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Why (not) abolish?
“If I am a part of the government, I could do it in seven days. Since I am outside, I will abolish income tax entirely over the next three years.”

One could be pardoned for being puzzled. In what way would this increase the welfare of the people? Why should the Income tax, which presumably falls more heavily on the wealthy than the poor, be abolished?

Why Swamy is right 

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. As such, a high rate of income tax becomes a tax on success, according to Austrian economist Ludwig von Mises. 

Writes economist Arvind Virmani: 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 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, the efficiency of trade and investments will improve. 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 the most important reasons why income tax must be abolished.

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.3.0 lakh crore while corporate taxes pulled in Rs.4.5 lakh 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 and 62.5 per cent of them 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 taxes. Just a little over one per cent of the population paid income tax. 

Why Swamy is wrong 

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

Several economists point out that when in 1997 tax rates were slashed to a maximum of 30 per cent, tax revenues went up. Another compelling 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.

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

On the whole, Virmani says a simple ‘no’ to the idea of abolishing the 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 salaried folks that have to bear the brunt of this tax. Is this then a just system?

What’s the verdict

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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