When It Comes to Taxes, the Fortune is at the Bottom of the Pyramid


Sometime back the Income Tax department released some detailed data about the income tax returns filed during the assessment year 2012-2013. The income tax returns for the income earned during the financial year 2011-2012 were filed during the assessment year 2012-2013. The department released some other data points as well.

I had hoped I won’t write anymore columns around the data, but then that is not how things have turned out to be.

One of the interesting data points that I wrote extensively about was that in the assessment year 2012-2013, only around 2.88 crore individuals filed income tax returns. Of this number, around 1.62 crore did not pay any income tax. Only the remaining 1.26 crore individuals paid some amount of tax.

Of this number, around 1.11 crore paid a total amount of income tax upto Rs 1.5 lakh. The average income tax paid by these individuals was at around Rs 21,068. Of course, the median amount of income tax paid would be even lower.

The interesting thing is that even though the average income tax paid by these individuals was low, the total income tax paid, added up to a substantial Rs 23,446 crore. This was by far the highest amount paid by any category of taxpayers.

The next highest amount of tax was collected from individuals who paid income tax in the range of Rs 5.5 lakh to Rs 9.5 lakh. Around 1.79 lakh individuals fell in this category and paid a total income tax of Rs 12,580 crore. The average income tax paid worked out to around Rs 7.04 lakh. While at an average level this was substantially higher than the income tax paid by those paying tax of up to Rs 1.5 lakh, on the whole it was lower.

What does this mean? This essentially means that when it comes to income tax there is a fortune waiting for the government at the bottom of the pyramid. The term “fortune at the bottom of the pyramid” was coined by management guru CK Prahalad in a book of the same name.

In this book, Prahalad looked at the distribution of wealth and the capacity to generate incomes in the form of an economic pyramid. As he wrote: “At the top of the pyramid are the wealthy, with numerous opportunities for generating high levels of income. More than 4 billion people live at the bottom of the pyramid on less than $2 per day.”

Prahalad’s book was about these people and he felt that the “dominant assumption is that the poor have no purchasing power and, therefore, do not represent a viable market.” This he believed was incorrect and went on to show through various examples that even those earning less than $2 per day and can add up to substantial market size.

Along similar lines, those paying an income tax of less than Rs 1.5 lakh can also end up paying a substantial amount of income tax in total, though individually the income tax that they pay is low.

Hence, there is a lot of money that the government can collect at the lower end as income tax. This is a point that was made even in the most recent Economic Survey, released in February earlier this year. Take a look at the following chart.


What does this tell us? It shows very clearly that the basic tax exemption limit, only above which an income tax has to be paid, has risen at a much faster rate than the per capita income in India. As the Survey points out: “We can calculate in some sense the “missing taxpayers” in India—not those who are evading taxes altogether or under-reporting taxes but those who have legitimately gone under the tax radar due to “generous” government policy.”

What does this calculation tell us? Or to put it simply who are these missing taxpayers? These are those taxpayers who got left out because the basic exemption limit beyond which an income tax has to be paid has been raised from the level of Rs 1.5 lakh in 2008-2009. It currently stands at Rs 2.5 lakh.

If this threshold had not been raised as rapidly as it was, the government’s income tax collections would have gone up tremendously.

As the Economic Survey points out: “We ask how many taxpayers there would have been in 2012-13 if the threshold had been maintained at Rs. 1,50,000 (the threshold limit in 2008-09). We find that there would have been an additional 1.65 crore units incorporated within the taxation system (an addition of about 39.5 percent) and tax revenues would have been about R31,500 crores greater. India’s tax-GDP would have increased by 0.32 per cent just by not having raised the threshold so generously.”

In fact, the Survey also points out that there is a lot that India can learn from China on this front. As it points out: “[The] Chinese success in bringing more citizens into the individual income tax net owes to setting a reasonable threshold for paying taxes and not changing it unduly. In contrast, in India, exemption thresholds for income taxes have been consistently raised. In fact, as Figure 7 [the chart shared above] shows, thresholds have been raised much more rapidly than underlying income growth so that today, the wedge between average income and the threshold has widened.”

The finance ministers who increased the tax exemption limit knew what they were doing. They were basically playing to the gallery. But the loss of taxes on this front was more than made up for through first through a higher service tax rate and now through various cesses like Swacch Bharat Cess and Krishi Kalyan Cess.

Of course, indirect taxes are in the end paid by everybody, even those who are not a part of the formal sector. In that sense, it was only fair on those paying income tax.

It is worth remembering that in economics there are no free lunches. If the government gives from one hand it takes away from another.

Disclosure: The basic idea for this column came after reading R Jagannathan’s column Why Nicking The Non-Poor May Yield More Tax Than Just Mugging The Rich on SwarajyaMag.com

The column originally appeared on the Vivek Kaul Diary on May 13, 2016