The well-off Indians don’t pay enough Income tax

Note: My posts may make you uncomfortable. It is worth your time if you believe in data, questioning, reflection and openness to ideas.

In my earlier post, I had written about our societal distribution not being a pyramid but an onion dome — it has a minuscule rich that have almost all the population below them. All the influential decision makers in our government and corporations are all in that spire, not the main body of the dome. Let’s talk about something that probably all of us think about and has been in the news recently — Income tax.

You may have heard about this.

Only 1.5 crore Indians pay income taxes which is just 3% of working adults. This is too low!

That reason is our tax structure and exemptions. As a result, regular, honest citizens don’t pay enough tax. People like the government official, the IT employee and the delivery boys. Let’s look at some facts (refer article).

Reason 1: Our starting salary for taxation is extraordinarily high.

Most nations in the world have an income tax threshold that is lower than their per capita income. In many countries, tax kicks in at broadly the level of poverty line income. India is a complete outlier in this aspect (refer Ninan).

• Our tax structure is such that income tax kicks in only after Rs. 5 lakh earnings. Only 3% Indians earn more than Rs. 5 lakh per annum to pay income tax.
• India’s per capita income is around Rs 1.4 lakh per annum. That is, the average Indian earns less than a third of the income tax threshold and, hence, will not pay any income tax.
• China’s share of income-tax payers grew from 3% in 1986 to 25% now. China has raised its income tax threshold only thrice in that period. India’s has remained stuck at 3% because India has raised it 13 times. The last one in 2019, when the threshold was raised to Rs. 5 lakh, reduced the taxpayers from 6 crore to 1.5 crore.

Reason 2: Even for the top 3%, our tax rates are too low.

• India starts with 5%, whereas in Britain the lowest rate of tax is 20%.
• In the US, it is 10% at the federal level, plus varying rates at state levels.
• Look at our rates compared to the champion of free market USA along with the UK and France.

Image source: ourworldindata.org/taxation Indicative line for India plotted by me.

Reason 3: Exemptions, exemptions, exemptions!

• Many of us are familiar with these: HRA, Travel allowance, DA, Books and Periodicals, Telephone, Health Insurance, Loan EMI etc etc etc.
• Agriculture income is exempt from income tax. Why? If a person has net income above the taxable limit, why shouldn’t they pay tax? Obviously, farmers not reaching the threshold income won’t pay tax like other Indian citizens. How much is the loss due to this exemption? According to this article — 1.2% of the GDP. In FY20, approximately Rs 2.5 lakh crore or 11% of the tax revenue projected for FY20 (Rs 21.63 lakh crore).

Consequences of this flawed tax structure:

1. Higher borrowing by the government leading to debt.
2. Higher indirect taxes like GST, excise etc. These impact the poor more than the rich.
3. Higher corporate taxes thus reducing our business competitiveness.
4. Low ability to spend on public goods — infrastructure, army, schools, hospitals, police and courts.
5. Low engagement of citizens in public goods: A citizen that pays income tax is likely to be more demanding about the performance of government agencies (Indian social democracy: The resource perspective).
6. Overemphasis on the narrative of tax exemption and black money. Over active and corrupt IT department, demonetization etc.

What should be done

I understand that implementing these recommendations is not easy politically.

1. Lower tax threshold limit starting at Rs. 1 lakh per annum. Tax slab can be low, say 10% till about 3 lakhs, 15% till 10 lakhs, 20% beyond that. (the details of rates and slabs should be worked out by the finance ministry keeping income distributions in mind).
2. Remove all exemptions to simplify accounting (for instance: exempt-exempt-exempt on PF is an anomaly globally) and eliminate creative ways to avoid taxes like sodexo coupons, travel allowance etc.
3. Remove exemption on agriculture income and bring it into the tax fold. Given the challenge in calculating profit, like with the 50% rule for small freelancers and entrepreneurs, government can automatically exempt a certain share of the income depending on cost of cultivation (say 75%) and only consider the remaining for taxes.

These recommendations will almost certainly increase the tax burden of people reading this article. However, we need to contribute our fair share being at the top of the onion dome. The aim of a good tax policy should be to get a broad tax base with simple, transparent tax structure that reduces distortions and hence black economy.