How to quadruple the number of tax payers in India

Have just two rates of personal income tax: 10 per cent and 20 per cent.

India’s tax to GDP ratio is around 12 per cent currently. It used to be around 10 per cent till recently. Most people think even this 12 per cent is too low and that it needs to increase to around 15 per cent.

But they forget two things. One, that as developing countries go, India is not doing too badly on this count and is more-or-less at par. Second, more importantly, a tax assumes the existence either an adequate income or adequate consumption or both.

India has a population of around 1,300 million people. Around 800 million of these live off the farms, and agricultural income is anyway not taxed. Nor should it be, given that on average – if you take out the urban crooks who launder money -- it rarely exceeds Rs 100,000 a year per family.

Of the  remaining 500 million people, barely 100 million earn enough to be able to pay income tax. Of these, around 25 million pay it,  and they are already being taxed properly.

The remaining 75 million who have taxable incomes get away scot free for one reason or another. The fault is entirely that of the income tax department.

Be that as it may, even with the best efforts to ensure maximum compliance, around 1,200 million people will still not have to pay tax. Their low incomes will not warrant it. This is India’s problem – too many free-riders.

Now if income is too low and you still want to raise the tax-GDP ratio, there is no alternative but to tax consumption more heavily. This is what the two-year old GST has done.

But because nearly 62 per cent of the items are taxed at zero percent, the central rate of 18 per cent has been fixed higher than it should be by about 3 per cent. This, in turn, has meant a far slower increase in consumption. Thus we get too little revenue from income and consumption, both.

So because governments have been focussing on the wrong ratio, namely, the tax-GDP ratio, we have shot ourselves in the foot as well as the head. It is time to give it up.

What then should be the right ratio to focus on? Indeed, does it make any sense to have such a target at all?

I think not because while such ratios help economists get the picture they want, it does nothing to help anyone else. After all, don’t forget: this ratio is  relatively new concept, just about 50 years old. Before that who measured GDP or the tax-GDP ratio?

What’s even worse, the idea of a tax-GDP ratio is connected to a political question: are we taxing enough? And since no government ever thinks so, the answer is always no.

This is the other manhole into which India has fallen. To get out of it, we need a different goal.

The simpler thing to pursue is the tax base or the number of people who don’t pay income tax. The target for the next five years must be a quadrupling of the number of people who pay income tax.

This is also the main case in favour of having just two rates of personal income tax: 10 per cent and 20 per cent. Not only will this improve the tax base (and thereby the  tax-GDP ratio) via better compliance, it will also bid farewell to the Gandhi family’s socialism which started in 1957, accelerated in 1971, mitigated in 1985 and left only a vestige in 1997.

Now even that vestige of three rates – 10,20 and 30 percent – must go.