Income Tax

Why Govt Loves Income Tax and Isn’t Going to Scrap It

One suggestion that I see people constantly make on the social media, particularly on Twitter, is that the government should do away with personal/individual income tax. They often say this with a lot of confidence, giving the impression that they have thought through the argument. Over the last one week, since the presentation of the annual budget of the union government, such  suggestions seem to have made a comeback.

But the confidence of the people making these suggestions largely comes comes from two things. One is that they haven’t had a look at the government data on taxes, which leads them to believe that barely anyone pays income tax and hence, it should be scrapped. Two, they have no idea as to how most governments operate.

Let’s take a look at a few charts to understand why this logic is all wrong. The following chart plots the individual income tax collected by the government as a proportion of the Indian gross domestic product (GDP), a measure of the size of the economy.

Source: Centre for Monitoring Indian Economy.
Revised estimate for 2020-21.
Budget estimate for 2021-22.

As can be seen from the above chart, income tax as a proportion of GDP has only gone up over the years. In 2019-20, it peaked at 2.68% of the GDP. In 2020-21, thanks to the economic contraction due to the spread of the covid pandemic and falling incomes, the income tax to GDP ratio is expected to be at 2.36% of the GDP. It is expected to rise again to 2.52% of the GDP in 2021-22.

The typical argument suggesting that the government should do away with income tax, goes somewhat like this. Oh, but very few people pay income tax. Now that is true, but that hardly means that the government will stop collecting income tax.

A slightly more sophisticated argument (at least the person making it, feels it is a sophisticated argument) goes somewhat like this. Oh, but income tax collected forms just a couple of percentage points of the GDP. That’s nothing.

Honestly, I find both these arguments hilarious. Guys making these arguments have no idea about how the data looks and as I said, which is where their confidence comes from.

Let’s look at the following chart, which basically plots corporation tax (income tax paid by corporates on their profits) and personal income tax as a proportion of gross tax revenue, over the years. Gross tax revenue is basically the sum of different taxes (corporation tax, income tax, union excise duty, customs duty, central goods and services tax etc.), earned by the union government.


Source: Centre for Monitoring Indian Economy.

What does the above chart tell us?

1) The corporation tax collected as a proportion of the total taxes collected by the government, has been falling over the years. In 2009-10, corporate taxes formed around two-fifth of the total taxes collected by the government. In 2021-22, the tax is expected to be at around one-fourth of total taxes. There are multiple reasons for this. Corporate revenue growth has slowed down over the years. Along with that corporate tax rates have also come down.

2) The importance of income tax in the overall taxes earned by the government has gone up in the last decade. In 2009-10, they formed around one fifth of total taxes and in 2021-22, they are expected to form around one fourth of the gross tax revenue earned by the union government. In 2019-20, income tax formed around 23.9% of overall taxes.

Hence, all taxes may appear small as a proportion of the GDP, but that does not mean that they are not important for the government. The government isn’t the entire economy as represented by the GDP but only a part of it and the taxes earned are a part of that part.

Now tell me which government in its right mind is going to drop a tax which is likely to bring in one-fourth of the total taxes earned by it. This especially in an environment where corporation tax collections as a proportion of the GDP have been falling over the years.

Another argument that is made is that income taxes should be eliminated and indirect taxes should be raised. So, with no income tax, people will earn more and hence, spend more, and the government will end up collecting more indirect taxes, and these taxes will more than make up for a loss of income tax.

While this sounds good in theory, the trouble is that unlike the physical sciences, in economics you cannot carry out real life experiments. So, no government is going to risk one-fourth of its revenue just because in theory they could do something else. Nah, not going to happen. The whole argument rests on the idea that if income tax is done away with people are likely to spend more. What if they don’t and decide to save more? There is no way of knowing in advance about how people are going to behave.

Actually, a more refined argument can be made here. People who pay a bulk of India’s income taxes already have most things that they need in life. Hence, their marginal propensity to consume will be low. This means that the extra money they earn thanks to lower taxes, they are more likely to save/invest it than spend it.

Hence, the argument that people are likely to spend more because they will earn more thanks to no income tax, doesn’t really hold. One thing that can be said for sure here is that if income tax is done away with, the stock market will go through the roof (not that it isn’t already).

