In our January 14 article, ‘Towards an income tax revolution’, we had outlined what we believe is a major opportunity for the Narendra Modi government to bring in a structural reform to our income tax structure. What we suggested, and expand on today, is an integrated approach to both taxation and redistribution. The latter can take, and has taken, many forms over the years. Technology (Aadhar), and political will (demonetisation) allow India to finally begin to think big, and efficiently, in terms of redistributive policies.
But the two are necessary, not sufficient, for successful implementation. There is money involved, and the last thing the Modi government should do is to revert to the bad old days of “in the name of the poor” corrupt policies like PDS, NREGA, loan waivers, fertiliser subsidies etc. There is a buzz around that the budget might contain a basic Income policy. One of us (Surjit) had offered a discussion of how Rs 1,000 per person per month could be transferred to every one in the bottom half of the population, and that the cost would be Rs 5 lakh crore (trillion). As Subhashis Banerjee has correctly pointed out (‘A contentious proposal’, IE, January 14), the calculations are incorrect if transfers have to be made to the bottom 50 per cent; the calculations are correct if transfers are to be made to the bottom 20 per cent, the percentage of poor according to the upwardly adjusted poverty line of Rs 1,525 per person per month. The Tendulkar poverty line for 2016-17 is a lower Rs 1,250 per person per month. The error is unfortunate, and regretted.
Negative Income Tax : We are proposing, in lieu of basic income for all or even for a targeted population, that each non-farmer worker (hereafter just worker) receive a transfer upto Rs 15,000 a year. The negative income tax is obtained according to the formula 15,000 — 0.05*income of worker (upto an income of Rs 3 lakh). In the aggregate, for about 240 million workers (72.7 per cent of the worker population) the total outgo for NIT is Rs 1.7 lakh crore or an average of Rs 7,100 per earner recipient of NIT.
The Tendulkar poverty line, for a family of five, in 2016-17 prices, is Rs 75,000 a year. According to NSS data, the average number of earners in a poor family are close to 3.1; even for a two-earner household, the transfer will be equal to an average of Rs 16,000 (Rs 8,000 per earner). The average earning for the bottom 25 per cent of earners is Rs 90,000. For these 25 per cent, the take home post NIT income is 2*(90,000+8,000) or Rs 1,96,000 a year — well above the five person poverty level income of Rs 75,000.
Proposed Income Tax system: In several comments received on our previous proposal (‘Towards an income tax revolution’, IE, January 14), the one overwhelming response was that while the flat tax rate of 12 per cent was appreciated, most felt that it was politically unrealistic. Hence, we now propose a new revenue neutral system. This will be a two rate structure, 10 and 20 per cent. For the income range Rs 3-6 lakh, the tax rate is 10 per cent; for those above Rs 6 lakh, the tax rate is 20 per cent. Details are presented in the table. Note that there is a loss of Rs 1,181 billion in the new system with compliance unchanged. What is noteworthy about tax compliance in India in 2013-14 is that while tax compliance for those earning less than Rs 10 lakh was close to 30 per cent, the rate for those earning more than Rs 10 lakh is as low as 20 per cent. As the PM had mentioned, in 2013-14, there were only 2.4 million earners with income above Rs 10 lakh — our NSS distribution for 2016-17 suggests that the number of workers in this category is around 12 million.
Why should our numbers be believed? For two reasons: The mean income of our constructed distribution broadly matches (within 10 per cent) the mean income as obtained from national accounts. Second, and more importantly, official tax receipts for each of the years 2011-12 to 2015-16 match the receipts obtained via our synthetic distribution. Note that compliance rates are estimated via the number of official taxpayers (MOF data 2013-14) and the taxpayers as per the constructed distribution.
There are gains for all workers in the new system. A person earning Rs 4 lakh has her tax liability reduced by 35 per cent; for those earning Rs 8 lakh, the tax liability is reduced by 20 per cent, and for those earning Rs 16 lakh, the reduction is 27 per cent. A minimum set of compliance changes assumed by us are as follows: All compliance in the new tax regime is estimated to be 40 per cent. With this change in compliance, the new system will still entail a loss of Rs 640 billion. This will still mean that only 4 out of 10 workers actually pay taxes in India. In the US, 85 of every 100 people pay taxes. We will still have a very long way to go — but we can begin to get there.
This loss can be made up either by another few percentage points increase in compliance (even with the reduced tax rates, we are assuming only a 40 per cent compliance rate) or by removing all budgeted tax incentives. In 2015-16, total incentives for tax payers was Rs 550 billion, with Section 80C (mutual fund investments for rich taxpayers) accounting for Rs 450 billion. There is no need for this payment to the rich in the new system — hence, removal of this exemption is able to reduce the tax loss in the new system to zero. Actually, a small loss of Rs 90 billion. This can go towards increasing the net income transfer.
What remains is the financing of the NIT. As outlined above, the cost of NIT is Rs 1.7 lakh crore. If NIT is part of official tax policy, then there seems to be little need for anti-poverty programmes like the PDS or NREGA. These programmes are not only costly, but also involve a lot of corruption, as most analysts and politicians have pointed out over the years. Currently, the total expenditure on these two wasteful programmes is Rs 1.75 lakh crore. If the government decides to eliminate other in-the-name-of-the-poor (but not benefitting the poor) programmes, the net income transfer, per worker, can be increased.
With the adoption of this thinking, and new anti-poverty policies, absolute poverty will be zero in India, and according to a much higher poverty line. And with no extra cost. The only assumption we are making in the tax reform is that tax compliance rates have to increase to 40 per cent. The demonetisation policy has provided the stick for increased tax compliance — our proposed policy provides a much needed carrot.