Finance Minister Nirmala Sitharaman
hinted last week that the government was considering lowering and rationalising personal income tax
rates, among other measures, to boost economic growth, which slowed to 4.5 per cent in the second quarter of the current fiscal year. There are a variety of reasons why the government should revisit and rationalise income tax
in the forthcoming Union Budget. For one, it would be a logical step after the reduction in corporate tax rates earlier this year, and would help take the process of direct tax reforms forward. The simplification of the tax structure has a better chance of improving collections in the medium- to long-run. Second, this will provide an opportunity to rationalise taxes for different category of taxpayers and remove distortions.
For instance, the late Arun Jaitley highlighted in his 2018 Budget speech that in the assessment year 2016-17, salaried individuals on an average paid Rs 76,306 as income tax, while the average for individual business taxpayers, including professionals, was Rs 25,753. Even at the aggregate level, collection from salaried individuals was roughly about thrice the amount of income tax
paid by individual business taxpayers and professionals. Third, lowering tax rates for individual taxpayers is expected to increase their disposable income and help boost consumption, though the impact on the overall economic activity could be limited because of the small taxpayer base.
The government, though, would have done well to release the report of the task force that reviewed the direct tax laws. This would have enabled a more informed public debate on the issue and, consequently, placed the government in a much better position to take the reforms process forward. At a broader level, while the idea of rationalising individual income tax rates needs to be welcomed, it is important to note that the government is in a difficult position in terms of revenue collection and will need to strike a fine balance. A sharp reduction in rates can adversely affect revenues and further weaken the government’s fiscal position. Most analysts believe that it will be almost impossible for the government to contain the fiscal deficit under the target of 3.3 per cent of gross domestic product in the current year. Since the economy is unlikely to witness a sharp recovery in the near term, revenue collection in the next financial year could also remain under pressure.
The focus should, therefore, be on removing distortions and rationalising exemptions, along with tax rates, to minimise the impact on revenue mobilisation. In the July Budget, for instance, the government raised the surcharge for “super-rich” taxpayers, which further complicated the income tax structure. Such measures should be avoided. A significant increase in tax rates, even for a small group of individual taxpayers, raises the possibility of evasion. While there is no certainty of an income tax cut translating into more spending as during tough times the tendency is to save more, a simpler regime with reasonable tax rates can be expected to help improve compliance and increase the base. Meanwhile, the government should also work on building institutional capacity in the tax department with better use of technology to check evasion. This will help improve revenue mobilisation and reduce the burden on honest taxpayers in a more sustainable manner.