A better way to increase consumption and hence, indirect tax collections is to reduce goods and services tax on mass produced goods. The impact is going to be much greater in this case.

There are other reasons here as well. There is a huge income tax bureaucracy in place. What happens to those people with no income tax? Income tax is also used by politicians in power to harass those in opposition or other people opposing them. Why let go of such an option?

All in all, income taxes are not going anywhere, even though when the BJP was in the opposition, it was pretty vocal on the issue of doing away with them.

But now they need to run the country and the gross tax revenue collected by the government, has come down over the years. The gross tax revenue as a proportion of the GDP peaked at 12.11% in 2007-08. In 2019-20, it was at 10.61%. It is expected to fall to 9.75% of the GDP this year and rise to 9.95% of the GDP next year, still significantly lower than the all-time peak level.

So, next time you want to go shouting on Twitter asking the government to do away with personal income tax, please do remember these points.

Why a Billionaire Tax Doesn’t Make Any Sense for Politicians

Incentives.

In the end everything boils down to it.

In the run up to the annual budget of the union government presented by the finance minister Nirmala Sitharaman, on February 1, many economic commentators suggested that the government should resort to a one-time billionaire tax.

The idea being that the stock market has rallied big time during the course of this financial year. Hence, while the income of the average Indian has fallen thanks to the economy contracting, the super-rich have become richer.

This one-time tax could fund a lot of extra expenditure in the budget in 2021-22, as the government tried to act as the spender of the last resort in an environment where private spending has slowed down and industrial expansion isn’t happening at the same pace as it was.

If you are the kind who practices first level kind of thinking, this makes perfect sense. The rich have grown richer. So, let’s take money from them and give it to those who need it. It also leads to greater equality, at least in your head. This kind of Robinhood thinking has prevailed for centuries. Hence, there is no reason for it to go away in 2021.

Nevertheless, if you are the kind who practices second level thinking and at the same time thinks about the incentives on offer, you would know that something like this doesn’t make sense and is also unlikely to happen.

Let’s try and understand this pointwise.

1) It is important to understand that billionaires don’t have cash lying around to pay this tax. So, one way they would have raised cash to pay this tax would have been to sell some of their shares. Of course, given the sudden increase in supply of shares in the market could have led to the stock prices falling.

2) Actually, more than the billionaires selling their stake to pay up the tax, the stock market would have seen this move of the government in a negative way and sold off, even before billionaires would have started thinking about how to pay the tax. In fact, in the run up to the budget, the stock market did worry about new taxes and there was a sell off last week. This was its way of telling the government, please, no new taxes. It has been rising this week, since it realized that no news on the tax front is good news.

3) Currently, the government needs the stock market on its side, with its plans to raise Rs 1.75 lakh crore through the disinvestment route next year. And that is only possible if the stock prices continue to remain at high levels. Hence, it would have made no sense for the government to disturb the status quo. If the market would have fallen, it would have impacted the ability of the government to raise the amount of money it wants to through disinvestment. This would have, in turn, impacted its ability to spend.

4) These were the near-term reasons. But there are more issues at play here. Most Indian billionaires finance political parties both on record and off record. In their eyes they are already paying a billionaire tax. A lot of this money finds its way into the economy and is spent, during election time. In that sense, billionaire money is pump priming some part of the Indian economy all the time, given that elections to state governments happen every year.

Of course, no billionaire does this as a social service. They are looking for a quid-pro-quo from the government. That needs to be kept in mind as well.

5) It’s important to look at this entire idea from the point of view of the incentive at play for a politician as well. Politicians exist to win elections. For this they need money, a massive amount of it. They can’t win elections by spending money within the limits set by the Election Commission. Where does this money come from? To a large extent from billionaire businessmen who operate in spaces where they need to deal with government all the time. Hence, why would any politician in his or her right mind try to disturb this equation by irritating the main funders through a high one-time income tax. It just doesn’t make any sense.

6) Finally, a high-income tax, one-time or otherwise, is always a bad idea. One it leads to a narrative of inconsistent tax policy, which the Indian government anyway suffers from. Two, it also leads to high income earners, who can leave the country to leave the country, and move to tax havens. The highest income tax rate in the country currently is greater than 40%. Hence, not surprisingly, a whole bunch of high-income earners have moved or want to move to places like Dubai. This obviously means they no longer pay their income tax in India.

