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Why (not) abolish Income tax?

If I am a part of the government, I could do it in seven days. Since I am outside, I will abolish income tax completely over the next three years, declared Dr. Subramaniam Swamy recently. One could be pardoned for being puzzled. In what way would this increase welfare of the people? Why should the Income tax which presumably falls more heavily on the rich than the poor be abolished?

Why (not) abolish Income tax?

Why Income tax must be cut or abolished

 

Though it is based on the principle of ‘ability to pay,’ high income taxes take money away from precisely those sections of the populace that earn and save the most. This section also creates the output that is consumed by the wider public, like consumer durables, investment instruments, etc. greatly contributing to overall welfare. As such, a high rate of income tax becomes a tax on success, according to Austrian economist Ludwig von Mises.

 

Writes economist Arvind Virmani in his blog: abolition of income tax would extinguish the difference between ‘white’ income, (that is income which has suffered tax) and ‘black’ income, which has not. It will the level the playing field between honest and dishonest taxpayers. Since there will be no tax, those who manage to evade taxes, usually with the collusion of a corrupt bureaucracy and the powers that be, will not be able to amass wealth illegally. People will happily find avenues of becoming rich honestly. Similarly, efficiency of trade and investments will improve. Freed from calculating for tax effect and misguided tax incentives, businessmen will invest in those projects that bring in the best returns. Additionally people would be encouraged to move investments from unproductive stakes in gold and real estate into productive enterprises. The terror of the rapacious taxman would be at an end.

 

These are some of the most important reasons why income tax must be abolished or at least be reduced to the bare minimum.

 

Figures to figure…

 

In India, total tax receipts were Rs.15.5 lakh crore in 2015-16. Income taxes along with corporate taxes doubled to about 7.5 lakh crore in 2015-16, from 2009-10. Of this income tax accounted for Rs.2,99,051.24 crore while corporate taxes pulled in Rs.4,52,969.68 crore. In 2009-10, direct taxes formed 61 per cent of the taxes collected while this has dropped to 51 per cent in 2015-16. The share of direct taxes to GDP was 6.3 per cent in 2009-10, while sliding to 5.4 per cent in 2015-16.

 

The primary data shows that of 1.25 billion population, only 2.5 per cent filed income tax returns. Of this 62.5 per cent filed nil returns. 56 per cent of individuals paid no tax, while 39 per cent paid 21 per cent of the taxes on individuals. The balance 5 per cent paid 79 per cent of the taxes. Just a little over 1 per cent of the population paid income tax.

 

Is it fiscally possible?

Given that the current year’s budget has forecast a deficit of 3.9 per cent, according to pro tax economists, any abolition of income tax, even if only on individuals is likely to blow a big hole in the budget.

 

Yet several economists point out that when in 1997, tax rates were slashed to a maximum of 30 per cent, tax revenues actually went up. Another powerful argument is that since any tax cut would put more money in the hands of the people increased spending would even things out in the medium term as revenues from indirect and other taxes surge. Cutting taxes then would be a recipe for growth rather than a fiscal disaster. Anyway, prudence would dictate that tax cuts while welcome must be accompanied by spending cuts to keep budget dynamics under control.

 

Downsides…

 

The downside of abolishing income tax is that if personal income tax alone is abolished while corporate tax continues, it would incentivise people to move away from the company form of business organisation. Abolishing income tax would also increase economic inequality even if in theory this would be only for a short period of a few years.

 

Pros and cons…

 

On the whole, Virmani says a simple ‘no’ to the idea of abolishing income tax.

On the other hand Swamy says: “the rich know how to avoid tax and the poor are not in the tax bracket. It is the middle class, young professionals, salaried employees who pay tax.”

 

Clearly it is the salariat that has to bear the brunt of this tax. Is this then a just system?

 

The answer probably lies somewhere in between, encompassing an increase in the exemption limit, stretching tax slabs, while minimising tax rules to save honest taxpayers from being harassed.

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