Time to shelve personal income tax

During November 2020, Finance Minister Nirmala Sitharaman announced various stimulus packages to boost the economy. The Finance Minister had said the stimulus provided by the government, as part of the 12 announcements made under ‘Atmanirbhar Bharat 3.0’, amounts to ₹2.65-lakh crore or around 15 per cent of GDP.

Any stimulus package, it must be understood, will have an adverse effect on the country’s fiscal position. However, stimulus through tax reforms will be more helpful in the long run. As the government finalises the Budget for the next financial year, there is an opportunity to provide stimulus through direct tax reform.

Last year, corporate income tax was reduced and, now, it is time to consider abolishing personal income tax. This will be a blockbuster reform that would boost growth.

For the year 2020-21, the tax on income is budgeted at ₹6,38,000 crore out of a gross tax revenue of ₹24,23,020 crore, which comes to 26 per cent of total receipts. Other items of revenue are corporate tax of ₹6,81,000 crore, GST ₹6,90,500 crore, Customs ₹1,38,000 crore, excise duties ₹2,67,000 crore and service tax ₹1,020 crore. For 2018-19, the cost of collection was 0.62 per cent, which will also be a saving if personal income tax is abolished.

As revealed by the Prime Minister at a summit in February 2020, only 1.46 crore Indians pay income tax, which is just one per cent of the population.

Personal income tax is effectively collected only from salaried individuals. All other categories somehow escape by adopting different methods.

The salaried class pays tax on the income and then spends the net income, whereas the business and professional classes spend money under various business expenses and reduce their tax liability.

Expenses on phone, electricity, domestic and foreign travel, water, entertainment, etc., are part of tax-deductible expenditure for the business and professional category. Big agriculturists hardly pay any income tax. Even political parties ensure that they do not pay any tax.

Generation of black money

It is a general tendency among people to evade tax. Tax planning or tax avoidance is considered a legitimate exercise to reduce the tax liability. However, evasion is an offence. There is a parallel black money economy in the country. By allowing black money, we are actually decreasing the supply of currency in the economy and making it dearer.

There are no reliable estimates of black money generation or accumulation, and neither is there an accurate, well-accepted methodology for making such estimations. Among the estimates so far, there is no uniformity or consensus about the best methodology or approach to be used for this purpose.

If personal income tax is removed, then there will be no scope of any black money from tax evasion of genuine earnings and the entire funds will be available for productive purposes of the economy.

This will increase consumption or national savings, investment and growth. Ill-gotten money, through corruption etc., may however continue to be part of the parallel economy even after this exercise.

In 1973-74, personal income tax was it its highest level of 97.5 per cent. The Direct Taxes Enquiry Committee 1971 attributed the large-scale evasion to the exorbitant tax rates and recommended reduction in the marginal tax rate.

Subsequently, with every successive Budget, the tax rate has been brought down. Becoming rich or being rich is no more considered a sin and no one wants to penalise the rich.

Credit creation by banks

Assuming that banks generally retain 3 per cent of the deposit under the Cash Reserve Ratio and lend 97 per cent (including SLR requirement), every ₹100 of fresh deposits will increase the money supply by ₹3,200.

This is because, the 97 per cent will come back to the banking system as deposits, which will be lent again retaining 3 per cent, and the process will go on and on. This is called ‘credit creation’ by banks.

If any black money comes to the bank as legitimate deposit, this will steeply increase the money supply and hence productivity also. This will also significantly increase the lending capacity of banks.

If personal income tax is removed, some 6.32 crore people will be free from the burden of submission of various tax returns. Income tax regulations require people to maintain and submit various records and returns. The Income-Tax Department tirelessly scrutinises the returns, which are followed by demands, refunds and protracted correspondence. The litigations generally go on for years together, taking a toll on both the citizen and the government.

The various organisations effecting TDS will also be free from the burden of collecting, remitting and submitting various returns if personal income tax is shelved.

Or, as a via media, the income tax rate be kept at nil for one or two years and the result seen before scrapping the levy. In the coming years, the GST rate can be rationalised to offset the revenue loss.

A number of countries in West Asia like the UAE and Qatar, do not levy income tax. India, too, should try this option, which may also be a good way to attract foreign investments.

The writer is a retired banker