The recent report of the Standing Committee on finance has engineered a sharp discussion on the merits of a tax hike on the rich in India. Former RBI governor Mr C Rangarajan has opined, possibly on the basis of the ?findings? contained in the report, that perhaps India needs an inheritance tax along the lines of the US. Indeed, it can be argued that the Indian glitterati and perhaps even the policymakers take their cue from happenings in the US. That the US debate on economic matters should be of considerable interest (and introspection) to all of us is beyond question. The US is both the lead economy and certainly the ?lead? economist in the world. Many of the most talented economic thinkers and policymakers in the world have been trained, and trained rigorously, in the US. So you know where I stand in learning from the US.
But it should be abundantly clear to most, if not all, that on taxation matters, particularly individual taxation, the US is the worst country to follow. Their system is broken, and all the US manages to do with its direct tax code is apply band-aids at every opportunity. The US does the same in its lame attempt to remedy its antiquated and repressive and regressive and obscene lack of laws on gun control. The US does need to address issues of inequality and taxation and gun control?it does not at all follow that we, or anyone else, have to do the same.
We have enough problems at home without worsening our balance by importing some from abroad. If we have to change the Direct Tax Code; it has to be based on something considerably more rational than aping the US. The table documents the data presented on page 40 of the Standing Committee report.
Some peculiar results. It seems reasonable to assume that the average income in each slab is equal to the mid-point of the range. This rule obviously does not apply to the top bracket, >R20 lakhs, about which more below. If average income is known, then the effective tax paid by the average person in each slab can be derived. And this is where difficulty begins and credibility ends?the effective average tax rate for the R5-10 lakhs category is 16.4%. Given our tax laws, and deductions, this rate should be around 11%. The discrepancy is very large; if true, it suggests that our tax administration is doing something beyond belief and should be hired either by the CAG or the US tax authorities.
But don?t be too hasty with your conclusions. Note the effective tax in the next category, R10-20 lakhs. For this group, the effective tax rate is only 8.64%, and half the tax rate of the lower slab. Given our relatively simple tax laws, with very few deductions, the effective tax rate for this group should be 19%. You can do your own simple math; for 2011-12, the tax slabs were 10 % on R1.8-5 lakhs; 20% for R5-8 lakhs and 30% thereafter.
There is a deduction for interest on housing loans of R1.5 lakh and a maximum deduction of R1 lakh of principal on the purchase of a house. This reduces the effective tax rate to 14.3%?closer to 8.6% but still very far away. And, for this to happen, there would have been 1.4 million individuals buying houses above R15 lakhs in 2011-12. Possible, but not likely! So what gives? CAG and US tax authorities, hold off on hiring India?s tax officers.
But wait?look at the eye and tax popping figures for the R20 lakh and above category. This super-rich class comprised only 1.3% of all tax-payers and accounted for 63% of the personal income tax collected in India in 2011-12?and possibly salivated the minds of India?s tax officials. This is the highest in the world by an order of magnitude. Second to India is the US where the top 1% accounts for 37% of income tax, and much further behind are the tax authorities of Europe.
What is the tax rate the super rich are paying? Theoretical calculations suggest that this rate should be close to 25%. What is the average income of the super-rich? With this effective tax rate, and the number of tax individuals and amount of tax collected by the Indian tax authorities, the average income of this group is R92 lakhs. But is this average for 4 lakh tax payers realistic? It is not, and here is why.
The last official calculation of the Indian tax distribution was conducted by Mr Vijay Kelkar for the ministry of finance (Report of the Task Force on Direct Taxes, 2002). That report estimated that those earning above R10 lakh in 2002-3 comprised only 0.26% of taxpayers, and had an average income of R31 lakhs. Interpolating (and some estimation with the use of income distribution data), one obtains that those earning above R20 lakh in 2002 were less than 0.1% of taxpayers. With inflation and income growth, this fraction has now increased 40 times to 4.3% of the population.
It is near impossible for the average income in the above 20 lakh category to have increased by 150% in the last decade. The reason is simple accounting. Assume for a moment that the average income for this category was R40 lakh in 2002. If there are no new entrants into this category, then the average income will be around R1.3 crore in 2011 (per worker income increased in nominal terms by 3.2 times between 2002 and 2011). But any new entrant will have incomes closer to R20 lakh rather than R40 lakh. The net balance between these two forces is unlikely to increase the average much; our simulation shows that this average rises from R40 lakh in 2002 to R44 lakh in 2011-12. If this mean income is assumed, then the effective tax rate of the super rich is 53%.
No matter how one looks at the income tax data, it does not make sense. Sensible policy can only be made if the data is credible. Can there be a right to information about aggregate income tax data for each year, as done in most of the world except perhaps China? Are we left with only two courses of action?aping the worst from both US and/or China?
Surjit S Bhalla is Chairman of Oxus Investments, an emerging market advisory firm, and a senior advisor to Blufin, a leading financial information company. This research emanates from a project on the generation of monthly GDP data for India
