
The Union Budget is just round the corner and expectations are peaking over cuts in the personal income tax rates. While presenting her seventh budget last July, Finance Minister Nirmala Sitharaman had offered limited tax relief, which failed to improve individuals’ purchasing power.
The decline in wages and persistent rise in prices have tightened household budgets, which is reflected in private consumption steadily going south. If consumption grew at a mere 7.45 per cent in the first quarter of 2024-25, the growth further slowed to 5.96 per cent in the second quarter. So the upcoming budget needs to focus on boosting consumption - and one simple way is through tax cuts.
Sitharaman had announced an overhaul of income tax laws last July; reports suggest the government may introduce a bill for it in the forthcoming parliamentary session. While such a legislative change takes its own time, Sitharaman might want to consider a partial rollout of tax reforms when she presents the budget next week.
The Income Tax Act 1961 has been amended almost every year. The countless deletions and additions have rendered the Act incomprehensible to an average taxpayer, and have increased the cost of compliance and administration.
They have also emerged as the biggest cause for litigation. Despite repeated attempts to rewrite it, the 1961 Act remains an unfinished agenda. Every effort to overhaul only makes one thing clear - that the old law is way too complicated, with provisions that are sometimes overlapping or contradictory, and even inconsistent with basic tax principles.
It fails to deal with routine transactions, allowing for tax avoidance that has serious revenue consequences. In short, the current law goes against the goal of ensuring a reliable, equitable and non-distortionary source of revenue.
Tax reform is a complex economic and political process. Any proposed change must remove distortions and minimise the cost of compliance and administration. Importantly, it must include Adam Smith’s doctrine of equity, economic efficiency and simplicity.
While overhauling the tax laws, the government must remember that the purpose of taxation is not to encourage growth; rather, it should be designed to be revenue-neutral. Income tax laws must be such that they are easy to obey, but hard to disobey.