Column : Let the rich pay a little more

Written by MK VENU | Updated: Jan 16 2013, 05:56am hrs
The government has caused some anxiety among the middle class by suggesting the forthcoming Budget could tax the rich. The anxiety occurs because in India it is difficult to define the rich, in relative terms. Even someone earning R15 lakh to R20 lakh a year can be described as rich relative to the 500-million-plus earning less than $2 a day. Generally speaking, individuals earning about Rs 1.5 lakh a month see themselves as very middle class. I have heard them complain about LPG subsidies being withdrawn. Though it is entirely legitimate to ask this income category to make some sacrifices to provide extra welfare to the 500 million living under $2 a day, their stock response often is: The government is wasting so much social welfare funds it already has, so why should we sacrifice more Remember, this is also the class which has on numerous occasions protested at Delhis India Gate over a whole range of issues since 2011.

Young, middle class urban Indians are also voting very aggressively as seen in successive assembly polls.

So, finance minister P Chidambaram is bound to be mindful of who he defines as rich in case he chooses to put a legitimate surcharge of 10% (additional tax of 3%) on a certain higher income category. A surcharge, by definition, is meant to be a temporary levy. The finance minister would not want to tinker with the three basic tax rates of 10%, 20% and 30% whose sheer simplicity was authored by him in 1997. By temperament, Chidambaram dislikes complex structures in tax design.

So, it is likely that he will keep nearly 97% of all individuals filing tax returns out of the ambit of tax the rich.

Of the roughly 33 million tax return filers, only 1.4 million show earnings of over R10 lakh a year. That means 95% of all tax returns are for incomes below R10 lakh annually charged at 20% tax rate. The finance minister need not disturb 95% of the current taxpayers paying 20% peak tax rate.

To levy a surcharge, he needs to just focus on the top 3% of the tax-paying population which is in the 30% tax bracket now.

Roughly the top 3% of the taxpayers may be contributing a little over R1,40,000 crore to the income tax kitty. These individuals will mostly be earning over R24 lakh a year. A surcharge of 10% (or 3% extra tax) in this category would be quite legitimate. They will end up paying 33% income tax, which is still among the lowest that the relatively wealthy pay anywhere in the world.

The government could also legitimately look at taxing dividends earned by high net worth individuals at a higher rate than currently charged at the company end before dividend distribution. The current tax rate for dividend is 15% at the company end. Lets say for those earning dividends of above R15 lakh a year, the normal 30% rate of income tax be applied. Since 15% is already paid at the company end, the remaining 15% tax can be charged on high net worth individuals earning dividend income above a certain level. This will also spare small dividend earning shareholders who are mostly in the middle class.

These are some simple ways of ensuring that the really rich end up paying some more tax to help tide over the current fiscal cliff. Once the economy comes back to the 7%-plus GDP growth trajectory, these additional taxes can be withdrawn.

Overall, the finance minister will focus far more on cutting expenditure to arrest the fiscal profligacy that had become the norm after the 2008 global financial crisis. The scope to reduce expenditure is immense, precisely because of the deliberate excesses in fiscal pump priming before and after the 2008 global economic crisis. The massive growth in the funding of centrally-sponsored schemes has resulted in the total budget for such programmes touching R2,37,000 crore annually now. Even if you uniformly knock off 10% from all schemes, very much doable, there would be a saving of R23,000 crore. This can be done without any pain.

An official told me at least R90,000 crore of the centrally-sponsored funds are not even routed through the official state budgets. These monies are managed through SPVs set up under district collectors to be spent on schemes such as Sarva Shiksha Abhiyan, MGNREGA, etc. Massive unused funds are lying with banks belonging to various SPVs. Some of these will surely be recalled. We have seen a massive expansion of welfare programmes without the necessary capacity to implement them properly. No one was questioning this.

World over, uncontrolled fiscal stimulus had got a new legitimacy. And now everyone is standing on the edge of a fiscal cliff. The finance minister seems to have the full support of the UPA chairperson to cut wasteful spending this time around. The Congress has figured that, incrementally, runaway populism will not help politically. There is a new political consensus to cut wasteful expenditure across the board. Chidambaram is likely to save far more by cutting expenditure than by raising funds from new taxes. On fiscal consolidation, the Budget will clearly surprise on the upside.