Given these reasons a billionaire tax didn’t make any sense. Having said that, there is a case for clear rationalization of tax rates that is needed. You can’t have a small proportion of the salaried paying the highest marginal rate of more than 40% or even 30%, whereas those who can use the benefit of indexation while paying income tax, not paying any tax at all or a very low rate of tax. This needs to be corrected.

Raghuram Rajan’s 10 Solutions to Get Economy Going Again


Summary: This one is for all of you, where are the solutions wallahs. Of course, I have offered many of the solutions that Rajan has offered in a column, but never put them together in one place.

One of the perils of writing on the Indian economy in the last six years has been the repeated comment from a few, don’t tell us about the problems, but give us the solutions. I mean how do you discuss solutions without highlighting problems. How do you come up with a prognosis without coming up with a diagnosis in the first place?

It’s not that one hasn’t highlighted solutions in what one has written over the years, but it’s just that where are the solutions wallahs, don’t seem to notice them. This belief that economics has solutions to everything (particularly among the non-economists, which means most of us), is very strong.

Over the years, I have come to believe that this is primarily because almost all of us are brought up writing exams where every question has an answer and every problem (in the mathematical sense of the term) has a solution. Life and economics don’t work like that. If everything had a solution, the word problem wouldn’t exist in the first place.

Nevertheless, this piece is all about solutions; things that the central government can do right now (and should have been doing by now) to get the economy going again. I have just finished reading Dr Raghuram Rajan’s piece on the Indian GDP (Gross Domestic Product) collapse. GDP is a measure of the economic size of a country.

Dr Rajan, who was the governor of the Reserve Bank of India (RBI), has offered many solutions. These are things that the government can do to get the economy going again. I have offered many of these solutions in my writing as well, though never gotten around to writing about all the solutions together at one place.

Let’s take a look at these solutions, one by one.

1) The government needs to expand its resource envelope in every way possible, Rajan writes. At the cost sounding like a broken record, it needs to sell its stakes in many public sector enterprises (how many times have I said this). In fact, in a sense it has already missed out on the current buoyant state of the stock market. The total amount of money collected through the disinvestment route during this financial year, remains close to zero.

Rajan also suggests that the government should be ready for on tap sale of its stakes in public sector enterprises, to take advantage of every period of market buoyancy.

2) Many public sector enterprises own land, in prime areas of India’s cities. And this land needs to be sold (Again, how many times have I suggested this). In fact, in a city like Ranchi, where I come from, the Heavy Engineering Corporation (a public sector enterprise) sits on acres and acres of government land. All this land across all these companies needs to be sold and money be raised. Of course, this isn’t going to happen overnight.

But that’s not the point here. If the government shows serious intent on this front by announcing a time-table to do this, as well as making preparations for the sale, this is something that the bond market will notice and be happy about.

3) Why is it important to keep the bond market happy? With tax collections collapsing by 30%, between April and July 2020 in comparison to the same period in 2019, it is but natural that the government will end up borrowing more. This is likely to push up the return (or the yield) that the market demands on the government borrowings, given that there is only so much financial savings going around. Other factors that will give confidence to the bond market is the publishing of the correct fiscal deficit numbers unlike the massaged numbers that are currently declared (well, well, well, I have been saying this for a couple of years now). Fiscal deficit is the difference between what a government earns and what it spends.

Another important reform suggested by Rajan is the setting up of an independent fiscal council, which can keep an eye on the deficit numbers (This is something that the former deputy governor of the RBI, Viral Acharya, has also been suggesting).

All in all, the government should seem like making serious moves towards restoring fiscal stability, which is currently lacking.

4) The world will recover faster than India, given that the covid-curve has been flattened across large parts of the world. Given this, economic demand in many of India’s bigger trading partners will recover faster than in India (Again, a point I made in a piece I wrote for the Mint on September 7, 2020). This means that faster exports growth can be a way for India to recover, suggests Rajan. But the trouble is that we are looking at import substitution as a policy more and more and imposing tariffs on imports. This raises the cost of inputs that go into goods that are ultimately exported.

