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Friday, 10 February 2017 05:25
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Incorrect to say tax rates don’t impact compliance

 

 

Given the likelihood of a large compensation to states on account of GST, it is perhaps understandable that finance minister Arun Jaitley didn’t want to take a chance on increased compliance by lowering income tax rates beyond what he did for the lowest income bracket—that was done as a sop for the problems this group faced due to demonetisation. What is not understandable, though, is how many economists argue that there is no point lowering rates since there is dramatic evidence of increased compliance. Indeed, though we still have far too few people paying taxes, there can be little doubt the sharp increase in personal income tax collections is largely correlated with the fall in tax rates. To be sure, increased efforts by the taxman in computerisation and in keeping tabs on expenditure has increased compliance—if people are confident they will not get caught, even a 5% tax rate as opposed to 35% today will not have too many takers.

In 1990, the lowest tax rate was 20% and it was applied at an income of R22,000 or around 3.5 times the per capita income; the top rate was 50% and applied at an income of over R100,000 or 18 times the per capita income. By 1997, when P Chidambaram became the finance minister, the lowest rate was cut to 10% and levied on an income of R40,000 (3.3 times the per capita income) and the top rate was cut to 30% and applied to an income of R150,000 (12.2 times the per capita income). Though personal income tax collections fell after that—from 1.3% of the GDP in FY97 to 1.1% in FY98 and FY99—they recovered soon enough to rise to 1.5% of the GDP in FY2000 and are today at 2.3% of the GDP; the GDP collapse in FY98 is probably responsible for the slowdown in tax-to-GDP in that year.

If tax collections haven’t risen as much in recent years, apart from the slowdown since FY12, one reason could be that tax rates are too high—the bottom rate of 10% kicks in at R2,50,000 which is just 2.5 times per capita income and the top rate of 30% at R10 lakh which is just 10 times per capita income. Indeed, comparing the tax returns for assessment year 2014-15 with a theoretical income structure for the year, you get a compliance ratio of around 25% for R3.5-10 lakh income bracket, but that falls to around 10% for those in the R10-15 lakh tax bracket—that is, those earning around R10-15 lakh per year pay lesser taxes than they should, probably the result of the 30% tax bracket kicking in at R10 lakh itself. Since the GST should start stabilising by next year, and there will be a significantly larger number of taxpayers—or incomes disclosed—because of demonetisation, the finance minister would do well to address the larger issue of tax reforms next year.

 

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