Increasing threshold: Ensuring more people contribute to income tax

The decision, announced in the Union Budget, to change income-tax slabs and rebates such that no tax will be due on an income of ₹12 lakh and below has been widely welcomed. While the change in tax slabs and rates also means that those with higher taxes will have their burden reduced, the highlight is the fact that those earning ₹1 lakh a month in regular income — a little more for salaried workers, thanks to the standard deduction of ₹75,000 a year — will no longer be required to pay income tax. The government has presented this as a sign of faith in the middle class. Other commentators view it as a mechanism for reviving consumer demand and growth in the economy. Yet there are certain basic questions that must be asked about these changes, and about the logic behind them.

 

The most important question is this: In a country at India’s income level, is it right or wise to exempt those earning ₹12 lakh a year from the income-tax net? This may not be considered a particularly high income by global standards. But those are not the standards that should be taken into account when setting Indian tax requirements. In India, it is hard to argue that this does not count as the upper end of the income spectrum. In 2022-23, net national income at current prices per capita was about ₹1.7 lakh. Private final consumption expenditure per capita was in fact below ₹1.2 lakh. In other words, a salaried income of ₹12.75 lakh per annum is 10.6 times per capita private consumption expenditure. This is a remarkably high threshold, by global standards for exemption from income taxes.

 

While it is obviously the case that those earning even higher incomes must shoulder a disproportionate share of the direct tax kitty, creating such a high bar for exemption has its own problems and creates its own injustice. The tax foregone, of ₹1 trillion, will have to be made up for by other sources — and indirect taxes are notoriously regressive as compared to direct taxes. In other words, those earning 10 times per capita private consumption expenditure will be subsidised by those earning far less — for example, through their payments into the goods and services tax pool. It is also unwise to effectively narrow the tax base; more people should grow accustomed to the idea of paying income tax, even a small or nominal amount. The government should aim to collect small amounts of tax from a large number of people, not the other way around.

 

Meanwhile, if the object of these tax changes is to stimulate certain changes in consumer behaviour, it too should be reconsidered. Theoretically, there is no reason to assume that tax cuts will cause consumption growth at the required level instead of increased savings or inflationary pressure in supply-constrained sectors. Practically, the recent experience of corporate tax breaks — which cost ₹1.8 trillion or so in revenue foregone — did not lead to increased investment, as many hoped. The government has promised to come up with a new, simplified tax law soon. This is an important first step towards further broadening the direct-tax base. Hopefully, after that, a more rational approach to income-tax exemption levels will become possible.