Of course, the intermediary goods that go into the making of goods that are exported, can be produced in India, but this will happen at a higher price. Hence, this makes us uncompetitive at the global level (A point I made in a piece I wrote for the Mint in February). Also, reversing the entire import substitution bogey will mean going against the current atmanirbharta campaign, a very successful perception management campaign. (In economics, just because something sounds good, doesn’t mean it is necessarily good). Economics is not the only thing that any government is bothered about.

5) Rajan suggests that the focus on Mahamta Gandhi National Rural Employment Guarantee Scheme (MGNREGS) as a way of putting money directly into the hands of the poorest, should continue. If this means spending more money under the scheme, then so be it. (Okay, I had suggested this as far back as March in a piece I wrote for the Mint, even before the government had taken this route.)

6) While, MGNREGS takes care of the lack of economic activity in rural areas, the urban areas get left out under the scheme. Hence, the government should be making more efforts to put money into the hands of the urban poor, suggests Rajan.
One of the things that the government has done is to put Rs 1,500 over a period three months into female Jan Dhan accounts. This cost the government around Rs 31,000 crore. I think it is time to put money into male Jan Dhan accounts as well (Again, I have been saying this for months now). This will take care of the urban poor to some extent. I know this isn’t the perfect solution because proper targeting will continue to remain a problem, but it is better than doing nothing.

7) Rajan further suggests that the government and public sector enterprises should clear their dues as fast as possible. This will put more money into the economy and particularly into the hands of corporations and help them survive. (Something I had said in March). A newsreport in The Financial Express today points out that the total amount of money owed by the central government and the public sector enterprises, amounts to Rs 9.5 lakh crore, or a little under a third of the Rs 30.4 lakh crore that the central government plans to spend this year. Of the Rs 9.5 lakh crore, Rs 2.5 lakh crore is owed to the Food Corporation of India (FCI). The remaining Rs 7 lakh crore is a large amount on its own. Even if a portion of this is cleared, the economy will get some sort of a stimulus.

As far as a real stimulus goes, focusing on physical infrastructure is the need of the hour, leading to creation of demand for everything from steel to cement. One area that can really get the Indian economy going again is real estate. I have discussed this so many times before. But for that to happen, so many other things need to happen, including many of the current real estate firms going bust and banks losing a lot of money. Creative destruction needs to be unleashed. Of course, the deep state of Indian real estate is not ready for something like this and will not let it happen.

8) Rajan also suggests that firms below a certain size could be rebated the income tax and the goods and services tax, they paid last year (if not the whole amount, but at least a part of it). This could be an easy and direct way of helping smaller businesses, which have faced the brunt of the pandemic all across the world. (Okay, I haven’t suggested anything like this anywhere, from what I remember).

9) Rajan recommends that public sector banks need to be properly recapitalised as the extent of losses due to covid are recognised. I feel that if the government doesn’t have the money to do so, then it needs to let these banks raise money from the market and in the process, the government should be okay with the idea of diluting its stake. (I have written a book on this )

10) And finally, as the moratorium on repaying loans taken from banks and non-banking finance companies has come to an end, there are bound to be defaults. Here, the government should have a variety of structures in place to deal with the emanating problems, and not have a one size fits all approach. Also, in my opinion, dilution of the entire insolvency and the bankruptcy process, is really not the right way to go forward.

So, to all the where are the solutions wallahs, these were 10 solutions that Dr Raghuram Rajan has offered to the government (Actually, there are more solutions in the piece he has written, but I have stopped at ten. Some of these solutions are about land reforms, labour reforms, genuine ease of doing business reforms, etc., to improve India’s competitiveness, which keep getting made endlessly over and over again). Rajan has also said that the time to do these things is now and not wait for things to get worse.

In my writing over the last few months, I have recommended eight or nine of these solutions as well, though never put all these solutions at one place. One important solution that I think needs to be quickly implemented, is a reduction of the goods and services tax on two-wheelers.

The trouble is that most of these solutions need money to start with. And for that the government needs to come out of its comfort zone and start raising money in ways that it has never done before (like selling land). Also, all reforms need intent and communication clarity to be able to explain these things to the junta at large. Plus, they may not lead to electoral gains immediately, something like a focus on an actor’s suicide may.

