A balanced approach of taxation for growth and equity

India’s tax system: A subject of intense debate

India’s tax system, like its economy, has been a subject of intense debates, from the left, right, and centre. Right or wrong, just about everyone is unhappy about it.

With evolving priorities, the country faces a complex challenge: how to generate funds for sustained growth, maintain fiscal discipline, and promote social equity while ensuring that the national value and wealth generators are also kept in good humour. Too many factors to balance.

Among the many debates on tax reform, abolishing personal income tax or significantly restructuring it has gained prominence. Advocates of this idea highlight its potential to spur growth, while skeptics warn against worsening inequity.

This article examines the key aspects of the debate, evaluates policy options, and proposes a framework that balances all these factors.

The case for abolishing or restructuring Personal Income Tax

One of the most prominent advocates for abolishing personal income tax is Dr. Subramanian Swamy. According to him, eliminating personal income tax will empower the middle class, boost consumption, and enhance savings. The logic is straightforward:

1. Increased Disposable Income: Removing personal income tax would leave more money in the hands of individuals, esp the middle class, enabling them to either spend or save.
2. Boosting Demand: Higher spending would create additional demand, stimulating industries, creating jobs, and supporting GDP growth.
3. Capital Formation: Savings would flow into banks, mutual funds, and other financial instruments, increasing the availability of capital and debt for businesses and infrastructure development.
4. Ease of Compliance: Eliminating income tax would reduce compliance burdens and administrative costs for both taxpayers and the government.

The case of the opposition: Regressive impacts and revenue concerns

Critics of this approach, however, caution against the risks:

1. Dependence on Indirect Taxes: If personal income tax is abolished, indirect taxes like GST would become the government’s primary revenue source. Indirect taxes are inherently regressive, as they impose a disproportionate burden on lower-income groups.
2. Revenue Loss: Personal income tax contributes around 20% of the government’s total revenue. Abolishing it could lead to fiscal deficits unless offset by other measures.
3. Equity Concerns: Income tax is one of the few progressive taxes, where higher earners pay a larger share of the taxes. Its removal could widen income inequality.

Finding the middle ground: A balanced approach

Instead of outright abolition, restructuring the personal income tax system to benefit the majority while ensuring adequate revenue could be a more viable solution. Here is a balanced proposal:

Raise the Exemption Limit

Increase the tax exemption limit under the new tax regime to Rs.10 lakhs. This would relieve the middle class while focusing tax collection efforts on higher-income groups.

Also, income tax exemption for the rich may not help boost the demand for productive items.

If the government wants to have a large taxpayer base or monitor borderline cases, it may tax those above Rs.7.5 lakhs a nominal 1% and go easy on verifications.

Simplify and Flatten Tax Slabs:

Introduce wider and flatter tax slabs to ensure simplicity and fairness:

• Rs.10-15 lakhs: 5-10%
• Rs.15-20 lakhs: 20%
• Rs.20 lakhs and above: 25%

Eliminate Deductions:

Disallow exemptions and deductions to simplify compliance and broaden the tax base. A simple, predictable system encourages voluntary compliance.

Introduce a Mild Wealth Tax:

A progressive wealth tax on ultra-high-net-worth individuals (e.g., assets above ₹50 crores) could supplement revenue while ensuring equity. Rates could start at 0.1% and cap at 0.25%. This will also help keep a tab on them.

Review Tax Exemptions:

Income Tax exemption for agricultural income and income earned by bodies like sports bodies like IPL and BCCI above a certain limit may be considered. Even if it faces opposition, a good idea may be to tax them a small % to start with could be a good beginning.

Simplify GST & Focus on GST Compliance:

Simplify and strengthen GST compliance mechanisms to boost indirect tax revenue. While GST is regressive, improved compliance ensures higher revenues without raising rates. Make one good simplification and desist from tinkering with it continuously.

Incentivize Investment and Philanthropy:

Provide targeted incentives for investments in startups, infrastructure, and job creation. Encourage philanthropy through tax benefits for donations to certified social causes.

Addressing the Fear of Capital Flight and Evasion

One concern with higher taxes on the rich is the risk of capital flight, tax evasion, and reduced economic activity. These fears are valid but manageable with appropriate measures:

• Competitive Tax Rates: Maintain top marginal rates below 30% to remain globally competitive and discourage relocation to tax havens. Respect business & industry and give some creatively crafted privileges.
• Stable and Transparent Policies: Consistent and predictable tax policies reduce uncertainty and build trust.
• Incentives for Domestic Investment: Encourage wealthy individuals to invest domestically by offering tax advantages for long-term investments.
• Data-Driven Monitoring: Use advanced analytics to track high-income earners and reduce evasion.
• Trivial Many vs. Vital Few: Where to Focus Revenue Efforts

Applying the ABC analysis to revenue sources highlights where India should focus its efforts:

A-Class Revenue Sources

Indirect taxes (GST), corporate taxes, and income tax from high earners (₹10+ lakhs) provide the bulk of revenue. Strengthening compliance and plugging leaks here will yield the highest returns.

B-Class Revenue Sources

Taxes on middle-income earners and capital gains are moderate contributors. Simplified processes and targeted compliance efforts can maximize their potential.

C-Class Revenue Sources

Taxes on small businesses, penalties, and minor levies contribute minimally and often involve high administrative costs. These may be simplified or phased out.

Conclusion: A Path to Growth and Equity

India’s personal income tax system needs minor reform that balances growth and equity.

It is already in the right direction but doesn’t appear to be based on ABC analysis and sensitivity to the retired and middle class, who are a vocal lot. Satisfying them will cost the government very little but earn their goodwill. It.

While abolishing personal income tax might sound appealing, it could have regressive effects and undermine fiscal stability.

A more balanced approach, raising the exemption limit, simplifying slabs, and focusing on compliance, can achieve the twin goals of boosting economic growth and savings and ensuring social fairness.

At the same time, ensuring stable, predictable policies and improving public spending efficiency will build taxpayer trust and encourage compliance.

With the right mix of reforms, India can create a tax system that supports its vision of inclusive and sustainable development.

Note:
1. Text in Blue points to additional data on the topic.
2. The views expressed here are those of the author and do not necessarily represent or reflect the views of PGurus.

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