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  • Tanisha Vijayvergiya

How Does India's Finance Minister's Economic Model Impact Income Taxation?

by: Tanisha Vijayvergiya , B.A.LL.B, 4th year

IN THE economic model of India's Finance Minister, Manmohan Singh, there exists a firm fundamentalism concerning taxation of incomes. The fundamentalism is no doubt backed by a sound theory—the theory of Comprehensive Income Taxation.1 The essence of this theory is twofold. First, the tax-base should be broadened. This implies that a larger part of personal incomes goes through the tax-mill and a larger number of income earners are brought into the tax-net. This also implies that tax-preferences in the form of deductions and exemptions should be severely curtailed so that the erosion of tax-base is arrested. Second, the rates must be kept low. This will encourage voluntary compliance and ensure fairness of the tax-burden.

 The two aspects of the fundamentalism mentioned above are interdependent and justify each other. Experience shows that a larger amount of income passing through the tax-mill at lower rates would fetch more revenue collections than a much lower amount passing through the tax-mill at unrealistically high rates. Apart from higher revenue collections the broadbased low rate taxation of personal incomes would have also other salutary effects on the growth of the economy. The following further arguments could be advanced in favour of the fundamentalism as to the low rates of tax.

Arguments that justify lower rates of tax

Lower tax rates will create better incentive to work and earn and thereby generate more goods and services and more employment opportunities. Lower lax-rates will leave a higher post-tax income in the hands of the taxpayer. A higher amount of post-tax income (discretionary income) will leave a wider choice to the tax-payer between consumption and savings and in his personal preferences in matters of savings and consumption. This will promote a more natural and flexible proportion of savings to consumption in the economic society. It is often forgotten that both consumption and savings are necessary for healthy growth of the economy. Higher consumption will fetch higher amount of indirect taxes. Besides, it will by itself promote consumerism and growth of consumer goods industry and employment in that sector. We can sum up saying that they also serve who earn and spend. On the other hand, higher savings will ensure higher flow of funds to the private sector through intermediary activities of banks and financial institutions and the capital market. For savings as well as consumption the tax-payer needs substantial discretionary income. A broadbased low rate tax on incomes has an inherent tax-neutrality and better meshes into a liberalised economic policy.

Democratic realities of imposer-imposed dialectics

At the level of popular acceptance, however, the fundamentalism of low rates of tax will be welcomed only by those whose tax burden is reduced. Those who do not have to pay these taxes and who are in clear majority in Indian democratic society will oppose reduction in the rates of tax, dubbing the measure as pro-rich. With greater professionalism informing the tax policy formulations the majoritarian thrust is better contained and out of the imposer-imposed dialectics over the decades a sensible rate structure can be said to have emerged. It is a recent global development that professionalism backed by intellectual commitment to sound theory rules the fiscal world rather than majoritarian imposition. The majoritarian thrust in favour of taxing a few affluent persons at confiscatory levels is ineffective and out of fashion in the present world of fiscal policy.

 As to the fundamentalism of broadening the tax base, its concretisation again will draw the ire of all tax-payers, particularly the salaried class. The dialectical outcome of pressures in this direction are to be found in the partial restoration of the deduction available to incomes from certain savings (Rs. 7,000 as per Finance Act 1992 and Rs, 10,000 as per Finance Act 1993) raising of the tax-free threshold (Rs. 30,000 as per Finance Act 1992 and Rs. 35,000 as per Finance Act 1994) and the enhancement of standard deduction for salaried income in terms of section 16 (to Rs. 15,000 as per Finance Act 1993). But it must be remembered that once low rates of tax are resorted to as a matter of tax policy, a Comprehensive Tax Base becomes logical and imperative. Low rates of tax and a Comprehensive Tax Base justify each other in terms of equity, apart from producing greater efficiency in conjunction.

Predicament and responses of salaried class

The broadening of the tax-base can be achieved by:

Keeping a low tax-threshold; and (ii) drastic cuts in tax preferences for approved savings and incomes from such savings. The salaried, unlike the non-salaried class, is virtually tax trapped. They have no opportunity to understate their incomes through various devices and they cannot escape the hard bites of taxation by income-shifting and income-splitting practices widely resorted to by their brethren in the non-salaried class.2 Over the years of their tax-trapped state the salaried class have witnessed, with dismay and a feeling of being wronged, successive governments wooing the evading tax-payers with amnesty schemes.3 Over the years they have standardised their pleas for mitigation. They are : (i) raise the tax-free threshold; (ii) increase standard deduction; (iii) increase tax-preferences for approved savings. Later in our discussion we will show that each one of the pleas is unwittingly subversive of a just and efficient tax order and helps the non-salaried class to avoid and evade taxes more than it mitigates the burden of the salaried class. Such avoidance and evasion will inexorably increase the tax burden on the compliant among the non-salaried tax-payers as well as the tax-trapped salaried tax-payers.

Individualised deduction: a concrete scheme

Keeping in view the above parameters a formula for the individualised deduction may be enacted as under:

(i) the individualised deduction may be limited to the excess, if any, of the reported living expenses of the tax-payer over the aggregate of all his untaxed incomes.

(ii) The upper limit of such individualised deduction should be Rs. 36,000 (indexed to WPI of 31-3-1994).

(ii) In case of persons with reported taxable income exceeding Rs. 72,000 (indexed to WPI of 31-3-1994) 25 per cent of such excess, limited to Rs. 12,000 (indexed to WPI of 31-3-1994) should be added to the aforesaid limit of Rs. 36,000 (indexed to WPI of 31-3-1994).

(iv) “Reported living expenses” should include all personal expenditure including vehicle maintenance and personal life insurance. All special personal deductions and exemptions should be dispensed with, whether based on the nature of income or on the nature of application of income.

(v) The income brackets in the rate schedule should be reduced to two as recommended by the Raja Chelliah Committee and tax rates at 20 per cent on the first Rs. 1,20,000 and 30 per cent on the balance.

The above scheme will ensure that in the tax-world there is no circulation (or claim of circulation) of untaxed surplus derived out of a tax-free threshold and standard deduction. A predictable tax-payer's response to such a scheme of individualised deduction would be to withdraw funds from the sight of the tax collector and report the living expenses upto the allowable limit. Such withdrawn funds would be either spent away on special occasions without actually reporting such expenditure or invested with the risk of meeting found out. As the withdrawal of funds ostensibly for meeting living expenses will act as estoppel against future claims of availability of the same funds for investment, such spurious claims are neatly inhibited. As nobody's investment or expenditure can be explained away as out of untaxed surplus of the tax-payer or of somebody else, such over reporting of living expenses will prove counter-productive.

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