You see the government just doesn’t have the incentives to do the right things.

PS: I sincerely hope this should satisfy the appetite of all the where are the solutions wallahs, out there.

The ‘GULZAR’ Principle of Investing for Regular Income and Safe Returns

Summary: There is no real way of earning a regular and a safe income that is enough to meet the monthly expenses.

The headline was a clickbait. But now that I have your attention, let me explain the logic behind it.

The title song of the 1979 Hindi film Gol Maal was written by the lyricist Gulzar (Honestly, calling him just a lyricist is doing his talent a great disservice. Other than being a lyricist, he has written screenplays and dialogues for a huge number of Hindi films. He is a poet and a short story writer. He is also a translator of repute. Oh, and he has also directed a whole host of Hindi movies as well as a few TV serials along the way. Also, for the millennials, Hrishikesh Mukherjee made Gol Maal, much before Rohit Shetty started using the title for everything he could possibly think of).

Now getting back to the point I was trying to make. In the title song of Gol Maal there is a line which goes: “paisa kamane ke liye bhi paisa chahiye,” essentially meaning, in order to earn money, you first need money. And that is what I am going to write about today.

In the twenty months, as the economy has gone downhill, people have been getting in touch with me on email and the social media, with a very basic financial query. The numbers were small first but post-covid this has turned into a deluge. The question being asked is how a reasonable monthly income can be generated from savings, without taking any risk, in a safe way.

The answer to this question has become very important as people have lost their jobs or seen their salaries being slashed and incomes falling. What does not help is the fact that the post-tax return from bank fixed deposits are now largely in the range of 4-5%. The inflation as measured by the consumer price index is close to 7%.

Before I try answering this question, it is important to understand why interest rates on bank fixed deposits have fallen. The simple answer to this lies in the fact that there is too much money floating around in the financial system, with the banks not knowing possibly what to do with it.

Between March 27 and July 31, a period of little over four months, the non-food credit given by banks has contracted by Rs 1.32 lakh crore or around 1.3%. The banks give loans to the Food Corporation of India (FCI) and other state procurement agencies to primarily buy rice and wheat directly from the farmers at the minimum support price declared by the government. Once these loans are deducted from the overall loans given by banks, what remains is non-food credit.

What does non-food credit contracting tells us? It tells us on the whole borrowers have been repaying loans and at the same time not taking on enough new loans. It also tells us that banks are reluctant to lend. Further, as we shall see, there has been a huge surge in fixed deposits with banks, as people have increased their savings in the aftermath of the spread of the covid-19 pandemic. Banks will take time to lend all this money out.

Between March 27 and July 31, the total deposits of banks have gone up by Rs 5.95 lakh crore or 4.4%. In an environment, where the non-food credit of banks has contracted whereas deposits have jumped big-time, it is but natural that interest rates on fixed deposits have fallen. In fact, the weighted average term deposit interest rate or simply put average fixed deposit interest rate has fallen from 6.45% in February to 6% in June, the latest data available. Now that we are in August, the interest rates may have possibly fallen even more.

In fact, there is nothing new about interest rates on fixed deposits falling, this has been going on for close to eight years now. Having said that, interest rates shouldn’t be looked at in isolation, it is important to compare them with the prevailing rate of inflation. Take a look at the following chart. It plots the average interest rate on fixed deposits during the course of a year, along with inflation as measured by the consumer price index. The difference between the two is referred to as the real rate of return on fixed deposits.

Interest v/s Inflation


Source: Reserve Bank of India.

What does the above chart tell us? Between 2014-15 and 2018-19, there was a healthy difference between the average interest paid on fixed deposits and inflation. (Of course, this is without taking tax on fixed deposit interest into account, else, the difference would have been lower).

These were the years when first Dr Raghuram Rajan and then Dr Urjit Patel were at the helm at the Reserve Bank of India. In 2019-20, the real return on fixed deposits narrowed to 1.6%. Shaktikanta Das took over as RBI Governor in December 2018.

Let’s take a look at the real return on fixed deposits month wise since December 2018, the month when Das took over as RBI Governor. The real return on fixed deposits as explained earlier is the average interest rate on fixed deposits minus the prevailing rate of inflation.

