Indian income tax rates: Not as high as they are steep

December 25, 2019 12:41 AM

Let us start with 2.5% and gradually increase it by 2.5% for each slab.

income tax, taxationSince income up to Rs 5 lakh is completely tax-free, and it goes up significantly and steeply once you cross this danger mark, there is a natural temptation to contrive to reduce one’s income to just Rs 5 lakh or less.

By S Murlidharan

A flat rate of taxation doesn’t sit well with income taxation because its bottom line is one-size-fits-all. One of the fundamental canons of taxation is tax according to one’s ability or capacity—greater the income, higher the rate, the one that creeps up rather than shoots up dangerously. This ideal is met by progressive rates of taxation.

In 2018, Sweden’s top personal income tax rate was 61.85%, Denmark’s was 55.8%, and Norway’s was 38.52%. Nordic nations follow a unique brand of capitalism—free enterprise, right to property, coupled with high rates of income tax so as to be able to pursue welfare economics across the board with education and health being universally free. Being peaceniks, they spend very little on defence, with Norway having no defence budget. In comparison, the Indian maximum marginal rate of 30% is not very high. On the contrary, what is questionable and needs immediate correction are the steep rates of progressive taxes in India—nil on income up to `2.5 lakh, 5% on income between Rs 2.5 lakh and Rs 5 lakh, 20% on income between `5 lakh and `10 lakh, and 30% on all income in excess of `10 lakh. Of course, these slabs are tweaked in favour of senior and very senior citizens. Now, 5% to 20% is a quantum jump; such leapfrogging is what encourages splitting of income.

Since income up to Rs 5 lakh is completely tax-free, and it goes up significantly and steeply once you cross this danger mark, there is a natural temptation to contrive to reduce one’s income to just Rs 5 lakh or less. To wit, if one were to report an income of Rs 5.5 lakh, he has to pay Rs 22,500 as increased by education and health cess of 4%. With some tax planning, one could have avoided it by knocking off the extra `50,000 that is sticking out as a sore thumb. Businessmen in particular and non-salaried class in general who get considerable latitude in arranging their tax affairs would see to it that there are as many taxable units as possible, with each one not reporting more than Rs 5 lakh as income. Such latitude or leeway is simply not available to the salaried class.

Contrast this with Singapore’s rates, which go up gradually, almost imperceptibly, from 2% to 3.5% to 7% to 11.5% to 15% to 18% to 19% to 19.5% to 20%, before flattening out at 22%. This is as it should be. In other words, the bane of Indian tax rates is its steepness and not its highness. Let’s start with 2.5% and gradually raise it by 2.5% at each slab. Let the maximum marginal rate be 40% or more to compensate partially for the resultant loss of revenue, but let it kick in at the levels of income beyond Rs 50 lakh or more.

It is not only the Narendra Modi regime that is swearing by welfare economics, but other political parties across the political divide too are. Therefore, Nordic taxation should not be difficult to sell to our political class as well as people.

Upping the maximum marginal rate by 10 percentage points to 40% may not be compensation enough for the loss of revenue from making our tax rates gradually increasing. So, we may have to resort to other forms of direct taxes. Indirect taxes including GST are regressive, impacting as they do adversely the poor. Wealth tax may have to stage a comeback, albeit with a generous exemption thrown in. Late finance minister Arun Jaitley threw the baby out with the bath water when he abolished wealth tax in the 2015 Budget on the irrational ground that the collections therefrom were hardly enough even to justify on cost of collection touchstone. He should have realised that the fault with the then wealth tax regime was its selectivity—just six types of assets were targeted—whereas it ought to have targeted all assets. There is no reason why there shouldn’t be wealth tax of 2% on net wealth in excess of Rs 2 crore after exempting residential property or properties up to another Rs 2 crore. No one is going to resent it when it is reasonable.

Estate duty too should stage a comeback. It has been in a suspended animation since 1985. Some states in the US impose estate duty or its variant inheritance tax almost at penal rates, close to 50% on the ground that nobody should get properties on a platter. A 10% estate duty on estate in excess of Rs 5 crore cannot be assailed as excessive or unreasonable. Finance minister Nirmala Sitharaman should rationalise our direct taxes regime as above. When she does so, the charge of high rates of income tax would become muted.

The author is a CA, and a veteran columnist on taxation, finance, business and commercial laws

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