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Why personal income tax rates need a revision
January, 07th 2022

With the budget comes the hope and expectation of tax rate cuts, especially for the salaried class. Budget 2022-23 comes at a perilous time—just when there were signs of an economic recovery, Omicron has upended all calculations. As the variant spreads faster, it has forced countries to close borders, intensifying supply side pressures and aggravating inflation. The incomes of millions of Indians have been severely hit, with jobs lost, pay cuts enforced and many businesses forced to shut down operations. Consumer demand was barely crawling back to normalcy—the new variant is likely to derail consumer sentiment and demand further.

Direct tax reforms have been an ongoing process with the Modi government, with a lot of emphasis on increasing compliance and simplicity of interface, including faceless assessments and so on. But as it turns out, the salaried, middle and lower-middle class have got the raw end of the tax deal that the government has worked out over the years. Corporate tax rates are amongst the most competitive in the world with no room for further rationalisation—down to 15 per cent for new manufacturing units. But in terms of income tax rates, the salaried tax payers continue to be taxed at relatively higher rates.The government introduced a new income tax scheme in its budget last year, giving taxpayers the option of choosing between the old regime or the new regime. The new regime offered a lower tax rate for those who gave up benefits of tax deductions on select savings and expenses. But as Sanjeev Kapoor, a chartered accountant and CEO at S.P. Kapoor and Company, a Delhi-based accountancy, explains, in a majority of the cases people don’t want to switch from the old system because nearly everyone has some sort of savings. “Nearly all assesses have their PF getting deducted. Multiple income tax regimes create a mess. When we talk about simplicity, there are glitches in the system, inordinate delays in filing notifications and so on. When we (as a CA firm) face trouble, how can an individual navigate the online filing system without help?”.

The new tax regime came into effect from April 1, 2020 (financial year 2020-21) under section 115BAC of Income Tax Act, 1961. It doesn’t allow 70 exemptions and deductions such as house rent and leave travel allowance, education allowance, section 80c and 80d benefits and home loan interest deduction under Section 24. Vikram Doshi, partner at Price Waterhouse adds: “Two schemes don’t work—they add to complexity. We don’t need two regimes. Confusion and uncertainty should not be there in taxation.” There is a strong case for further rationalisation of income tax rates for individuals.

 

Arvind Panagariya, economist and professor of economics at Columbia University says that a direct tax reform is long overdue. “In the Indian system, an income between Rs 2.5-5 lakh gets taxed at 5 per cent. If I earn Rs 4,99,999, I get taxed at 5 per cent, if I earn a rupee more then I get taxed at 10 per cent. It disincentivises me from any work to move beyond the income bracket. Unless I jump over a lakh rupees. If my income is Rs 6,00,000 I would do everything to keep it below Rs 5,00,000—this system creates a huge incentive to lie. In India, marginal and average tax rates are same. The horizontal inequity in taxation has to end. If income is coming from another source, it gets taxed differently. This has to end.”

In terms of individual tax rates, India’s income tax rates are among the highest in the world. Effective tax rate for salaries over Rs 15 lakh comes over 30 per cent, while corporate tax rate is down to 15 per cent for new units. Even as fiscal considerations might weigh down tax cuts in the budget, the salaried class, that pays taxes and pulls the consumption levers of an economy has been left in the cold for too long. Budget 2022-23 might be the time for a fresh start. Also, over the years, exemptions have nearly dwindled and what are left are not entirely reflective of the current times— such as conveyance allowance and house rent allowance. There is a cap on allowances which is not reflective of the market reality plus cost of education is a big cost for middle class Indians. The budget can take a holistic look and make the exemptions more reflective of the current times.

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