Crash in real returns


Source: Author calculations on data from the Reserve Bank of India.

This chart is as clear as anything can get. The real rate of return on fixed deposits has simply collapsed since end of 2018. This has happened as the interest rate on fixed deposits has fallen and inflation has gone up.

The interest rate on fixed deposits has fallen primarily because the rate of loan growth for banks has crashed over this period. This we can see from the following chart.

Loan growth crash


Source: Reserve Bank of India.

The above chart clearly tells us that the loan growth of banks has crashed since December 2018. In fact, for the week ended July 31, it stood at just 5.4%. Given this, the Indian economy was slowing down even before covid-19 pandemic struck.

Hence, as economic growth has slowed down, the loan growth of banks has slowed down and this has led to fixed deposit interest rates coming down as well. The point being that in economics everything is linked.

Of course, there is more to this than just the economy slowing down. Since February,  like the rest of the central banks, the RBI has printed and pumped money into the financial system to drive down interest rates, in the hope of getting businesses and people to borrow more.

Also, with collapse in tax revenues, the government will have to borrow more this year, in order to keep its expenditure going. Hence, it likes the idea of borrowing more at lower interest rates. The RBI goes along with this because among other things it also acts as the debt manager of the government.

The problem is that India’s economic crisis has grown worse since the covid pandemic hit the world, leading to a lot of individuals losing their jobs or facing salary cuts. Small businesses have been majorly hit and incomes have come down dramatically.

In this environment, people are now looking to generate some sort of a regular income from their savings. Of course, most them want to do this in a risk free way. As one gentleman recently asked me: “I am currently not employed after having worked in the corporate sector for 10 years. My request to you is to honestly guide me on how and where to invest to earn steady income especially when the fixed deposit interest rates have fallen so low.”

The first thing I can clearly say is that the gentleman believes that there is a solution to his problem. He believes that it is possible to generate a good steady income despite fixed deposit interest rates having fallen.

I see this belief among many people. My guess is, it stems from the fact that way too many personal finance publications believe in offering solutions to everything. I mean, why will a reader read you, if at the end of it you say something like there aren’t really any solutions to this problem that you might have. At least, that’s how their thinking operates. Also, they need advertisers. And advertisers love solutions to everything, even when none really exist.

In June 2020, the average rate of interest on a fixed deposit was 6%. Once we take income tax into account, the rate of return would be much lower. Of course, there are banks out there which are offering a rate of interest of 7% or more. Nevertheless, these banks are perceived to be among the riskier ones. So, the question is are you willing to take on more risk, for a 1-1.5% higher return? If yes, then these investments are for you.

While, we live in an era where no bank is going to go bust, they can and have been put under a moratorium or periods under which only a limited amount of money can be withdrawn from them. And money that can’t be spent when it is needed, is essentially useless. Hence, if you do end up putting money in a bank which offers a 1-1.5% higher return, do remember not to put all your money into it.

There are corporate fixed deposits which offer a slightly higher return but again they don’t have the same safety as a bank does.

If you are senior citizen, you can look at the Senior Citizens Savings Scheme. But that comes with the pain of dealing with the post office.

Debt mutual funds as many people have found out over the last one year, come with their own share of risks. They were marketed to be as safe as fixed deposits, but they weren’t anywhere close. Also, irrespective of what financial planners and wealth managers might say, debt mutual funds are fairly complicated products, which I am sure most people selling them don’t understand. And that’s why they are able to sell them in the first place.

A lot of individuals in the last few months have turned towards investing in stocks. The logic is that the stock market has rallied from its March low. On March 23, the BSE Sensex, India’s premier stock market index was at 25,981 points. Yesterday, August 26, it closed at 39,074 points, a jump of over 50% in a period of a little over five months. This rally has been driven by a few stocks and if you had invested in the right stocks, you would have ended up with good gains by now.

While, one can’t question this logic, but what one needs to remember is that on January 12, the Sensex was at 41,965 points. From there to March 23, it fell by 38% in a little over two months. The point being the stock market can fall as fast or even faster than it can rise. Also, do remember this basic point that a 50% fall can wipe off a 100% gain. (A 38% fall would have written off a 61% gain).

