Income Taxation in India

There are two things in our economy which I feel need a re-look and fresh thinking, since they affect both the countrymen and the economy. The first is the direct taxation in our country, especially income tax and second is the banking system in India. Here I will discuss the former.

Every family, state and country needs resources in the form of revenue or income. This is the only way expenses can be met. An individual and the family always strive to increase its revenue. So does the state and in the process there arises a conflict of interest. There is a trade off. More for the state means less for an individual and the family. Since it is the state that makes policy and laws, it is the individual and family that suffer. Moreover, the increasing obligations of administration, development and welfare are overwhelming and the state needs resources to meet these. Add to that the inefficiencies of the system and corruption, the need for resources increases. This has resulted in the governments becoming tax hungry.

The major sources of this revenue for a state are the direct and indirect taxes. The direct taxation, in the form of income tax (around 20% of the total revenue receipts) and corporate tax (around 33% of the total revenue receipts), contributes almost half to the revenue pie. Being visible, the income tax hurts. The income tax levels are too high, the threshold limit too low. The number of people paying income tax is negligible. Similarly, the companies do not participate honestly in this exercise of nation building. In the process there has arisen something we call a parallel economy, the black money and the ill gotten Swiss and other off shore accounts. Estimations are that this parallel economy is bigger than the real economy. The government loses on this potential source of income.

Black money is black because our laws make it so. It is money that has been mostly generated by an economic activity, yet it is black, because a portion of it has not been paid as tax. Taxes are not paid because one, the individual entity is maximising its revenue and two, the limiting and confusing and complex laws of the land. How many countrymen can claim that they understand the income tax and its laws? The net result is the existence of a parallel economy. The state loses its revenue. It is a loss-loss situation. Yet year after year, government after government, the system remains unchanged. And yet every government wants its direct tax and its share in total revenue to increase? Reminds me, keep doing the same thing and expect a different result!

There ought to be a win-win situation, for an individual and the state, with a lesser burden for an individual and more revenue for the state and practically elimination of the parallel economy. Can such a situation exist at all? Let’s think with a fresh mind.

First and foremost, the policy makers have to understand that under the existing system they cannot eliminate the parallel economy, rather it grows by the day. But they can surely collect revenue from this parallel economy. One, by making some activities like gambling, betting etc legal. These activities exist and continue to grow and the state cannot eliminate these. Two, by changing the income tax laws as regards rate, procedure, investigation and punishment.

The threshold level should be realistic. An average Indian has a right to a decent living and he works hard for that and the policy makers have to understand and recognise that. An average family needs Rs 50,000 to Rs 75,000 per month to survive, add to that the annual expenses. So I propose a threshold limit of Rs 10 lakhs per annum for an individual family.

Reduce the income tax rate on all incomes, legal or illegal, above Rs 10 lakhs to 10%. No slabs, no rebates, no confusion, no litigation, no corruption. One, a lower rate of tax means an incentive and a more willingness on the part of an individual to contribute to the nation building effort. Two, all incomes, whether legal or illegal, should be in ambit of tax. For example, whether one robs a bank or avoids indirect tax, but pays 10% tax on it. Our existing system cannot stop these activities, at least collect tax on it.

The procedure has to be that there is a simple form where you state your income and tax on it, 10%, No Questions Asked. Till, a person declares his income, irrespective of the source, and pays tax on it, he should be protected to the extent he has declared as income. If people are given immunity as regards source of income, the incentive to pay tax increases.

Further, laws have to be in place that acts as a serious deterrent for both avoidance and corruption. Any income not declared should carry an exemplary punishment, say 10 to 20 years in prison, besides a heavy fine.

Then there is the agriculture and allied sector which lies untapped. One, it is a vote bank. Two, there are recurring farmer suicides. Three, farming sector has diminishing returns mainly due to increasing input costs, vanishing subsidies, still dependent on vagaries of weather, exploitation at the hands of middlemen, practically lack of farmer friendly policies, especially post harvest policies and infrastructure, lack of scientific support from our universities and crippling blow of debt and banking sector. Simply stated, farming is not attractive in India anymore.  Despite all this, it is time that very big incomes in this sector are taxed. Say, sales above Rs one crore in agriculture and allied activities are eligible for a tax of 10%. I am a farmer myself and will be more than willing to pay 10%, if I earn more than a crore.

My contention is that a simpler, realistic, just and hassle free system along with a strong deterrent will translate into a higher number of people paying tax. A lower rate of tax accompanied by a larger number of people paying tax will eventually increase the revenue collected by the state. It will also mean a growth in happiness index i.e. the welfare, less litigation, less corruption, more tax literacy and more disposal income with the individual. In short, there ought to be a more efficient and people friendly system in place.

Eventually, economies grow because there is consumption, which means a growing demand for goods and services. Even the government’s fiscal and monetary policies and spending aim at increasing consumption and eventually increase economic activity, thanks to Keynes.

There are two models before us. Pick your model. First, there is the existing and complex tax regime, which envisages more tax from an individual and encourages corruption and tax avoidance and eventually restricts consumption. Second, a new, simpler and just tax regime, which envisages lower tax from an individual but a wider tax base in terms of numbers and activities covered. The added benefit is that the extra disposable income with the individual households will mean more consumption and saving and a boost to the manufacturing and service sectors. The same amount of money with the government means inefficient utilisation and misplaced priorities on the one hand and loses due to corruption on the other.