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India’s Personal Tax Problem

India’s Personal Tax Problem

Arun Jaitley, India’s finance minister recently delivered a budget on the 29th of February 2016, which has received positive responses from global investors for sticking to a fiscal deficit target of 3.5% of GDP via a raft of measures from disinvestment of government assets, higher indirect taxes, to an amnesty for those who have dodged taxed in return for a 45% tax deduction.

According to India’s economic survey for the 2015-2016 financial year, revenue collection met the target set for the year. This is a welcome relief for the financial ministry seeking further macroeconomic stability. However, dig deeper into the numbers and revenue was primarily boosted by indirect tax collection zooming due to the resilience of India’s informal economy and the government boosting the indirect tax rate via schemes such as the Swatch Bharat (Clean India) cess. Direct tax collections comprising of personal taxes and corporate taxes posted weak growth.

It is well known that Indian corporates are burdened with a mountain of debt and earning has been subdued. The elephant in the room is insufficient tax payment by India’s rich and middle class. (salaried and self-employed). The Indian tax to GDP ratio has been stuck at 17% for the last two decades. This is a major anomaly considering the country has added middle-class households at a rapid pace since economic liberalisation since 1991. Even compared to peers in developing countries like China, the Indian middle class is undertaxed.

As a result, the Indian government has had to borrow more money to meet obligations (subsidies) and higher expectations, resulting in some 30% of federal revenues being spent on servicing debt. It’s clear that India as a country needs to raise more revenue. Indirect taxes are regressive as they target the poorest disproportionately. Considering the government also wants to introduce a pan-India GST tax (or VAT), indirect tax rates are expected to rise in the near term. Due to a revenue crunch, India cannot combat poverty effectively and is a recipient of foreign aid despite having the wealth to alleviate the problem.

According to the Economic Survey, hardly any Indians pay personal taxes of note, at some 15 to 17 million. This is a result of populist policies of successive governments in providing the middle class and wealthy loopholes. One such destructive policy is continuously raising the lower threshold beyond which any taxes have to be paid. As a result, most Indian middle-class households don’t even qualify for paying taxes. This is further compounded by India’s self-employed middle class (who form the majority of the middle and are not captive like their salaried peers) such as small business owners, doctors and lawyers, and so forth either dodging taxes or using creative methods not to pay their fair share. India just does not have the means to track all of them to collect rightful dues. Excuses for lack of payment range from “government should make the rich pay more” to “ they will waste our money anyway”.

If India is to combat poverty, the tax base of the government has to increase. Then only can the poor receive assistance to improve their condition selling government assets is an unsustainable solution. One of the biggest overlooked reforms Arun Jaitley has made (despite plenty of grumbling)  has been in keeping the thresholds for personal taxes the same, ensuring that more people qualify to pay taxes, spreading the tax net. It is imperative that these slabs stay untouched during this government’s term if India is to free itself from borrowing and inculcate a tax paying civic sense and responsibility.

Furthermore, considering salaried middle-class forms the backbone of revenue collection in most developed economies, India needs to spur growth in the number of the salaried middle class. This might mean incentives for corporates such as reducing their taxes from 30% to 25%. Making them globally competitive implies the faster creation of a salaried middle class due to robust hiring. New innovative methods need to be implemented to catch the self-employed middle. This might imply taxing their operational income to increasing taxes on assets their own or lease. Such bold moves should rightly be welcomed and encouraged by the press, investors and economists alike. The upliftment of India’s poor depends on the same.

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