Budget 2018: Don’t do away with income tax, Mr Jaitley

By Ram Singh
Several commentators, including Anjana Menon in this paper (‘Just Get Rid of Income Tax’), have advocated the abolition of income tax (I-T) in favour of a consumption tax (CT). They argue that this would, at one stroke, eradicate both tax evasion and black money, expand the tax base and ease fiscal constraints for GoI and the states. Such beliefs are far removed from reality.

Unlike I-T, taxes on consumption are typically regressive. A CT is levied on the actual spending on goods and services, savings are not taxed. The poor spend most of their income. So, they effectively are taxed on all their income. The rich, who save the lion’s share of their income, are not.

Burden of a flat CT of 40% is equivalent of 40% of income of a poor person who spends all his income, but it amounts to just about 13% of income for the rich who spend around one-third of their income. In contrast, a good I-T regime is progressive: the rich pay a higher proportion of their income as tax.

Additionally, the move will have several detrimental effects. I-T collection amounts to more than .`4.5 lakh crore. To keep the revenue same, CT would have to be increased further to raise this amount. This would requiresky-high tax rates on goods and services. The effect will be either dampen demand and, therefore, reduced tax revenue, or a disproportionate burden on the middle and the lowermiddle classes who already spend a majority part of their income.

Various studies suggest that more than half the national income is appropriated by the top 10% of Indians. Given the high propensity of the rich to save, a CT will leave a substantial proportion of the national income untaxed. In contrast, under I-T, most of the income at the top is taxed. In sum, the abolition of I-T will accentuate the already alarming level of economic inequality in the country.

In theory, the regressiveness of CT could be reduced by taxing goods consumed by the rich differently than the ones consumed by the poor. Luxury cars can be taxed at a much higherrate than, say, salt, bread and milk. Unfortunately, differential taxation is not easy. How does one ensure that sale receipts for expensive saris, jewellery and high-end furniture are not manipulated to record their cheaper versions?

Moreover, the experience with implementation of the goods and service tax (GST), a CT, shows that products originating from informal and semi-formal sectors are hard to be taxed. Even in the formal sector, CT can be avoided by underinvoicing the sale receipt at the last leg of the value chain, a scenario much more likely at higher tax rates. That is why the tax rates under GST have been a saga of one foot forward, two steps back.

It is a mistake to blame the phenomenon of black money on I-T per se. To a large degree, it has its genesis in illegal mining, underinvoicing of gold and jewellery, and rampant underreporting in the real estate transactions along with benami properties. If anything, the abolition of I-T may exacerbate the situation by freeing up income of the top earners for investment in such nefarious schemes.

Some of the existing taxes are also to blame for the state of affairs. For instance, consider the tax on real estate transactions, a.k.a., stamp duty. Under it, buyers and sellers collude to evade tax.

If a transaction worth Rs 10 crore is reported as being worth Rs 5 crore, at stamp duty rate of 8%, the parties will only pay Rs 40 lakh as tax, rather than Rs 80 lakh if they reported truthfully. Further, underreporting enables the seller to evade capital gains taxes. Processes like this are the main culprit in the generation of black money.

Stamp duty should be replaced with an annual tax on the assessed value of the property. The existing mechanism for determination of circle rates, or registry rates, can be improved and used for the purpose. A property tax independent of ownership and the reported value of transaction will greatly reduce the scope for tax evasion and black money generation.

Moreover, a meaningful wealth tax is needed. According to a Credit Suisse report, the richest 5% of Indians account for as much as 68% of the nation’s wealth. If even at a wealthincome ratio of 4 and tax rate of 1%, it can add more than Rs 3.25 lakh crore to the official kitty each year. There is also a need to do away with tax exemptions on long-term capital gains.

The existing tax regime needs several reforms. Scrapping of the I-T is not one of them.

The writer is professor, Delhi School of Economics