Time to get rid of income tax

Kaushik Basu, a professor of economics at Cornell and chief economist of the World Bank until recently, argues that demonetisation mostly hurts people who aren’t the Government’s intended targets and the approach only places a temporary dent on corruption.

If fully eliminating black money forever is the goal, there is actually a better idea. We should abolish the personal income tax. That would automatically make most money legitimately white (except that made from crime).

This will also free people to unlock unproductive assets such as gold and real estate and convert them into instruments that generate an annual return. This will lower our gold import bill and strengthen the rupee. Bank deposits would shoot through the roof, bringing interest rates down, further priming the economic pump.

Because there is no income tax to collect, the country will immediately see citizens deciding how to additionally spend or invest about ₹3 lakh crore annually. This spending is done by politicians who have several self-interests, such as winning elections and staying in power. It would also be a surgical strike at inefficiency. India’s personal income tax is pathetically weak as a revenue-generating mechanism. Fewer than 2 per cent of Indians paid any income tax in assessment year 2014-15. (The US equivalent is 53 per cent.) Fewer than 4 per cent filed a return. (The US equivalent is over 90 per cent.) Eliminating personal income tax would therefore affect only 4 per cent of the population — whereas demonetisation has affected every man, woman and child.

Nor are income taxes such an important component of the economy. Despite aggressive enforcement in recent years, the personal income tax to GDP ratio is extremely small for a country this size. In 2007-08, this was a mere 2.18 per cent. In 1997-98, it was 1.20 per cent. Our government’s inability to collect income taxes during a 10-year period of robust GDP growth is inexcusable. India’s income tax contribution barely nudged up one percentage point of GDP.

And there’s the cost of compliance. Taxpayers spend crores of otherwise productive hours each year assembling supporting documents, meeting accountants and devising ingenious ways of paying the smallest tax possible. The country would forever rid itself of problems from foreign tax havens. With no need to hide money abroad, the rich will keep cash home, providing additional liquidity for economic growth. After all, money can only be saved or spent. Finally, eliminating the personal income tax will shutter the sprawling (and feared) I-T department and its vast bureaucracy. It will rid us of an important source of corruption.

There will be problems. The biggest would be that the Government would lose tax revenues to the tune of over ₹3 lakh crore.

But there are plenty of ways to recover this amount. With all money white, there is little incentive for hoarders to keep cash out of the banking system. Banks could be asked to withhold a small tax on all deposit interest and transfer it to the Government (like TDS). Take SBI’s March 2016 balance sheet which showed deposits of ₹1,730,722 crore. Assume 10 per cent tax on 8 per cent interest — this amounts to ₹13,845 crore from just one bank. Not a trivial amount.

Additionally, all equities and capital gains transactions could be assessed a tax at source with money automatically credited to government coffers. Because Dalal Street transactions are electronic and intertwined with the banking system, this revenue source would be easy to track.

Attempting to be revenue neutral through static analysis ignores the new indirect GST taxes that are collected when economic activity picks up, owing to additional legitimate cash. When President Reagan cut taxes, economic growth and tax revenue both grew dramatically.

The second problem is that the perceived income inequity would grow. Our legacy of progressivism — that the rich should not only shoulder the burden of financing a part of the Government’s vast budget, but at proportionally higher rates than the poor — would be lost. But the country’s record of development is poor. The private economy, in contrast, has brought villages many modern marvels such as mobile phones, drug stores, motorcycles, cement, tractors and the internet.

The third problem is the impact on the jobs of income tax department employees. All affected employees could be moved to other departments, including the new GST agencies. The buildings and technology infrastructure could be used by other government departments. India’s indirect tax administration is a lot more efficient. Holding on to the personal income tax because it serves to advance a social policy goal, however inefficiently, is silly.

The writer is MD, education consultancy Rao Advisors LLC