Government may rationalise personal income tax rates

If broad hints dropped by Finance Minister Nirmala Sitharaman over the weekend are any indication, the government may be considering a rationalisation in personal income tax rates. Coming after a significant reduction in the headline corporate tax rate, this prospect of lower personal income tax payments has already made large swathes of individual taxpayers hopeful. Particularly salaried Indians, since they believe they carry an unfair burden of taxation and the load on their backs should be reduced anyway.

According to government data, just about 6% of Indian individuals pay any tax at all on their income. The need to rationalise personal income tax rates exists, but whether any such move will lead to a boost in consumption demand and therefore lift a sagging economy, remains in doubt.

“(A cut in personal income tax) One among the many things we are looking at,” Sitharaman was quoted as saying at the Hindustan Times Leadership Summit 2019 in Delhi on Saturday. She was talking about fresh measures the government is considering to boost the economy, as GDP growth rates have been falling to record lows, quarter on quarter. And the latest estimates of full year GDP growth range between 5-5.5%, a significant downward revision from near 7% rates that were seen at the beginning of the fiscal year.

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The government has already announced several supply side measures (sector specific as well as bold ones like corporate tax rationalisation) to boost economic activity. The RBI has also gone in for unprecedented five successive rate cuts so that lending rates have fallen by 135 basis points since February this year. But the economy continues to be a drag and now, amid a clamour for steps to boost consumption demand, Sitharaman has thrown this pebble in the pond.

Will any rationalisation actually spur consumption demand?

CARE Ratings’ Chief Economist Madan Sabnavis pointed out that it would be an exaggeration to say that any reduction in personal income tax rates will do so.

“Whatever tax relief we are talking about would not be substantial from the point of view of an individual though will cost the government a large amount. We have seen the PM Kisan Scheme costs the government ₹75,000 crore or so but gives ₹6,000 or so to a farmer which is hardly an amount to stimulate spending. Only if it (personal income tax relief) is large we expect spending,” he said.

So mere rationalisation in income tax rates is unlikely to boost spending by the common man unless the reduction is substantial. But a rationalisation is still a good idea. Akhilesh Ranjan, convenor of the task force on simplification of the direct tax legislation, said there was room to relook at rates for middle levels of income. He was referring to annual income between ₹5-20 lakh. “At present, we jump from 5% straight to 20% tax slab. This can be rationalised.”

Ranjan said rationalistion will not just reduce burden of taxation on the common man but may also lead to increased tax compliance. The task force has recommended ways to expand the overall tax base, lowering the tax burden and making taxation laws simpler. “Rationalising slabs will put more money in hands of people… If recommendations of this task force are accepted, the middle income group will see its tax liability fall by a third.”

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Perhaps alongside any move to lower rates of taxation, the government should also consider measures to widen the tax base so that total tax collections do not suffer significantly. The percentage of Indians paying any income tax is too small – the agriculture sector is almost entirely exempt from taxation on income. The task force has made recommendations on rationalisation of rates as well as on ways to bring small businessmen, more self-employed professionals and other such categories of Indians under the tax structure by proposing simplification of tax laws. The objective of these taxation reforms is to widen the personal income tax base from 6% Indians to 10%.

What about the super-rich?

Another contentious issue: Should the government consider lowering rates for the super-rich – those individuals who earn crores each year and are among the highest tax payers? In the 2018-19 Union Budget, the rate at which these individuals are taxed was increased so that effective tax rate now stands at over 42% for such tax payers.

Sabnavis said cutting rates at the higher level, though non-egalitarian, will help in boosting expenditure as this class has spending power. “But even this will be more at the margin as expectations are negative on economy and people may be less interested in spending. Consumption picks up only when more jobs are created and incomes increase. Today companies are not doing well and are economical with pay hikes.”

Meanwhile, whatever be the quantum of cuts in personal income tax rates, how will the government manage its own finances, given that the total tax collection thus far this fiscal has already been significantly below expectations? Sabnavis of CARE Ratings said total shortfall in tax collections this fiscal could be ₹2-3 lakh crore. The government itself has estimated a shortfall of about ₹1.45 lakh crore from lower corporate tax rates alone. In this scenario, will it find the nerve to lower personal income tax rates? One will have to wait for the Budget in February to find out the math.

Tax and Modi 2.0

There were no new tax breaks for the salaried aam aadmi in the first Budget of Modi 2.0. As proposed in the Interim Budget in February 2019, those having taxable income less than ₹5 lakh do not have to pay any tax but for individuals having taxable income over ₹5 lakh, there is no change in slabs. For the super-rich though, the Budget spelled doom. It levied a fairly steep increase in taxes for those earnings over ₹2 crore in a year. For annual income between ₹2-5 crore, effective tax rate was hiked by 3% points while for those earning over ₹5 crore, effective tax rate increased by 7% points. So for anyone making over ₹5 crore a year, the effective tax rate climbed to over 40%.

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