A month after finance minister Nirmala Sitharaman hinted at reform in personal income tax, speculation is rife that the government will cut income-tax rates in the coming Budget. This would be ill-timed, given the huge shortfall in revenues after the steep cut in corporate tax that would take a while to work through the system.
Till January 15, direct tax collections fell by about 5% (year on year). Giving in to the demand, largely from the middle class, will weaken the government’s resolve on fiscal discipline, with minimal, if any, impact on demand & growth.
The focus must be to raise more revenues through better implementation and effective use of the goods and services tax (GST), and more than make good the Rs 1.45 lakh crore giveaway in corporate taxes. In the medium term, as revenues rise, income-tax rates can be lowered, with the present rates kicking in at higher thresholds of income.
This should be accompanied by structural reform to taxation of savings that would nudge people to save intelligently, bring efficiency in the tax system and encourage investment and growth.
India’s maximum marginal rate (MMR) of tax of 85% in 1973-74 — spread over seven tax slabs — was brought down to 30% in 1997-98, and slabs compressed to three. The MMR has not been changed since then, though the surcharge has been tinkered with over the years. The exemption limit now is Rs 2.5 lakh. Plus, there is a rebate for income between Rs 2.5 lakh and rs 5 lakh that brings tax liability up to Rs 5 lakh to zero. But if there is any income above Rs 5 lakh, say, the income is Rs 5,00,100, the tax liability would be Rs 12,520, 5% of the income between Rs 2.5 lakh and Rs 5 lakh, and 20% of Rs 100. A maximum 30% rate is charged on income above Rs 10 lakh. Also, the hike in the surcharge in this year’s Budget has pushed up the effective income-tax rate on income above `5 crore to about 42.7%. That’s way too steep.
The task force to re-write the income tax law, steered by former CBDT member Akhilesh Ranjan, is reported to have recommended scrapping the surcharge. This is welcome, given that surcharges are meant to be only temporary levies and the revenues are not shared with states. However, the panel’s suggestion to have five slabs and an MMR of 35% for incomes above Rs 2 crore is not a good idea. Restricting the number of slabs to three reduces ‘bracket creep’, in which inflation pushes taxpayer into a higher tax bracket without any rise in real income.
India should not be out of line with the global practice of having as few rates as possible, and should make the tax base more comprehensive. Fact is, a large part of the burden of paying personal income tax falls on salaried employees, even as the self-employed, high-income earners among professionals, traders and producers in the unorganised sector get away without paying much tax.
Tighter rules for presumptive taxation, a scheme that allows businesses and professionals to compute their tax on an estimated income or profit, to shore up revenues are okay. Tracking income has become far simpler now with bulk of the production coming under GST.
Proper implementation of GST holds the key. Let revenue authorities use big- data analytics to mine information and doggedly pursue audit trails to widen the direct tax base, raising the direct tax-to-GDP ratio that is about 6% now. A closer coordination between direct taxes authorities and the GST administrations will lead to compliance gains across the board. The other long-pending reform is to remove the distortions in the tax treatment of savings, something that needs political will and courage.
The Arbind Modi panel to overhaul the income-tax law (whose recommendations have not been made public) mooted removing income-tax incentives on schemes such as the Public Provident Fund and post office saving deposits, while raising the threshold for paying income tax. Alternatively, it suggested continuation of the incentives on savings schemes, but on fewer of them. In either case, the panel moots the exempt-exempt-tax treatment, wherein no saving would be taxed, but income from that saved asset would be charged to tax.
This would allow people to postpone their tax liability to a stage when amounts are withdrawn, leaving them with more financial savings. Of course, the consequence is that retirement incomes would be taxed. That may seem cruel, especially as India does not have a universal social security system. To reduce the pain, tax slabs must be wide and rates moderate.
The trick lies in calibrating the two reform measures to make the tax system more efficient and equitable.
Views expressed are author's own
