bottom of the pyramid

Every year, before the annual budget is presented, suggestions are made to scrapthe income tax paid by individuals. The economist/politician Subramanian Swamy has also said so in the past. The logic typically offered is that the individual income tax forms a very small part of the total taxes collected by the government, and hence, it should be scrapped.

Let’s look at Table 1, which

Table 1:

Source: Author calculations on data from Incometaxindia.gov.in.Table 1 has data up to assessment year 2015-2016. Income tax for the money earned in the financial year 2014-2015, would have been paid in the assessment year 2015-2016. The budget documents of the government of India do not list out the total income tax paid by individuals, separately. Hence, the latest numbers for the total income tax paid by individuals, isn’t available in the public domain.

These numbers are separately declared by the income tax department, on a non-regular basis.

What does Table 1 tell us? It tells us that the income tax paid by individuals, forms a small portion of the total tax collected by the government, during any given year. This is the logic offered by those who say that individual income tax needs to be scrapped. More than this, once the taxes are scrapped, people are likely to spend the money not paid in the form of income tax, in various ways. They might decide to go on a holiday or redo the house or go out and eat more often.

Hence, when this extra spending happens, the incomes of many other people will go up and they are also likely to spend more as well. Thus, the multiplier effect will work. This will ultimately benefit businesses, which will make higher profits, and hence, pay more income tax on their profits. Further, the government is also likely to collect more indirect tax. And net net, scrapping income tax for individuals won’t make much of a difference, for the government.

Also, this is likely to force the government to cut down on frivolous expenditure. It is also likely to force the government to get rid of many loss-incurring public-sector enterprises, which continue to bleed. Basically, it will force the government to cut down on what I have been calling Big Government in many of my previous pieces.

All this makes perfect sense, but in theory. Now let’s take a look at Table 2, which basically lists out individual income tax in rupee terms.

Table 2:

Source: Incometaxindia.gov.in.While, income tax from individuals, might look very small as a proportion of total taxes collected by the government, but the absolute amounts on their own are not small at all. In fact, let’s take a look at the assessment year 2015-2016. The total income tax from individuals during this year stands at Rs 1,88,031 crore. This money is enough to finance the budget of many departments of the government of India. And this is money that the government is collecting for sure.

If the government scraps this, where will it get this money from? By now, the income tax paid by individuals must have easily touched Rs 2,50,000 crore. As supporters for scrapping individual income tax point out, the government is likely to earn more money from corporations paying higher income tax on their higher profits. Also, it is likely to collect more indirect tax as people end up spending more money.

The word to mark here is likely. No government is going to want to take such a big risk. Every government likes some amount of certainty when it comes to the taxes that it collects. Also, it has been suggested that if scrapping income tax for individuals is not possible, income tax can be done away at the lower levels of income.

This is where things get even more interesting. Take a look at Table 3. Table 3 basically plots the total taxes paid by individuals paying an income tax of greater than zero but lower than and equal to Rs 1,50,000. This is the lowest bracket for which the income tax department provides data.

Table 3:

Source: Author calculations on data from Incometaxindia.gov.in.While, the individuals paying an income tax of less than or equal to Rs 1,50,000, pay a very low average income tax every year (around Rs 25,000 in assessment year 2015-2016), on the whole it adds up to a substantial amount. This is what Professor CK Prahalad called the fortune at the bottom of the pyramid. For assessment year 2015-2016, it amounted to a total of Rs 44,615 crore, which would have again enough to finance the budgets of several government departments.

Also, at lower levels, the idea is to get people to start paying income tax. Once they start doing that, they are more likely to continue doing it, in the years to come. Further, given that a major portion of these taxes are directly cut from salaries by companies and handed over to the government, the government has to do very little in order to collect this money. Hence, there is no reason for the government to scrap individual income tax, though theoretically it might make immense sense.

Also, the things that the government will have to do if it scraps individual income tax would require much more work than it is currently used to. And we all like to take the easy way out.

The column originally appeared on Equitymaster on January 16, 2018.