Madame Finance Minister, here's why you should shower us some love on the personal taxes front

The Indian taxpayers' charter emphatically declares that government 'shall treat every taxpayer to be honest unless there is reason to believe otherwise'.

Published: 06th January 2023 08:51 PM  |   Last Updated: 06th January 2023 09:24 PM   |  A+A-

Finance Minister Nirmala Sitharaman holds a folder case containing the Union Budget 2021-22 in Delhi. (Photo | Shekhar Yadav, EPS)

Will she? Won't she? Possible tax reliefs are the biggest draw in every budget. (File Photo | Shekhar Yadav, EPS)

Taxpayers have a 'till death do us apart' relationship with the sovereign. Predictably, the treasury collars Rs 6 out of every Rs 10 it earns in taxes. Successive governments vow to leave more money with citizens, yet hope to raise as much revenue. Doing so, however, is neither simple nor easy.

As it is, India loses Rs 1 lakh crore a year, or 4.3% of its annual tax revenue, to tax evasion, according to the State of Tax Justice 2021 report. In fact, in 2019, the 15th Finance Commission too pegged the gap in tax collections at 5% of GDP or Rs 10 lakh crore using FY20's national output.

It's this anomaly that Prime Minister Narendra Modi promised to correct during his 2014 pre-election pitch. In the backdrop of the government's 10th budget next month, The New Indian Express takes stock of the progress made thus far.

The NDA government struck a rich vein in the past ten years as the tax base doubled from Rs 3.79 crore in 2014 to Rs 7.14 crore in 2022. But the tax-GDP ratio, indicating the strength of the exchequer, barely got better.

If the tax-GDP ratio under UPA I and II averaged 11%, it stood at 10.55% for the incumbent government. Interestingly, last fiscal saw a bumper tax haul shattering historic records, with the tax-GDP ratio touching 11%. The combined Centre-state tax-GDP ratio is at a relatively respectable 16-17%. Still, that's way below the OECD average of 33.5%.

Undeniably, India's tax-GDP ratio has always been below potential, while industrial countries enjoy twice as much and also get proportionally twice the revenue from direct taxes than indirect taxes. 

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Direct taxes are considered progressive, as the rich pay proportionately more than the poor, while indirect taxes are regressive with everyone paying the same tax. The poor spend much of their income on consumption, which means a greater share of their income goes towards taxes than the rich, whose consumption to income ratio is lower. This explains the advanced nations' reliance on direct taxes.

In contrast, India collected more indirect taxes accounting for 75% four decades ago. Direct taxes-GDP stood at a lowly 2% during 1990s, but was 8% for indirect taxes, placing the burden of nation building squarely on the middle class and the poor! This, despite finance minister Manmohan Singh reducing the number of income tax slabs from eight to three in 1992.

A significant turnaround began when P Chidambaram's 1997 'Dream Budget' replaced rates of 15%, 30% and 40% with 10%, 20% and 30% respectively. This helped improve the indirect-direct taxes share to 61:39 by 2003, while the tax-GDP ratios changed to 6% each for direct and indirect taxes, reflecting the shifting patterns of tax burden borne equally by the rich and the poor. 

A few years later, in 2005, Chidambaram's budget yet again stood out for introducing sweeping direct tax reforms. Corporate tax rate was cut from 35% to 30%, and though personal income tax rates weren't changed, he made significant changes to tax slabs and exemptions. The changes took three years to work their magic and for the first time in 2008, direct taxes leaped ahead of indirect taxes, initiating the historical shift in the country's tax revenue mix. Their share remained 55:45 or thereabouts for a while.

In the past ten years, the NDA government has ensured that the direct-indirect tax mix has improved further to 60:40. It's commendable because, though the 2005 budget widened the tax net, the slew of tax reliefs and relaxations in subsequent budgets meant that the effective income tax threshold was over Rs 5 lakh. Besides, Finance Minister Arun Jaitley reduced the entry-level tax rate from 10% to 5% in 2017 for income earners between Rs 2.5 lakh and Rs 5 lakh.

The government placed all its bets to sustain the trendline growth by increasing tax compliance alone. While in its first term, it channelled energies on expanding the tax base going back to basics.

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The Indian taxpayers' charter emphatically declares that government 'shall treat every taxpayer to be honest unless there is reason to believe otherwise'. Drawing inspiration from this, the government championed the principle of voluntary compliance, rewarding honesty. But before that, it also simplified the filing of income tax returns (ITR).

Though we don't have a common ITR form for all taxpayers, we've covered a significant ground from filling incomprehensible ITRs to an auto-filled returns in 2022. Likewise, while the promised 24-hour refund hasn't begun, we've jumped hoops from endless waiting period to receiving refunds within weeks or months. 

If widening the tax base took priority in the first term, NDA-II focused on gradual phasing out of exemptions and with good reason. As per the 15th Finance Commission estimates, the revenue foregone in lieu of tax reliefs was estimated at Rs 3 lakh crore for FY20. Inarguably, it makes sense to have a simple method of lower tax rates with no exemptions (which also reduces the scope for disputes) than having higher rates with reliefs encouraging tax evasion.

The government began testing this hypothesis first by announcing corporate tax rate cuts in 2019. It was a bold move to lower the top corporate tax rate by 10% to 25% for all companies with deductions (22% without deductions) and 15% for new manufacturers, dismissing concerns of a triple whammy of lower revenue, higher fisc and inequality. It also offered companies a flat tax, without exemptions.

It took a while, but the results started trickling in. During April-June 2022 quarter, corporate tax revenue was up 30% and taking FY20 as the base, revenue shot up 66%, or an average tax buoyancy of 2.0 over three years. Moreover, the effective top tax rate stood 22.5%, lower than the projected 25%.

With evidence on its side, an emboldened government pressed the proposal of tax rates with and without reliefs to personal income taxes. Announced two years ago, it's voluntary, but the intent towards a clean, simple and low tax rate structure, is unmistakable.

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But the catch here is, tax rates haven't been reduced. Moreover, the top effective income tax rate is north of 42% as against 22.5% for corporates. A good tax policy ensures that the marginal personal and corporate tax rates do not differ materially.

Clearly, we need rate parity. Right now, it's uneven, and hence a good place to show some love in this budget or next.

  • The OECD average for direct tax collection in 2018 was 67.3% of the total tax collection, while for India, it was 60% in FY22.
  • Direct taxes are considered equitable and in most developed countries, the share of direct taxes in the total taxes collection is higher than indirect taxes.
  • In FY18 and FY19, direct tax-to-GDP also touched 5.9% and 6% respectively, while the share of indirect taxes stood at 5.3% and 4.9% respectively.
  • The share of direct tax to GDP is expected to be at a four-year high of 5.5% this fiscal, while indirect taxes will likely moderate to 5.2% from 5.4% in FY22. The decline is due to the decline in excise collections.
  • The shares of direct taxes and indirect taxes also indicate how the government has managed its public finance. Low direct taxes and corporate taxes suggest that the tax burden is shifting towards the poor.


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