Many Indians are expressing their unhappiness with income taxes on social media, even though few pay any.
However, most of the 75 million individuals who filed returns last year — less than 7 percent of the population — consider themselves to be middle class. Their loyalty is electorally crucial to Prime Minister Narendra Modi. Hence, the calls for an overhaul of India’s six-decade-old tax code are becoming impossible to ignore, even though two previous attempts — in 2010 and 2019 — haven’t gone anywhere.
A third shot is on the way, probably after next month’s annual budget presentation, according to media reports. This one had better hit its target.
But what should be the goal of the reform? Simplifying the current law, with its bewildering array of rules, sub-rules, clauses, sections, and subsections will be helpful to taxpayers and accountants. Beyond that, any such revamp has to ensure greater fairness: an equitable sharing of the burden between capital and labour, between the rich and the poor, and between the current and future generations.
Everyone agrees that India’s tax base is too narrow. Nearly 47 million, or 63 percent of those who did file returns last year, paid nothing. At the other end of the spectrum are 40,000 movers and shakers, each of whom paid at least $100,000. While they are vocal about everything from pollution to potholes, most of these wealthy people are internationally mobile, free to up and leave if they don’t like the bargain, and thousands have been doing just that annually in recent years. Together, though, the elite account for less than a fifth of income tax collections.
Politically, it’s the taxpayers in the middle whose views matter. That’s because more than four-fifths of the burden falls on them. And of late, this group has been grumbling about how badly it’s getting ripped off, not just when it earns, but also when it spends on a new car, or gets lucky in the stock market. High consumption taxes, levies on capital gains, and tolls on badly maintained highways are adding to the unease that too much is being taken away from too few.
An expansion in the tax base will lift the burden for those currently feeling squeezed, but that will require individual prosperity to be more widely spread. A big chunk of the 600 million-strong workforce is still stuck on farms — agricultural income is tax-exempt — or engaged in informal occupations that pay little. The most that can be done in the short-term is to give some breathing room to the middle class in the upcoming budget — even though revenue will take a hit.
It isn’t the only way. Lowering the goods and services tax, which ranges from zero to 28 percent, to a uniform 12 percent, bringing petroleum products in its ambit and sharing the proceeds with cash-strapped cities, will make many more people happier than the narrow group of income-tax payers. But that’s a separate challenge. A fresh fiscal bargain between New Delhi and 28 state governments on indirect taxes can’t happen in a hurry.
The other problem is philosophical. The Modi administration, now in power for over a decade, wants investment to lead growth. So it can’t raise the corporate tax rate, which it cut unexpectedly in 2019. It also wants a permanent reduction in the cost of accessing global capital, especially for large-scale infrastructure projects. To that end, it believes it’s important to demonstrate that a 3 percent or lower annual budget deficit for the federal government, adopted as a target 20 years ago and met just once, can be a viable goal in the medium term.
Since the rewriting of the tax code is happening when people want relief but the government is out of painkillers, there’s anxiety about what will ultimately come out of the exercise. The previous administration had bungled it when, having failed to amend the tax code for the better, it ended up changing it for the worse. The 2012 budget of the Congress Party-led coalition, now in opposition, was a disaster. It introduced retrospective changes in tax rules. Jittery investors sold Indian assets heavily in 2013. The rupee got hammered.
If the proximate cause back then was the Federal Reserve’s “taper tantrum,” the threat this year comes from Donald Trump’s policies on trade and immigration, and their impact on US interest rates. After all, in June 2013, the 10-year Indian government bond offered a 5 percentage point premium to the comparable US Treasury note, and investors judged that to be insufficient yield for the additional risk. The extra spread currently is a little over 2 percentage points. The margin of safety for India’s expensive equity market is low.
Investors may be more forgiving if the target for lowering the budget deficit in the upcoming financial year to 4.5 percent of GDP, announced four years ago, is delayed by 12 months, principally to invest more resources in infrastructure and reverse the growth slowdown. Right now, the soured sentiment of the salaried class is a bigger worry. Only when it has the confidence to spend more, will those at the bottom of the income pyramid be able to pay down their debt. Better household finances will encourage more corporate investment, create new jobs, and lift growth.
Hence, the urgency to amend the tax code — and get it right this time.
Credit: Bloomberg
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