Growing needs for financing development interventions and strict borrowing limits set by the Fiscal Responsibility and Budget Management (FRBM) Act forced the Union Government in India to look out for ways for increasing its revenue. One of the options that it exercised for mobilizing more revenue in Budget 2013 was to propose a 10 per cent surcharge on the super rich in the country—people whose taxable income exceeds Rs 1 crore a year—for a year. In this context, we may note here that the peak personal income tax rates have been increased over the past five years by the United Kingdom (40 to 50 per cent), France (40 to 45 per cent), Germany (42 to 45 per cent), South Korea (35 to 38 per cent) and Mexico (28 to 30 per cent).
Expressing concerns over the proposal to increase peak income tax rates, some sections from India Inc have argued that this will discourage entrepreneurship and can also result in professionals shifting to low tax domiciles like Singapore.
This, it is argued, can have negative implications for investments in India. Cases of tax exile have been a reality in some of the developed countries, but these occur in countries with extremely high peak tax rates. India, however, with a highest personal income tax rate of 30 per cent has tax levels below the G-20 average of 37 per cent and far below the developed countries' average of 42.2 per cent (within the G-20). Therefore, an increase in peak tax rate to around 40 per cent can bring India more in sync with the tax structure across other G20 countries.
The highest marginal income tax rate on (employment) income in India at present (2012-13) is 30.9 per cent; this includes an education cess of 3 per cent levied on the tax rate of 30 per cent. The highest marginal rate (30 per cent) becomes applicable at Rs 10 lakh of taxable income in a year. The data available from the annual income tax returns filed for the year 2011-12 indicate that raising the highest personal income tax rate to 40 per cent could have yielded additional revenue that can be of crucial importance since India’s government spending in key sectors, like, health, education, and food and nutrition security, among others, is far short of the desired levels.
However, another matter of concern that should not be eclipsed by the peak tax rate debate is the low level of tax compliance in India with regard to personal income tax. This is proved by the miniscule 12.2 per cent share of personal income tax in total tax revenue in India, compared to G-20 average of 26.7 per cent, with figures going up to a high 46.2 per cent for USA. In the past also, the Comptroller and Audit General’s reports have reported income tax compliance level in India to be far below 50 per cent.
What about capital gains tax?
In addition to the low compliance level, another drawback of Indian tax structure with regard to taxing the super rich is the very low attention given to wealth tax. Wealth tax in India is very narrowly defined and is not progressive at all. According to the Planning Commission, 5 per cent of households possess 38 per cent of total assets in India. The number of dollar billionaires in India as per the Forbes list has also risen from 13 in 2003 to 55 in 2011. According to Credit Suisse Wealth Report 2012, India with a wealth of US $ 3.2 trillion is home to 1,58,000 dollar millionaires. Other global wealth reports also have similar findings. However, wealth tax collection in India in 2011-12 was a miniscule Rs 1,000 crore.
Differential treatment given to various forms of income for taxation purpose is another matter of concern. Capital gains tax acquires special attention in this category, as many people in developed countries have become rich by virtue of capital gains. Capital gains tax is the tax to be paid on gains accrued due to appreciation of any asset/capital possessed; the asset can be real or financial. Capital gains on real estate are grossly under-reported in India to escape tax. As regards capital gain on financial assets, India (like Turkey) is one of the few countries among G-20, which exempts individuals from capital gains tax specifically based on the criteria of holding period.
Low level of peak income tax rates, low level of income tax compliance by citizens, low level of wealth tax and a liberal capital gains tax regime have resulted in a low share of direct taxes, at around 37 per cent, in total taxes (in 2011-12) in India. Higher share of indirect taxes, at around 63 per cent of the total tax revenue, implies that the Indian tax system is relatively unfair to the poor as they cannot escape tax on many kinds of consumption commodities.
Although our policymakers did try with the philosophy of lower taxes to increase voluntary compliance level, recent spending and investment data indicates that this might not have made people willfully comply with filing tax returns. As revealed by the Union Finance Ministry in December last year, during the assessment year 2012-13, only 1.462 million assessees, including professionals and companies, had declared their taxable incomes as over Rs 10 lakh; whereas the I-T department had information that 3.38 million persons had made cash deposits totalling Rs 10 lakh or more in the savings bank account, 1.6 million persons had made payments of Rs 2 lakh or more against their credit cards, and over 1.19 million people had decided to purchase or sell house property worth Rs 30 lakh or more. This clearly shows that reduced tax rates alone can’t result in increased compliance.
Hence, it can be said that, given the low tax rates and high income inequality in India, increasing marginal tax rates on highest income slab is a good policy measure. However, an increase in peak income tax rates without any measure to improve the compliance level among the non-complying sections of citizens might look more like a tax on honesty. Therefore, the need of the time is to increase the peak income tax rates along with measures to improve the compliance level.
The author works with Centre for Budget and Governance Accountability (CBGA), a New Delhi-based policy research and advocacy organisation; he can be contacted at firstname.lastname@example.org