over R25 lakh.
Given tax compliance levels are the lowest among those earning between R10-20 lakh a year—they pay an average tax of 8.6% going by the taxman’s data—there is a definite case for lowering the tax rate to encourage compliance. Indeed, the history of India’s tax reforms over the decades, has been one of lowering rates to bring in more compliance. Which is why, in the case of personal income taxes, their share has gone up from 2.9% of total taxes in 1991 to 17% in 2001, 17.5% in FY11 and a projected 21.8% for FY15. In even the case of corporate taxation, there is a case for cleaning up R68,000 crore worth of exemptions and bringing the nameplate rate of taxation down from 32.44% at the moment closer to the effective rate of 22.85%. Right now, the taxman is not able to identify tax avoidance since each firm avails of different exemptions—once all the exemptions are cleaned up, however, the taxman would be able to identify tax avoidance more easily.