There is an assumption that India's low income-tax base is only the result of tax evaders. Not so
In a recent revelation, the IT department stated that a little more than two crore Indians, or 1.7% of the population, paid income tax in the assessment year (AY) 2015-16.
While the number of people who filed for income tax rose from 3.65 crores to 4.07 crores in the 2015-16 assessment year, a little more than half (2.06 crore) actually paid taxes, as the rest claimed incomes below taxable levels. The total income tax paid by individuals was Rs 1.88 lakh crore in AY 2015-16, which is well below the Rs 1.91 lakh crore collected in the AY 2014-15.
In the broader political discourse, the fact that less than 2% of Indians pay income tax is seen as a sign of widespread evasion. In his Budget speech last year, Finance Minister Arun Jaitley claimed that India is a “tax non-compliant society and too many people evade taxes.” Another feature of this sentiment is the belief that most Indians under-report their income.
With black money becoming a major talking point for political parties, the perception that many Indians don’t pay or under-report their incomes has become well-entrenched in mainstream society.
Income tax evasion is a serious concern, but that does not determine why India has such a small income tax base. Data tells us otherwise.
Latest figures suggest that India’s per capita income is a shade above Rs 1 lakh. In other words, the average Indian earns a little more than Rs 1 lakh every year. Given the gross income inequality that exists (richest 10% of Indians own 80% of the total wealth, while 336 million Indians live in extreme poverty), one can safely assume that a significant majority of Indians earn less than Rs 1 lakh per annum, while a much smaller proportion of people make more.
With the income tax exemption limit fixed at Rs 2.5 lakh per annum, is it any surprise that a significant majority of Indians do not pay income tax? In other words, only those who earn 2.5 times more than the national average income are eligible to pay income tax.
A recent study by the People Research on India’s Consumer Economy (PRICE), backed by surveys conducted by National Sample Survey Organisation (NSSO), the average income of the wealthiest 20% of Indians is a mere Rs 95,000. In other words, even a significant segment of India’s most affluent 20% do not pay income tax on their annual income which is less than Rs 2.5 lakh.
The bottom line is that Indian is a low-income country, where the income tax exemption threshold is set very high. Unlike India, other major developing economies set their income tax exemption threshold at approximately half their respective average national per capita incomes. India sets it at 2.5 times above the average.
Lowering the threshold to say Rs 1 lakh may bring in more people under the tax net, but it will not necessarily have a significant impact on the tax revenue India will earn. This is just the nature of the beast. Thus, it would be a mistake to equate the small number of taxpayers with dishonesty.
With political discourse dominated by corruption, black money, and tax evasion by some high net worth Indians (stashing their money in foreign bank accounts), it has become easier for government to sell measures like demonetisation. Despite the government’s claims, demonetisation did little to increase the number of Indians filing for income tax.
To increase revenue generated from income tax collections, some in the government have suggested taxing medium and large farmers, besides companies invested in agriculture.
Taxation of agricultural income is a state subject. As per the provisions of the Income Tax Act, 161, agriculture income is exempt from taxation by the Centre.
Only income generated by major plantations is subject to tax by some state governments. Of course, having our legislatures dominated by big landowners has also ensured exemptions on agricultural income.
Earlier the NITI Aayog had recommended bringing agricultural income within the personal income tax net. Despite this proposal, it is hard to tax agrarian income because these transactions are primarily conducted in cash, and do not pass through the formal banking system. Besides major plantations, there is little to no account keeping in the agricultural sector. Moreover, 70% of Indians employed by the farm sector own less than 1 hectare of land.
However, National Sample Survey (January 2013- December 2013) data suggests that agricultural households with more than 4 hectares of land (4% of the total agrarian households) hold a 20% share in the overall agricultural income of this country. These higher land holdings, which earn income above a certain threshold, say the Rs 2.5 lakh limit, could attract income tax. Marginal and small farmers can remain exempt from personal income tax.
To figure out the threshold of imposing an income tax on this sector, NITI Aayog member Bibek Debroy argued that it can be decided after accounting for the average income of either a three or five-year period.
Exemption to agricultural income, studies have shown, only tend to benefit medium and large farmers, besides major companies invested in the agricultural sector not to mention suspected cases of non-farm income being shown as farm income to avoid taxes.
Another potential reason for such low returns on income tax is the number of instruments that allow citizens to earn tax-free income. Equity-linked savings schemes, public provident fund schemes, employees provident fund, and a whole host of insurance plans offer citizens a way of earning income which is exempt from tax. These instruments are critical for their savings.
Thus, the assertion that a low income-tax base is merely down to dishonest practices isn’t the complete truth.