Higher tax rates lead to lesser tax collections. The state needs to be the catalyst in triggering consumer demand, and taxation is an important policy parameter to shape the economy that we will have.

Taxation is an integral part of any economy. It’s the main source of revenue for the government. Recently, there have been efforts from the Union government to bring in income tax reforms and a new direct tax code is also being discussed.

Sometime back, an interesting question was asked by the current chairman of Central Board of Direct Taxes to Sadhguru Jaggi Vasudev on the low level of trust between the tax authority (government) and the taxpayer, particularly the income taxpayer. Sadhguru’s response was apt: When only a small section of the society (less than 2 per cent of the population) is paying taxes and the collected taxes do not show any direct benefit to the taxpayer (direct is anything that is only benefitting the taxpayer and not others), there will always be a lack of trust.

This feeling of injustice is natural for all taxpayers and even amongst the more affluent salaried class of taxpayers. Unlike income tax on business, which is charged on net profit and not gross income, a salaried individual pays tax on gross income and not after expenses. The small deductions allowed do not cover for the expenses and the rates are much higher.

The small taxpayer base in India may get even smaller due to the recent challenges to our economy. Imagine the plight of an individual who has been paying up to 45 per cent of his or her salary every year in taxes and happens to have lost his or her job during the current crisis caused by the coronavirus pandemic. This individual and the family would be feeling cheated at the hands of the state because they never saw any direct benefit in their tax outgo.

Different countries over the evolution of their economies have tried different models to tax their citizens. Taxes on property, wealth, income or services are common. We keep finding ways to tax our businesses, individual incomes, tax consumption with GST or transactions with entry taxes (customs, Octroi, Road tax, Toll tax etc.). Every government needs to balance its budget, the inputs (tax and other receipts) with outflows (governance expenses, investments for nation-building and, of course, wastage and pilferage).

The current ruling party, during its election campaign, had called for “minimum government, maximum governance”. We all understood that as an intent to reduce government expenses, with an aim towards increasing investment and reducing taxes. Unfortunately, these assumptions seem to have been misplaced. There has been no visible effort to reduce expenses, and at the same time, several initiatives are expected to increase the tax burden. High GST rates, rejigging of the income tax rates, and all different kinds of surcharges take the direct tax rates in some cases to over 46 per cent.

The promise of “minimum government” seems to have been abandoned in favour of populism and vote-bank considerations. Most of the good work done by this government was achieved by taking some benefits away from the taxpayer. Funding for the celebrated Ujjwala scheme, for example, came from the withdrawal of subsidy to the common man, and not from the savings generated by checking pilferage.

There are well-known relationships between tax rates and overall tax collection (explained by Laffer’s curve where higher taxes mean lower collection). Higher tax rates can be counter-productive. That is why the NDA, and also the previous governments, had more or less capped the personal income tax rate at 30 per cent. Some work done by this government towards reducing taxes for corporates was also in the hope that the savings would be invested back by the businesses to generate more jobs. More money was being sought to be put in the hands of MSMEs through easy loans.

While job-creation no doubt must be a priority, the government seems to be missing a point here. Jobs are dependent on the generation of demand. If we are able to get the 1.3 billion population to be a large consumer base, businesses would find ways to bring in investments, and economic activity would be triggered. The key is “consumption first” and everything else would follow, including investment in manufacturing and services. That is what drives the US economy.

The state can define policies that drive consumption by putting more money in the hands of individuals, lower taxes and subsidies. Higher demand will drive more sustainable development, and also investments which will create the jobs that are elusive right now. For long-term and sustainable economic progress, we need to build the virtuous cycle of consumer demand-driven growth that would also attract investments and create jobs to fulfil the demand.

Also, we need to reduce the overall cost of compliance for our honest taxpayers. Currently, at 46 per cent (at the top), plus the fee for advisors and tax planners, there is not much incentive for compliance. When the cost of non-compliance is not significantly higher than compliance, it is a sign of a system about to go bad.

There are a few options that can be explored to balance these taxes for individuals:

Eliminate Individual income taxes: This would be very radical, particularly in India. However, we will not be the first country to do this. There are several examples globally (UAE, Bermuda etc.) where no income tax is charged. This would save a huge amount of administrative cost that is invested and these very smart departments can be redirected to other areas that I will come to.

This would also bring in a huge surge in trust for the state and could trigger a much-needed reverse brain drain, enticing Indian talent settled overseas to return.

There are several ideas to fill the hole in the Union budget that would be created as s result of this step. One of them is the introduction of a small banking transaction tax. With the deeper banking penetration than ever before, thanks to some good work done by the government with the help of the JAM trinity, this is not an unviable option. The rich would be making many more banking transactions and thus would be prone to much higher tax than the poor. Having a slightly higher burden on cash withdrawals than on digital transactions will also shape the behaviour of our citizens, and help in reining in black money.

The total net personal direct tax collection in 2018-19 was about Rs. 4.7 lakh crore. The total payment systems (sum of RTGS, financial market clearings and retail payments) was worth Rs 2,728 lakh crore in 2017-18, according to Reserve Bank of India figures. Thus, less than a 0.2 per cent fee on all transactions would be enough to adequately make up for the budget shortfall from personal income tax collection. This fee of Rs 2 per thousand can be modified for different types of transactions like cash withdrawals and online banking. Thresholds, like no charges for transactions up to Rs 1,000, can also be introduced to further protect the poor. The entire CBDT team can be redirected to administer this more simplified and efficient system.

Make Income Tax VAT-able: The idea for any ad-valorem tax is to tax the value addition or tax the next level of the transaction. All taxes paid on the inputs are allowed to be offset in the final payout. The principle of ad-valorem can be stretched to the sphere of income tax, where any taxes paid on the income are offset with the tax paid to spend from the income.

One of the big challenges for the state is the administration of these taxes and measures to ensure that leakages are minimised. Even today, in a lot of transactions, there are two prices, with GST and without GST. Traders and businessmen would continue to find ways to wriggle out of taxation net until the consumer enforces compliance.

By making the incomes taxes paid adjustable against the GST paid, the consumer would ensure they collect receipts and ensure tax compliance for all purchases they do. For administrative ease, there can be thresholds (VAT credit for only invoices with over Rs 1000 GST paid, for example) or criteria on what would be VAT-able (say, groceries or banking transactions can be exempt).

The demand would get a boost and moreover, this demand would also drive compliance as the consumer will demand GST invoices, and start the virtuous cycle of visible demand in the main economy.

The compliance on the GST may itself be enough to make up for any loss to the state in terms of collection. The taxation from higher demand may be additional. Further, there may be an opportunity to integrate CBDT and CBEC and potentially generate administrative savings for the state.

Tax a family, not an individual: This is not an “either/or” option and can be implemented with any of the other models. Corporates are not taxed for each business. Only the overall legal entity is taxed. This same model can be extended to income tax as well, wherein the family, rather than the individuals, are taxed.

We are a country where our parents are often dependents in old age. There are deep cultural nuances to how we use the incomes we generate on taking care of our elderly (least number of old age homes across comparable economies), supporting our children (lowest student loans), or on marriages. The current taxation on the individual does not cater to this reality. As we start thinking about taxing families in place of individuals, the definitions for tax exemptions and deductions also begin to change. We start to account for costs for dependents, overall income for a family, cost of tuitions, and health and number of members of the family. There are several countries like the US and South Africa that enforce this type of taxation.

Overall, the state needs to be the catalyst in triggering consumer demand, and taxation is an important policy parameter to shape the economy that we will have. While the plans for reforms on the direct tax code is still being worked out, it is time to explore options including the radical ones that have been proposed.