Budget 2019: Slashing tax rates is a good way to boost collections; here’s why

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Updated: June 10, 2019 6:42:40 AM

Union budget 2019 India: Hiking surcharges on higher income brackets tempting, but won’t help as much as cutting rates to get more into tax net

Nirmala Sitharaman, interim budget,  income taxes, tax rates, Direct Taxes Code, GST, demonetisation, income-tax returns , income tax collectionsBudget 2019 India: Right now, there is a 10% surcharge on those earning Rs 50 lakh a year and 15% on those earning Rs 1 crore and above.

Union Budget 2019 India: Given the large likely tax shortfall if finance minister Nirmala Sitharaman sticks to the FY20 targets made in the interim budget, as well as the government’s perceived need to be seen as soaking the rich while helping the poor, chances are next month’s budget could see an increase in the surcharge on the well-heeled; recall prime minister Modi’s post-victory statement about how India had just two castes, the poor and those willing to help the poor. Right now, there is a 10% surcharge on those earning Rs 50 lakh a year and 15% on those earning Rs 1 crore and above.

There were, in FY17, 81,344 individuals who declared their annual incomes as over Rs 1 crore, and they declared a total income of Rs 218,312 crore; so, a 5% increased surcharge could net around Rs 10,916 crore additionally. And the 171,094 individuals who said their incomes were between Rs 50 lakh and Rs 1 crore declared an income of Rs 117,364 crore; so an additional 5% surcharge will net Rs 5,868 crore. Considering incomes have grown in the last three years, the surcharge will net even more today.

Also read: Budget 2019: How removal of LTCG tax on equities may boost stock markets

While this will work in the very short run, it barely scratches the surface in terms of the potential to collect more taxes from both the rich as well as the not-so-rich. Indeed, this was the philosophy behind the original Direct Taxes Code which sought to remove all tax exemptions—around Rs 75,500 crore in FY18 for insurance, investment in provident fund, etc—and to make large cuts in tax rates to compensate for this; the added advantage is that this makes the tax filing genuinely saral.

While some have argued that lower taxes will not, in themselves, bring in more individuals into the tax net, this may not be as true today as compared to the past. With the linking of bank accounts with PAN numbers, the taxman being able to get a lot more information on people’s spending and incomes with Project Insight, GST making companies file more data, and the reams of information the taxman got thanks to demonetisation, the taxman finds it easier to target non-filers today as compared to the past, but the ability of citizens to evade taxes still remains high. That is why, for instance, while the taxman had said that Rs 1.75 lakh crore of suspicious bank deposits were being probed post-demonetisation, the tax collected has been a small fraction of this. This suggests those who deposited large sums in banks after demonetisation were able to spin credible stories of how their incomes—on which tax is paid—were much lower.

Interestingly, while the total income declared by those filing income taxes was Rs 38.5 lakh crore in FY16, this rose to just Rs 43 lakh crore in FY17; within this, the income filed by individuals rose from Rs 25.2 lakh crore to just Rs 28.2 lakh crore. While it can be argued that the data on income-tax returns put out by the finance ministry isn’t really representative since personal income tax collections rose much faster than what the summary returns suggest, the fact is that after rising by 21% in FY17 and 20% in FY18, income tax collections rose just 10% in FY19; in other words, the demonetisation dividend is clearly over.

In a paper on tax compliance—for a Vijay Kelkar festschrift—Surjit Bhalla used 1989-2007 data and found that “for each 1 percentage point cut in the average tax rate, compliance increases by over 6 percentage points”. In this context, Sitharaman must look at how large income tax evasion is. It is difficult to believe that India had just 81,344 individuals who earned more than Rs 1 crore in FY17 or that just 1.7 lakh people earned Rs 50-100 lakh—that 10 lakh persons earned Rs 20-50 lakh also looks quite low—when 4.5-5 million Indians go abroad for holidays every year, or when Indian tourists spend $13-14 billion a year in just the US, or when 1.7 lakh Indian students spend $5-6 billion in the US (India has 5.9 lakh overseas students), and over 40,000 ultra-luxury cars priced at Rs 30-300 lakh apiece are bought every year.

In this context, the latest all-India income survey by research agency Price—Price’s Rajesh Shukla used to conduct similar surveys for NCAER for decades—estimates the number of those earning over Rs 1 crore at around 6.4 lakh in FY16 (see graphic) and those earning between Rs 50-100 lakh at 11.6 lakh (and yet, just 1.4 lakh persons declared this to be their income in FY16!). In which case, the finance minister can settle for earning Rs 20,000-25,000 crore by levying a higher surcharge on those earning over Rs 50 lakh a year or she could slash tax rates and bank on the greater compliance this results in; more so since the taxman also has more tools to catch those avoiding taxes.

Just a 10 percentage point hike in the number of crorepatis (that’s 64,000) who pay taxes if the total tax rate is slashed to 25% will add another Rs 40,000 crore to the tax kitty assuming an average income of Rs 2.5 crore; a 20 percentage point hike will yield Rs 80,000 crore. Indeed, it is not just at the top that Sitharaman will collect more taxes. The highest income tax level of 30% kicks in at an income of a mere Rs 10 lakh a year; while the tax data shows just around 28 lakh persons showed their income in FY16 at Rs 10-20 lakh, the Price survey estimates there are 136 lakh individuals earning this salary; if the tax is slashed to 20%, a 20 percentage point hike in compliance will result in additional taxes of around Rs 76,000 crore (assuming an average salary of Rs 14 lakh). In other words, the finance minister has more to gain by lowering taxes to get more people into the net; whether the tax bureaucracy and her government’s pro-poor stance will allow her to do this remains to be seen.

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