Turgot, the French economist and minister in Louis XVI regime, said, "The expenses of government, having for their object the interest of all, should be borne by everyone, and the more a man enjoys the advantages of society, the more he ought to hold himself honoured in contributing to those expenses." It is apparent that everyone ought to pay tax, and those who benefit from governance more should pay more.
A tax rate structure must, first, be objectively analysed to arrive at an equitable solution. The structure must consider the minimum taxable income or, where it is zero, the income up to which the lowest tax rate is applicable (LTR), and the income above which maximum marginal tax rate is applicable (MTR). It must also consider the minimum and the maximum tax rates and the number of income brackets.
If linked to some relevant economic index, these figures can have a rational basis. One such index could be Gross National Income per capita (GNIpc). Table 1 shows the relationship of GNIpc with LTR and MTR of seven developed and developing countries. This may be subject to certain adjustments but it does give a fair comparison to understand the issues involved.
The table shows many of the countries tax every unit of income. LTR as a factor of GNIpc of all the countries mentioned, except India, varies from 0.02 to 0.95. In India, it is 2.62, which is very high. The more contentious issue, however, is the maximum marginal tax rate and MTR. The table shows that in countries other than India, the ratio of MTR to GNIpc varies from 8.23 to 0.98. In India, it is as high as 13.08.
It is suggested that in India, LTR be lowered to Rs 1,00,000, which will be 1.31 times GNIpc, which is still high. Regarding MTR, it may be fixed at Rs 40,00,000, which would be 52.33 times GNIpc. Any further increase of LTR or MTR would make the ratios of such incomes to GNIpc very high and sharing of tax burden very inequitable.
As regards the tax rates, the table shows the lowest rate at five per cent and the maximum at 50 per cent. Besides, there are separate health care and social security levies in many countries. In many countries, besides the federal tax, states also levy income tax. By these standards, India, today, has moderate tax rates. In 1973-74, the highest rate was 97.75 per cent. It was reduced to 40 per cent by 1992-93, and then to 30 per cent in 1997-98. It has continued at this level since then. It is suggested to keep the minimum and the maximum tax rates at two and 40 per cent, respectively.
The number of income brackets may be kept at seven. In other countries, it varies from four to nine. The Gini coefficient that measures inequality - one representing maximum inequality and zero the minimum - would swing towards one if there are fewer income brackets causing greater inequality. Also, keeping the number of income brackets low would make the progression from minimum to maximum steep, and encourage the people make all efforts to keep the income within the lower income bracket to avoid tax. Having too many income brackets, on the other hand, would render it complex for calculation.
On these considerations, the personal tax rate structure shown in Table 2 could be considered. This rate structure may be kept undisturbed till GNIpc reaches Rs 1,00,000. Need for additional revenue may be met by levying surcharge for one or all the income brackets without disturbing the relativity of taxation. Concessions for special groups like senior citizens, physically handicapped and others may be given by allowing standard deduction of 20 per cent.
Lowering the tax rates at the middle income level would serve twin objectives. It would increase voluntary compliance and not only undo the parallel economy, but also add to the revenue as explained by Laffer Curve. But the more important effect would be on the economy. Increasing the disposable income in the hands of middle and lower income groups of people would flood the market with consumer demands and spur industrial growth, which in turn would create employment opportunities. It is well understood that beyond a certain level, any addition to income in the hands of a person does not create additional demands for consumption. This is partly the reason for the slowdown of economy in the rich countries and scramble for markets in the developing countries.
The author is a former Chief Commissioner of Income Tax. These views are personal
ak@kurotax.co.in
ak@kurotax.co.in