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Is it feasible to do away with income tax?
January, 20th 2014

If, last year, taxing the super-rich was the subject of debate, this year the discussion is on the possibility of abolishing income tax. It has been proposed that income tax be removed and replaced with a banking transaction tax (BTT) of 2 per cent on the money that is credited to a bank account. The argument is that the BTT would be more simplified and easy to collect. It would reduce the tax burden, prevent tax evasion and, therefore, generate additional revenue for the government.

Whether it is the Food Security Bill or provision of free water and subsidised electricity, such proposals always cheer the general public. The middle class has been reeling under high inflation for quite some time and the proposal to abolish income tax is likely to generate excitement.

Income tax is levied to fund the government's expenditure on defence, infrastructure and other developmental activities for the welfare of the nation and society as a whole. It also helps redistribute wealth and assets in society. The rich pay more, while the poor pay less or no tax at all.

In recent years, many developed countries have imposed higher taxes for the rich. A recent example is France, which has introduced a 50 per cent millionaires' tax on employers who pay salaries of more than 1 million euro. This rate actually becomes 75 per cent if one also counts the social security contribution. There are many other countries, where the tax rate, after including the social security contribution, is more than 50 per cent.

Some countries, such as Argentina, Brazil, Bolivia, Colombia, Peru and Venezuela, have used the BTT as an emergency measure to deal with the economic crisis. The BTT was levied on withdrawals (also on credits in some cases) and the rate ranged from 0.02 per cent to 2 per cent. However, this tax was levied only temporarily and wasn't seen as a replacement for the income tax. India, too, had a 0.1 per cent BCTT on cash withdrawals between 2005 and 2009, but the annual collection never exceeded Rs 600 crore.

In some countries, such as the UAE, Oman, Bahrain, Qatar, Saudi Arabia and Cayman Islands, there is no concept of personal income tax. However, these are very small countries rich in natural resources or are tourist destinations. India is a large country and there is a huge disparity between the poor and the rich. Therefore, a higher tax for the rich is the best way to redistribute income.

The BTT, however, does not differentiate between the rich and the poor. Anyone with money flowing into his bank account will be charged a 2 per cent tax on this amount. Whether it is a businessman, who makes Rs 1 lakh a day, or a humble peon, who earns the same amount in a year, will be subjected to the same tax rate.

It is likely to result in hardship for the common man. If you take a loan or receive money from a relative, 2 per cent of the amount will go into the government coffers. Think of the impact on people from the poorer sections, who are being paid government subsidy that goes directly to their bank accounts. Or senior citizens, who get a small pension and have an income that is below the taxable limit.

They will also be slapped with the BTT even though they are not required to pay tax. It won't stop there. If you pay an EMI on a home loan or your child's school fee, the bank or school may want to pass on the 2 per cent tax back to you. You might have to One of the basic arguments in favour of introducing the BTT is that it will help eliminate black money. However, many Indians still do not have

bank accounts. The tax will only affect those who have bank accounts, and to escape the tax net, they will start avoiding banking transactions as far as possible. This will result in more money flowing into the black economy. This is what happened in Argentina. When the government levied the BTT, the cash outside the banking system rose significantly.

There's another reason that the BTT may not be able to curb black money. In 1997-98, the government's Voluntary Disclosure of Income Scheme (VDIS) managed to pull Rs 33,000 crore of undisclosed wealth into the white economy. Thanks to the scheme, the government collected over Rs 10,000 crore in taxes that year. The undisclosed income was in the form of gold and jewellery (37 per cent), cash (50 per cent) and property (5 per cent). It was not in bank accounts.
Besides, if the BTT is being conceived to check black money—though it doesn't seem to be the case—will it not result in taxing such money at just 2 per cent, when it should be taxed at 33.99 per cent, along with interest? Won't it be unfair to the taxpayers who have been honestly paying their taxes all these years?

If corporate tax is removed and replaced with the BTT, it will impact the small-scale sector, industries that enjoy tax-free status or companies that are making losses, which would end up paying tax. How can this promote growth or employment? Will India also become a tax haven for foreign companies?

The bigger issue is sharing of the BTT revenue between the states and Centre. It has taken years of discussions and bickering to arrive at an understanding on the goods and services tax (GST). If the BTT is being conceived as an alternative to income tax, it is important to see the blueprint to analyse the pros and cons, and the likely impact. We have to wait, and watch whether the proposal can become a reality.

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