Editorial: FM’s taxing choice

By: |
January 24, 2015 12:36 AM

Can’t cut tax rates without reducing exemptions

Given that finance minister Arun Jaitley has promised to leave more money in the hands of consumers to fuel demand and growth, it can safely be assumed that he will try to reduce the overall tax burden in his first full budget next month. But while doing this, he must keep in mind that the space for raising exemptions is limited given the feeble economic growth we are seeing. Indeed, unlike his predecessors, it is unlikely chief economic advisor Arvind Subramanian will go along with unrealistic tax forecasts this time around. In his maiden budget, Jaitley has already increased the income tax exemption limit from R2 lakh to R2.5 lakh and the investment limit for savings under Section 80C from R1 lakh to R1.5 lakh; the top marginal rate of personal income tax and corporate tax both is at a moderate 30%. Any major restructuring of personal income tax slabs including the exemption limit, and also the corporate tax rate from here on, would simultaneously need weeding out of exemptions as prescribed in the original Direct Taxes Code (DTC). The main problem in the Indian tax system today is that the taxpayer base is not expanding because of the plethora of exemptions. The number of income tax assesses is still only 3.5 crore even as 17 crore people are holding PAN—the tax administration reform commission has estimated that the number of Indians who should be paying income tax should be at least 6 crore. The same applies to indirect taxes.

While GST is expected to take care of this problem in case of indirect taxes, a complete overhaul of the current DTC is required—given this will require Parliament’s approval, it seems unlikely it will take place in the current Budget. In the meanwhile, though, Jaitley does need to start working on what’s called the ‘missing middle’. India’s biggest problem is that the top rate of 30% kicks in at a low income of R10 lakh. So while 90% of the taxpayers in FY12 reported an income of under R5 lakh and paid just 10% of the total tax collections, those showing an income of over R20 lakh comprised 1.1% of the tax base but paid 63% of the total tax. This clearly shows that the real evasion of tax is in the middle bracket and once the limit is raised for levying 30% rate, evasion will go down to a large extent—interestingly, the original DTC draft proposed the 30% rate for income above R25 lakh. Of course, the problem here is that this can’t be done without getting rid of exemptions which added up to around a fifth of the direct tax collections in FY12—the sooner the FM starts working on cutting exemptions, the better.

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