Why Personal Income Tax should be lowered?

As discussed in earlier blog, with around Rs. 5 Lakh crores tax revenue from fuel which is much better for the country as a whole and around Rs. 15 Lakh crores GST collection estimated for FY 22, it is high time, the Government rationalises direct taxes. While reduction of corporate tax from 22-25% was a welcome move last year followed by nullification of retro tax last week; biggest pain point remains around personal income tax.

Before getting into arguments for lower income tax rate and broader base around the same, let’s look at some facts:

1.    During 2020-21, Corporate tax collection fell below personal income tax collection for the first time in 12 years due to lower tax rates and the COVID-19 impact on businesses. The corporate income tax collection for FY21 stood at Rs 4.57 lakh crore, while total personal income tax was at Rs 4.69 lakh crore. Experts say lower tax rates and GDP fall have led to lower corporate tax collection.

2.    However, both corporate and personal income tax collections shrunk in the financial year 2020-21 by 18 per cent and 2.3 per cent respectively, data from the Controller General of Accounts suggest (Look at the stark difference in de-growth here!). The Central government in September 2019 had slashed corporate tax rates by around 10 percentage points. New corporate tax rates for existing companies stand at 25 per cent while for new ones in manufacturing, it's 17 per cent.

3.    In last 12 years from 2009-10 till 2021-22 (estimated), personal Income tax collections have grown by highest at 324% while Corporate taxes having grown by 124% during the same time. Further, as a proportion of total tax, personal income tax has occupied pole position in these 12 years with more than 25% contribution and during the same period, the ratio between Corporate tax & personal income tax has come down from 65:35 to 49:51 now as depicted below:

Source: India Budget

4.    In 16 years between 2002-03 and 2018-19, the number of individuals who filed tax returns grew 62%, but the number of people who paid income tax rose by only 22%. The government’s attempt to bring more people into the tax administration’s net has been successful, but a rising percentage of those filing returns are able to prove they have no taxable income.

Source: Economic Times

In 2002-03, 4.4% of Indians aged 20 and more paid income tax, in 2018-19 this reduced to 3.8%. Population filing tax returns went up from 3.2% in 2002-03 to 4.18% in 2018-19.

5.    The revenue department is yet to officially release tax collection data, but the finance ministry informed the Lok Sabha on July 19 that Q1 tax revenue mop-up reached Rs 5.6 lakh crore, well ahead of estimates.

India is one odd example where personal income tax rates are very high while tax payers amount to hardly 4% of the population. Further, the stubborn attitude of Government to get the maximum out of Golden Goose, 4% tax payers as above meeting more than 1/4^th of the total tax revenues including indirect taxes, will kill the goose altogether as evident from the demand softening happening in the country aligned with pandemic situation.

While every Government must tax their subject to help in nation building and the tradition is age-old practiced through generations, in the course of time, we have somehow grown to develop the attitude of further oppressing the oppressed while leaving aside the others to enjoy the benefits. Even if we go back to the days of Lord Rama, it is being said that he believed in the tax to be collected similar to how Sun evaporates water and causes rain wherever is required.

Even if we look at what Chanakya has prescribed, he likened the tax collection process akin to the way a bee collects its food from the flower, which does not impact the flower and also meets requirements of the bee. Successive Indian governments seem to have ignored the other advice Chanakya gave regarding taxation – that it should be easy to calculate, convenient to pay, inexpensive to administer and equitable in its burden.

As currently implemented, it is not convenient to pay, compounded with the new income tax portal with millions of bugs as can be testified by the lakhs of people spending sleepless nights trying to grapple with the portal. And Income Tax is certainly not easy to calculate, since the layers of rates, surcharges & cess along-with exemptions which only experts could figure out.

Further, equity here has been politicised, like everything else in the country. In the quest for equity, the government has compromised on all the other tenets laid out by Chanakya, including that low taxes be paid by all rather than high taxes be paid by just a few. So much for relying on wisdom of the ages.

In The Wealth of Nations, Adam Smith argued in line with Chanakya that taxation should follow the four principles of fairness, certainty, convenience and efficiency. Keynes was highly critical of the government greatly increasing welfare spending while raising taxes to balance the national books. Keynes said this would not encourage people to spend their money, thereby leaving the economy unstimulated and unable to recover and return to a successful state.

We are today seeing the same thing happening in the country with the economy battered by pandemic, lots of people losing their livelihood, corprates holding back their capital spends, unemployment at a very high rate and even those who are employed have been taxed at the highest ultimately leading to their propensity to spend dying out and we are in the vicious loop.

Instead, as prescribed by Keynes, the government should spend more money and cut taxes, which would increase consumer demand in the economy. This would, in turn, lead to an increase in overall economic activity and a reduction in unemployment. Further, there is also a dire need to broad-base the tax net to cover vast majority of Indians.

While the Government attempted a new income tax regime last year, it has actually thrown a googly at taxpayers. Some experts said that the rationale behind the move may also have something to do with boosting the government's tax income as upfront tax rates in the new system could increase an individual's payable tax as it excludes common exemptions. The new taxation system provides a marginal boost for some individuals with no savings; it may also increase government's total income tax collection. On the contrary, it risks derailing long-term household savings and the future of the vast social security sector.

In a country where taxes are high and basic amenities like health, education, infrastructure are in doldrums while social support from the Government is zero to normal people (except Government employees), it direly needs a more humane Direct Tax system in line with modern economic realities.