Rates are out of tune for higher-income levels, need revisions

In 1974, American economist Arthur Laffer proposed a new theory that said reducing tax rates would help increase revenue. The idea did not get much credence then, but years later President Ronald Reagan implemented Laffer curve economics leading to a near doubling of tax receipts in eight years.

In India, tax cut demands are a regular feature of Budget expectations. This year is no different. Rates have been revised often, but the popular complaint is that the tax system burdens the salaried middle class.

Data shows that between 2012-13 and 2018-19 the number of taxpayers in the over Rs 5 lakh income bracket grew faster than those in the Rs 2.5 lakh to Rs 5 lakh group. Consequently, the Indians who earn more than Rs 5 lakh annually comprise a third of the total tax filers.

While the number of people filing taxes has increased, taxation at the higher end of the tax structure has become lopsided. When India amended the tax system in 1985-86, the difference between the per capita income and the income attracting the highest tax was 26.9 times. It reduced to 8.6-times by 2005-06, before rising again as the government revised the upper limit for paying tax. It has now come down to 6.7-times, as the top rate kicks in at Rs 10 lakh. A lower ratio indicates that the tax rate kicks in too early. A higher ratio, thus, is more beneficial for taxpayers.

There is disparity in the lower tax rates as well. While the difference between the lowest rate of taxation and the per capita income was 4.8 times in 1985-86, it is 3.3-times if one considers the Rs 5 lakh limit. Income tax is exempted for those earning up to Rs 5 lakh annually, but an additional Rs 12,500 is levied if income exceeds Rs 5 lakh.

India’s tax calculations do not consider increases in the cost of living either, like the United States does. In 2012-13, the upper limit was revised to Rs 10 lakh and hasn’t changed since. Before that the upper limit was tinkered with every five-seven years. Adjusted for inflation after 2012-13, the upper tax limit would have increased to Rs 16 lakh. For the lower bracket the tax would have started from Rs 8 lakh.

India is somewhere in the middle when taxation for the upper-income bracket is considered, but leaving tax rates untouched can translate into a heavier tax burden on the population compared to the world. In the US, the highest tax rate kicks in at 8 times the per capita income. The difference is 20 times in Vietnam and 13 times in China. However, these countries have much higher tax rates for the highest income levels. A purchasing power parity comparison shows a much lower level of taxation for people earning Rs 10 lakh or less in other countries.

This analysis does not consider exemptions reducing taxable income, but such deductions are common elsewhere in the world.

India would do well to keep taxes in tune with the times.