Hence, the larger point here as I mentioned in this piece I wrote a few days back is, just because an investor takes a higher risk by investing in stocks, it doesn’t mean he will always end up with higher returns, precisely the reason the word ‘risk’ is used in the first place. And by the way, the 10-year return on stocks (including dividends) is less than 9% per year.

So, the question is what should a person looking for a regular and safe income, actually do? As helpless as it might sound, there aren’t many options going around beyond the humble fixed deposit, especially for people who aren’t senior citizens. The trouble is the fixed deposit interest rates are at very low levels.

If you need to generate a monthly income of Rs 20,000 at 6% per year, this needs an investment of Rs 40 lakh.

The moral of the story here being that if you want to generate a regular safe income which is enough to meet your monthly needs, you need to invest more money. Or as Gulzar wrote in Gol Maal: “paisa kamane ke liye bhi paisa chahiye.” I would like to call this the Gulzar principle of investing for a regular income and safe returns.

Also, there are corollaries to this. These are very difficult times. Hence, there is a good chance of individuals ending up in a situation where they might have to spend their savings (rather than just the return on savings) to keep meeting expenditure.

Let’s take the example of a middle-class household with monthly expenses of Rs 50,000. In order to generate this income through a fixed deposit, an investment of Rs 1 crore is needed. Of course, the chances of a middle-class household with expenses of Rs 50,000 per month having savings of a crore, are rather minimal. In this scenario, they will have to resort to spending their savings. Given this, as I keep saying, the return of capital is much more important now than the return on capital.

In the short run, the only way to generate a good regular and safe income is find a job or any other source of income by selling the skills that one has (Like I write. I can do that for a media house or do it individually). In the long run, the next time you see interest rates of 8-9% available on fixed deposits or any other safe investment, invest in these assets and lock in the high returns for as long as possible.

While, this might not sound much like a solution but that is the long and the short of it.

Why income tax is not going to be abolished anytime soon

Dr Subramanian Swamy has time and again suggested that personal income tax should be abolished. The logic is that this will put more money in the hands of people, and they will go out there and spend a lot of it, and this will benefit businesses and the overall economy.

What the government will lose out on the direct tax front, it is likely to make up from indirect taxes like goods and services tax, as people consume more. Companies will earn more and as a result pay a higher corporate income tax.

So, clearly there is economic logic to what Dr Swamy has been suggesting over the years. But the fact of the matter is that no government will have the balls to take a decision like this.

Take a look at the following chart.


Source: Author calculations on data sourced from www.cga.nic.in and www.indiabudget.nic.in

The chart plots personal income tax as a proportion of total gross taxes collected by the central government. In the last ten years, this has gone up. In 2019-20, the last financial year, the total personal income tax collected formed 23% of the overall taxes collected by the central government.

Other than personal income tax, the central government collects central goods and services tax, corporate income tax, union excise duty and customs duty, as well. These taxes form a bulk of the taxes collected by the central government.

In 2020-21, the central government hopes to collect a total of Rs 6,25,000 crore as personal income tax. This is around 26% of the total taxes that the government expects to collect in the year.

Of course, this estimate was made before covid-19 struck. Nevertheless, irrespective of that what it tells us is that the government during 2020-21 hoped to collect more personal income tax as a proportion of overall taxes than it has ever done before.

If the government does away with individual income tax as Dr Swamy has suggested over the years and as many income taxpayers have come to wholeheartedly want, it loses nearly a fourth of its tax revenue immediately.

As mentioned earlier in the piece, this will mean a windfall for individual income taxpayers. As they spend a part of this money, the government will earn taxes in other forms. At least that’s what the theory suggests. The government can also sell a lot of assets (its shares in public sector enterprises and land) that it owns to make up for the elimination of personal income tax.

And that’s where the trouble is. No government in its right mind will give up on a fourth of its tax revenues, just in the hope of making up for it through other ways.

Also, it is worth remembering that the salaried pay a major portion of individual income tax. It is easy to tax salaried income. And anything that is easy to tax, no government is going to give up on. And finally, what happens to all the taxmen if personal income tax is done away with? So, clearly there is no incentive for the government to do away with personal income tax.

Hence, hoping that the government will abolish personal income tax is at best a pipe dream. It’s not going to happen.