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Can income tax be entirely abolished in India?

The first budget of the Modi 2.0 government will be presented in Parliament on July 5, 2019. Finance Minister Nirmala Sitharaman is meeting various industry associations and experts to take feedback and suggestions efore she finalises the Budget.

India’s GDP in Q4 FY 19 dropped to five-year low of 5.8%. The major reasons for the slowdown are decline in private consumption growth, moderate increase in fixed investment, and subdued exports, according to Ministry of Finance's monthly economic report. Balancing growth and fiscal prudence will be a big challenge for the new finance minister.

Every year around budget time, the chorus to abolish income tax gathers momentum. Bharatiya Janata Party leader Subramanian Swamy has been a big proponent of this theory since long.

There are 15 countries which don’t have personal income tax. Personal income taxes account for 5% of the total private consumption expenditure, 20% of net sales of Top 10 Nifty 50 companies of India and 2.5% of the GDP.

Factors in support of the ‘no income tax’ theory

Currently only 7 crore individuals in India pay income taxes, including TDS; while only 5 crore file tax returns (AY 2017-18).

This accounts for just 5% of the population. Even in terms of households, it implies that only one-fourth are paying income taxes. Out of the 5 crore who file income tax returns, 2 crore (almost half) file zero income tax returns. Despite several attempts, the tax net in India has not widened significantly. The number of individual taxpayers in India has grown at a CAGR of 9% from Assessment Year 2013-14 to 2017-18.

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Source: www.incometaxindia.gov.in

Why should we continue to burden this small population? The abolition of personal income tax will ensure parity among citizens with everybody paying indirect taxes.

India’s growth has been consumption-fueled and we are not export-oriented like China. The vast population demands things ranging from needles to aero planes. However, demonetization and a hurriedly implemented Goods & Services Tax, have led to a slowdown.

Many people, especially in rural India, lost their livelihood, while salary increments and bonuses in the private sector have been low. All this has led to a decline in sales of important sectors like automobiles and real estate. A consumption slowdown dampened sales in Q4 of even some FMCG firms.

Zero income taxes would increase the net take home of individuals by 10%-40% depending upon their tax bracket. This in turn will have a huge positive impact on consumption that can in turn boost industry and services growth.

Personal income tax collection in India in FY 2018-19 is likely to be Rs 5.3 lakh crore as per revised estimates. This bold step will give a Rs 5.3 lakh crore stimulus to the economy.

Factors against this theory

Total personal income tax collections account for 20%-22% of the total budgeted receipts of the government. If the government forgoes this amount, its total revenues would decline: meaning, it will have to either reduce expenditure or compensate through some other sources to maintain deficit at current levels.

Some of the social benefit schemes like NREGA, FSB, fuel subsidies, PM Kisan Yojana would need to be curtailed. But this may backfire against the government politically and thus is not possible. Parity will not be liked by the poor and lower class.

Why should people earning in lakhs not pay taxes, they could argue. After all, it is their societal obligation.

The only way for the government then would be to compensate this loss either through higher corporate taxes or higher indirect taxes or a mixture of both.

Higher corporate taxes would further dampen economic sentiment and private investment. Higher indirect taxes would lead to inflation and pinch the poor.

Around half of revenue loss can be recouped

If Rs 5.3 lakh crore is left in the hands of taxpayers, almost 30% could be saved as per the current savings rate of India. This means Rs 1.6 lakh crores could find its way into bank deposits, LIC plans, mutual funds, et cetera providing them with much-needed liquidity.

The balance Rs 3.7 lakh crore are likely to be spent on consumption, clothing, food, education, medical bills, electronic goods, travel, etc. Indirect taxes/GST collections on this could be to the tune of Rs 0.66 lakh crore and another Rs 0.09 lakh crore in the form of corporate taxes on profits made on the sale of these goods and services can be collected by the government. This way Rs 2.35 lakh crore (44% of revenue losses if income tax is abolished) can be recouped.

The Multiplier effect

The above analysis represents only the direct effect and excludes the spiraling or the multiplier effect. More money in the hands of taxpayers will lead to an increased demand for goods and services which will lead to increase in sales and profits for companies.

The corporate sector, in turn, will hire more people to meet this increased demand. These people joining the employment sector in turn would again save a part of their salaries and spend the balance of their incomes. This spiraling impact is huge but difficult to quantify.

Interim Budget contained measures to give a fillip to consumption

In a bid to boost consumption, former finance minister Arun Jaitley had proposed income tax exemption up to Rs 5 lakh in the interim budget of 2019-20. As per government estimates this is likely to benefit 3 crore tax payers.

As per my analysis, this will lead to about Rs 1 lakh crore loss of income tax revenue to the government. Its impact on consumption and GDP growth will need to be analyzed next year.

To conclude, despite the multiplier effect benefits, the government cannot take such a big risk of abolishing income taxes completely and forgoing 20% of its total receipts with immediate effect.

More so, when the economy is facing headwinds and it has fiscal deficit targets to achieve. However, the idea of zero personal income taxes is quite tempting and needs to be looked at seriously, taking small steps and implementing it gradually.

In my opinion, the exemption limit being increased to Rs 5 lakh is the first step towards progressively achieving a zero-tax regime.

The author is a political commentator and strategist advising political parties and leaders. He was a corporate and investment banker who tweets @politicalbaaba.)