Taxing the super-rich

India needs a predictable, stable, and moderate rate of taxation

Finance Minister Nirmala Sitharaman struck the right chord in the very beginning of her Budget speech when she stated that the government does not look down upon legitimate profit earning. This was a welcome remark. Businesses in India have been marred by licence raj for far too long and making money has not always been appreciated. To her credit, Ms Sitharaman extended the benefit of the lower corporate tax to all but 0.7 per cent of companies, though the expectation was that the benefit will flow to all. 

But the feel-good effect of the announcement did not last long, because the minister proposed an increase in the surcharge for taxpayers earning more than Rs 2 crore. According to the proposal, the effective tax rate for individuals with a taxable income of Rs 2-5 crore and above Rs 5 crore will go up by about 3 and 7 percentage points, respectively. While the proposal will affect only a small minority of taxpayers, the idea is flawed at multiple levels and should have been avoided. It is estimated to improve income tax collection by less than Rs 3,000 crore.     

At a broader level, this goes against the basic idea of simplifying the tax structure. Although various kinds of cess and surcharge have been imposed in the past, this Budget has taken it to another level. Clearly, a reversal will be difficult for political reasons. It is not clear as to why the government intends to undo a system that has worked well. Experience shows that collection tends to increase when rates are lower. 

It is well accepted that the government needs more revenue to increase capital expenditure and fulfil its social obligations. Therefore, in order to increase collection, the focus should be on compliance and broadening the tax base. The idea should be to encourage people to pay taxes and improve the tax administration to detect noncompliance. While there has been some progress on the compliance and administration part, regular revisions in exemptions and rebates limit the possibility of meaningfully increasing the base. For instance, the Interim Budget gave a full tax rebate to individuals with a taxable income up to Rs 5 lakh. The revenue impact of this was more than Rs 18,000 crore.

What is desirable is that instead of depending on large payouts from a small number of taxpayers, India should move to a system where a large number of people pay a moderate rate of tax. Again, history shows that a higher rate of taxation results in evasion. It is possible that the super-rich section of taxpayers with resources at their command would look for ways to reduce their tax liability. It would be interesting to see the actual resource mobilisation on account of the new surcharge.

Further, if the government believes that the rich should be contributing more, it should work on revising tax slabs. This will keep the structure simple and transparent, and the states will also get their fair share. In fact, the government has made the job of the panel working on a new direct tax code more difficult. Hopefully, the panel will recommend simplifying direct taxes, and the government will find it convincing. In order to grow at higher rates, it is imperative that India has a predictable, stable, and moderate rate of taxation.