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The Union Budget’s Part B announcements which concern income tax rates are followed with great interest. Each stakeholder has their own opinion on the appropriate rate of taxation.
The Government needs strong revenue collections for the country’s development and defense. Industry needs a lower rate of tax for higher profits and reinvestment. Households need more tax-free income to meet the rising costs of living.
Every stakeholder needs to be appeased some way or another. This article is about the last stakeholder – the household and the salaried worker powering it. What can we expect out of this budget realistically, and what should we aim for?
Let’s address the key question of the complexities over tax regimes. The new tax regime, introduced in 2020, now offers tax-free income for anyone earning ₹7 lakh or less. This is great. The vast majority of India’s tax-paying population falls under this limit. By the calculations that follow, this must be at least 75% of the income tax-filing population. It must no longer pay income tax. So have the vast majority opted for the new regime? The data says otherwise.
Last year, a tax-tech company put out a report citing data that 85% taxpayers had opted for the old regime while filing their tax returns. This, despite the tax-free income being much lower on the old regime where the slabs are locked at 2013-14 levels with no update to the 20% and 30% slabs.
Other institutional reports and minor surveys have revealed the same: people are hanging on to the old regime. It provides many deductions and exemptions: rent, tuition fee, and medical expenses being basic ones. Then there are insurance payments, loan deductions, and tax-saving investments such as provident fund.
All of these deductions and exemptions combined with the standard deduction of ₹50,000 allow taxpayers to get away with a lower tax bill in the old regime. There are also restrictions on switching from the new regime to the old, and taxpayers may see that as a loss of choice and agency.
Tax slabs must be adjusted for inflation regularly. For example, the 0% tax slab in 1994 was ₹35,000. It was ₹50,000 in 2004 and later ₹2.5 lakh in 2014—where it has remained since then in the old regime. In the new regime, the 0% slab has nudged up to ₹3 lakh. If such adjustments don’t happen, our tax bills would consume most of our income under the highest marginal slab.
Let’s adjust the 0% slab for inflation though. It was at ₹2 lakh in 2012-13. The Cost Inflation Index, which guides inflation indexing in tax calculations, has risen 81% since then. Therefore, at the very least, the 0% slab needs to be 81% higher at ₹3.63 lakh adjusted for inflation—or simply ₹5 lakh where income tax liability is already zero under both regimes.
Similarly, the 20% and 30% slabs remain frozen since the 2012-13 Union Budget. Adjusting them merely for inflation, the 20% slab should be at ₹9 lakh and the 30% slab should be at ₹18 lakh as opposed to ₹5 lakh and ₹10 lakh today.
This begs the question if the new regime with its much bigger slabs are better than the old regime. The 30% slab there applies to income above ₹15 lakh. In 2013, the tax bill on an income of ₹15 lakh was ₹2.88 lakh. Today, in the old regime, it’s come down marginally to ₹2.73 lakh. This isn’t much, considering the rise in costs of living. But under the new regime, the tax bill comes down substantially to ₹1.56 lakh.
Here, we indexed the tax liability using CII values. It tells us that from the 2012-13 levels, the tax liability, adjusted for inflation, should have come down to ₹1.58 lakh. This means the new regime helps narrowly beat inflation up to this income level.
However, above the ₹16 lakh mark, the new regime is not seen beating inflation. In fact, the gap between your actual taxes and what you should have ideally paid rises exponentially as your income rises. For example, at ₹30 lakh, your excess taxes appear to be ₹2.09 lakh a year.
This brings us to what the salaried are going to need. The costs of living aren’t going to take care of themselves. In fact, we calculated that despite the highest marginal rate today being 30%, adjusted for inflation, your ‘real’ effective tax rate is going up to 55%.
Your income may have risen in the last decade. But so have your expenses. And since the slab rates are frozen in a bygone era, more of your income is going into servicing taxes and expenses. Earning ₹10 lakh in 2013 is the same as earning ₹18.15 lakh in 2024, and ₹10 lakh now offers the same purchasing power as ₹5.50 lakh in 2013.
To adjust for these realities, the fact is tax slabs need to be much larger especially as the income tax base is seen strengthening to record highs.
Direct tax collections – a sum of income and corporate taxes – hit ₹19.58 trillion last year. Out of this, income tax accounted for 53%. Personal income tax has exceeded corporate tax collections. Incomes have gone up for sure, but the lack of inflation adjustment in tax slabs is also shaping this surge.
A little over seven crore taxpayers have filed their returns in recent years of which a little over five crore filed zero tax returns. Therefore, the nearly ₹10 trillion income tax collections are coming from a small minority of about two crore taxpayers, which works out to an average tax liability of about ₹5 lakh rupees per taxpayer. Assuming a 20-25% effective tax rate, we can back-calculate that the average taxable income of these taxpayers would be around ₹20-25 lakh.
This group is the cream of India’s workforce. But given their high incomes, do they not deserve inflation adjustment of their tax breaks? That is the difficult question the upcoming budget speech must answer. We expect the freeze on the old regime to continue. Perhaps adjustments will be made to the new regime. Regardless, here are some adjustments that ought to be made.
80C limits pertaining deductions such as home loan, provident fund, life insurance, and tuition are still at ₹1.5 lakh set in 2014 and must be enhanced to at least ₹2 lakh. The 80D deductions concerning health insurance premia must be enhanced to ₹50,000 for general taxpayers and ₹100,000 for senior citizens considering the rising costs of insurance premia post-covid.
Home loan interest and principal payments should be housed separately in its own section going up to ₹5 lakh. Rebates under 87A should be extended to incomes up to ₹6.30 lakh, benchmarking to the last such update done in 2019.
Lastly, under both regimes, a streamlining of tax codes is required. Gains and losses under different asset classes such as real estate or gold or mutual funds are treated differently. There’s also a need to relook double taxation such as the securities transaction tax.
Over to the honourable Finance Minister on July 23.
The writer is CEO, BankBazaar.com
