Amendments made in the rate structure of income tax (I-T) in this year’s Budget have been disappointing. Finance minister Nirmala Sitharaman enhanced the surcharge on tax payable on income between Rs 2 crore and Rs 5 crore from 15% to 25%, and that on income above Rs 5 crore from 15% to 37.5%. The tax liability for taxpayers in these two slabs has, thus, increased by about 3% and 7% respectively. The revenue gain is estimated at Rs 12,500 crore. These proposals, however, are flawed, and require reconsideration.
For starters, they are shrouded in opacity. The highest basic rate of tax for individuals remains unchanged at 30%, but the surcharge on the tax has been enhanced. Further, a 4% health and education cess is leviable on the aggregate of the tax and the surcharge, as in the case of all other taxpayers. So, from April this year, incomes earned between Rs 2 crore and Rs 5 crore will effectively be taxed at 39%, and those above Rs 5 crore at 42.9%. It would have been much more transparent to straightaway pitch the basic rate at these levels, without bringing in so many convoluted calculations.
The new proposals also fly in the face of the reforms introduced in February’s interim Budget when incomes below Rs 5 lakh — about 36 million individual taxpayers — were exempted from I-T. GoI had hinted then that more reforms were to follow in July. Instead, most of us now face status quo. High net-worth individuals (HNWIs) now confront needless pinpricks by way of enhanced surcharges that hardly benefit the exchequer. The revenue they will generate will be much less than 1% of the target of Rs 13.35 lakh crore fixed for the current financial year.
“In view of rising income levels,” Sitharaman had said in her Budget speech, “those in the highest income brackets need to contribute more to the nation’s development.” This is a throwback to the days of the licence-permit raj, when the tax structure was characterised by a multiplicity of rates, which contributed to the complexity of India’s unimplementable I-T legislation. Times have since changed. Modern optimal tax theory favours a minimal number of tax slabs. In any case, where the number of taxpayers is currently barely 3% of the population, how much income redistribution can be effected through income-tax?
Sure, there are countries where the highest tax slab is higher than in India: Holland (51.95%), the US (50.3%), Germany (47.5%), France (45%). But the level of compliance in these countries is much higher than in our country. Also, the taxpayer can make the fiscal connection between the taxes she pays to the State and the social security and other benefits she gets in return. This is not so in India where most welfare programmes benefit people who don’t pay I-T
It would be wiser to compare our maximum marginal tax rate with countries with comparable levels of development, and with whom we compete for foreign investment: Vietnam (35%), Thailand (35%), Indonesia (30%), Malaysia (28%), Cambodia (20%). Currently, our top tax band is higher than all these countries.
This latest tax measure is unlikely to go down well with the 9,400 foreign portfolio investors (FPIs), 30-40% of whom are organised as trusts. The finance minister has clarified that the rate increases will be applicable to such trusts as well. Since the new surcharges will substantially enhance the liability of such investors, many of them would rethink about continuing their operations in India.
By leaving a gap of about 8% between the maximum tax rate applicable to domestic companies (34.9%) and individuals (42.9%), the amendment will compel many taxpayers to corporatise to avoid tax. Sitharaman has suggested this course of action to FPIs. But she forgets that corporates are also burdened with a dividend distribution tax of about 20% when they declare dividends. In any case, the form of business organisation should be determined by the taxpayer’s business interests, not by the I-T rate structure.
GoI seems to have ignored the possibility of an increase in tax rate subsidising leisure, since the income to be sacrificed to enjoy such leisure will decrease. This is hardly a result a country aiming for a $5 trillion economy by 2024 would want to achieve.
Finally, a tax increase also transfers wealth from private hands to public coffers. When such a transfer is effected from HNWIs, it has the effect of reducing private savings. Had the tax not been levied, the amount transferred to GoI would have been saved. Is such money more productive as private investment or as public expenditure? The answer to this question for a capital-starved economy, trying desperately to shore up domestic investment, is obvious.
The writer was chief commissioner of income-tax