Glide path for direct tax

One of the headline initiatives in the Union Budget for 2020-21 was a proposed change to personal income tax applicable in particular to income below a threshold of Rs 15 lakh. Finance Minister Nirmala Sitharaman spelled out the changes in her Budget speech on Saturday. Essentially, tax rates would be reduced for income between Rs 5 lakh and Rs 15 lakh, as long as no exemptions were claimed. Ms Sitharaman pointed out that the number of exemptions and deductions in the personal income tax code had grown inordinately, and was over 100. She said that 70 of those would be withdrawn, but in order to aid those taxpayers who sought simplicity, an additional option of paying tax at lower rates with no exemptions would be introduced. Rates would be halved from 20 per cent to 10 per cent for income between Rs 5 lakh and Rs 7.5 lakh; income between Rs 7.5 lakh and Rs 10 lakh would be subject to tax at 15 per cent instead of 20 per cent; and so on till Rs 15 lakh. This provides a new set of options for those who do not wish to benefit from exemptions. From the point of view of simplifying tax payment, especially for younger people, this new layout has much appeal, and the finance minister deserves credit for moving forward in this direction. Importantly, there is a certain conceptual similarity to how lower corporate taxes have been introduced by this government.

 

The question that should now be asked, given this forward-looking move, is what the next steps will be. Clearly, the intent is eventually to move to an exemption-free or low-exemption direct tax environment, which will aid in compliance and in expanding the tax net. This is a positive intent. The transition should be made predictable and transparent, since it will affect how individuals save and how certain sectors, such as insurance, plan for their future. There is no conceptual reason, for example, why insurance should be seen by policymakers as a tax-saving form of saving rather than as its primary purpose, to provide a low-cost and clear way for individuals and corporations to pool risk and insure against low-probability events. Individuals, however, should have ample time to decide on how they will save for their future. In this context, for example, the limits on tax saving through provident funds and the like should be announced well in time.

 

There is clearly a demand as well for personal income taxes to eventually be brought in line with the new corporate income tax framework. At the moment, the government is perhaps pleased with the increasing corporatisation of partnerships being incentivised by the tax arbitrage in how they are treated. But eventually this difference too must be minimised in order to introduce efficiency. Nor will the aim of decreasing complexity for the individual taxpayer be met if she has to work out her tax under two different taxation schematics in order to understand which she should pay. In her Budget speech, Ms Sitharaman rightly said that it was almost impossible for a taxpayer to comply with the income-tax law without taking help from professionals and the new system would make things much simpler. But the fact is most taxpayers might still need professional help to determine if moving to the lower tax rates would benefit them. In any case, two tax regimes with optionality only make the structure more complicated. Given that the finance minister clearly has a vision as to where direct taxes should go, it is time to give India a glide path to that destination.

 



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