Even without the need to provide sops to taxpayers who have suffered due to demonetisation, finance minister Arun Jaitley has a lot of scope, and reason, to cut tax rates quite dramatically. Though India’s top tax-bracket attracts a 30% tax rate, and this looks high in comparison to some other countries, India’s effective personal income tax rate is a much lower 10-11%, based on data put out by the finance ministry for various categories of income tax payers in FY14. In that year, the data show, there were a total of 3.65 crore persons with an income of Rs 18.4 lakh crore and they paid taxes of Rs 1.9 lakh crore—that’s an effective tax of just 10.4%. Of these 3.65 crore, the data show, just a little over 1.9 crore paid taxes. A total of 2.4 million persons declared a gross income of over Rs 10 lakh, which seems low given 2.5 million cars and 14.8 million two-wheelers were sold that year.
Though the data does not directly give the total tax paid by those in each income tax bracket, using some assumptions yields reasonably accurate results. These 2.4 million persons reported a gross income of Rs 6.7 lakh crore and paid a tax of around Rs 1.5 lakh crore, yielding an effective tax rate of 22% as compared to the headline number of 30% plus cesses. There were, in addition, another 6.5 million persons who earned between Rs 5-10 lakh and reported a gross income of Rs 4.4 lakh crore in FY14. Since the maximum tax these persons could possibly have paid was Rs 43,964 crore according to the data released, that’s a maximum possible effective tax rate of 10% as against the headline rate of 20% for those earning between Rs 5-10 lakh.
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In other words, thanks to all the exemptions allowed, around Rs 50,000 crore a year on account of personal income taxes, and various expenses allowed as a set-off for the self-employed, the effective tax rate is quite low. Given this, the finance minister can, if he wishes, remove all exemptions and replace the myriad tax rates by a flat 10-11% one and see compliance jump. Alternatively, if that is too drastic and looks as if the rich are being favoured, a tax rate of 10% can be charged for those earning between Rs 2.5-10 lakh and a 20% rate for all those above this. The jump in the compliance rates should be quite significant and give the finance minister the tax buoyancy he needs while putting in place a reformist tax system on a par with the GST that he hopes to bring in by September.