Personal I-T revenue now equals all other direct taxes: That's a problem

For most of history, governments all over the world have taxed their citizens in order to meet the expenditure on public goods. These are wars, defence, currency, police, justice and, of course, the salaries of tax collectors. Plus some other things.
 
Then came populist democracy and governments began to tax in order to finance the creation of quasi-public goods and outright private goods. This led them to tax both businesses and people. In fact, people forget that the income tax as a permanent tax is just about 150 years old. Thus began the competition between income tax — namely, the tax on the incomes of people and businesses on the one hand, and taxes on output on the other.

 
Until the 1950s taxes on output contributed more to government revenue than those on incomes of people and businesses. But since then the balance has gradually been reversed. Now direct taxes contribute more to the total tax kitty.
 

India hasn’t been an exception to this general trend. Over the years, direct taxes have formed an increasing proportion of the government’s overall tax revenue. In the past six years the increase has been of about 5-6 percentage points each year. Even with goods and services tax (GST) stabilising and shouldering more of the load, the proportion of indirect tax is likely to remain about 40-50 per cent for the next few years.

 
The dilemma
 
This constitutes a problem because most demands made of the government, especially financial ones, tend to ignore the new constraints.
 
The perfectly reasonable demand for a reduction in personal income tax rates — or their incidence — on the middle class has to be seen in this context.
 
On the one hand, since corporate tax rates were just slashed last September, and GST is out of the Budget, personal income tax is the only avenue left for any relaxation. On the other hand, direct tax revenue needs to remain buoyant. For several years now, personal income tax has been forming an increasing share of direct taxes themselves. There has been an increase of 10 percentage points in their share over six years.

 
Given that the government just drastically cut corporate tax rates, it is highly unlikely to reverse that decision. So, to maintain direct tax revenues where they are, the government can’t really afford to cut its income from personal income tax. Yet it needs to do that because it needs to change the mood of the spending classes so that they feel good and spend more. This can only be done by reducing income tax.
 
Thanks to the job losses because of the pandemic, and the huge slowdown in economic activity, the number of people who can pay tax at the old levels — or indeed pay at all — has shrunk quite considerably. This has accentuated the income-tax problem.

 
It’s therefore the perfect dilemma.
 
Tax farm incomes
 
The truly absurd part of this tax dilemma is the fact that personal income tax is paid by just over one per cent of the population, or around 15 million people. The remaining 1.35 billion people pay nothing, even though possibly as many as 100 million of them can actually pay but either evade or, even worse, are exempted.
 
The way out is to widen the tax base by taxing anyone who shows an annual farm income of over Rs 10 lakh. NITI Ayog had proposed this in 2017 but nothing came of it. But times have changed. Just a small 10 per cent tax will do. Until 2008, China used to tax away in one way or another 45 per cent of farmers’ incomes. It now taxes them at 8 per cent.