Finance minister Arun Jaitley has done well to talk of the need to lower taxes, given how critical this is, not just from the point of view of India remaining competitive, but also garnering fresh resources. With a headline corporate tax rate of around 35%, India is way ahead of, say, China and various countries in South-East Asia where taxes are around 25%—given how mobile global capital is, a higher tax rate can affect India’s chances to attract investments.
More than that, as global evidence suggests, it is only when tax rates are low that collections can rise. Indeed, the history of India’s biggest tax revolution can be traced directly to the rationalisation of taxes for personal incomes. From 1.88% of GDP in 1990-91 as compared to 7.94% for indirect taxes, the share of direct taxes is budgeted to rise to 5.62% in FY17 and overtake indirect taxes whose share is projected to fall to 5.2%.
Apart from the rise in income levels, the biggest reason for the rise in direct taxes, particularly income taxes, is the change in tax levels. In 1991-92, the peak rate of tax was as high as 56% and this was applicable on an income of R1 lakh—that’s around 14 times the per capita income in that year. Today, the peak rate is down to a much lower 30% and this is applicable on an income of R10 lakh—that’s around 11 times the per capita income; in other words, the peak tax has nearly halved while the relative income on which this is levied is roughly the same.
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The lowest income tax rate in 1991-92 was 20% and began at an income of R22,000, or around three times the then per capita income. Today, the lowest rate is 10% and applicable at an income of R2.5 lakh or around 2.7 times the per capita income. With such sweeping changes, not surprisingly, the share of personal income tax in total tax revenues is up from 3.2% in 1991-92 to 20.3% in FY17. In the case of corporate tax, that Jaitley promised to cut to 25% over four years, the changes have been much less radical. The headline rate has fallen 45% to 35%, though the effective tax incidence has hardly changed—the Vijay Kelkar FRBM report had estimated it at 21.36% in 1996-97 for manufacturing companies, and the latest budget puts it at 22.06% for the same group. Not surprising then, that the share of corporate taxes in the total kitty rose from 15.7% in 1991-92 to just 31.4% in FY17.
Apart from the rates, it is also critical to remove exemptions—as the original Direct Taxes Code envisaged—and to further rationalise rates. Comparing the tax returns for assessment year 2014-15 with a theoretical income structure for the year, you get a compliance ratio of around 25% for R3.5-10 lakh income bracket; that is, a fourth of the number of people in that income group paid taxes.
This ratio, however, suddenly falls to around 10% for those in the R10-15 lakh tax bracket, and then rises again to the 21-22% range for those in the R15-30 lakh bracket and R30-100 lakh bracket—that is, those earning around R10-15 lakh per year pay lesser taxes than they should, probably the result of the 30% tax bracket kicking in at R10 lakh itself. If Jaitley is able to successfully deal with these issues in the budget, the chances of a further boom in direct tax collections are quite bright.