Should India Abolish the Income Tax?

Image via Indian Express

Indian voters have a choice between a stagnant agrarian India and a prosperous free-market India.

Ever since his ascension to the Prime Minister’s Office in May 2014, Narendra Modi’s governance has operated on the basis of two basic principles – “Maximum governance, minimum government” and “Sabka saath, sabka vikaas,” which translates to “mutual support and inclusive development.”

In the past decade, the West has been dominated by social democrats, while Asian countries have broken free from the primitive concept of government-administered economic manipulation. India has been a leading participant in this transitional phase of economic supremacy being transferred from the West to the East. After more than 60 years of rigid licensure laws, tough regulations, and complex tax codes, the Indian economy, led by Prime Minister Modi, has adopted more business-friendly measures by cutting back regulations and simplifying tax laws.

Similar to one of the pillars of “Reaganomics,” the BJP (the ruling party of India) government is reportedly considering the abolishment of the most prevalent form of direct taxation – the income tax.

Mr. Modi’s announcement on the 8th of November (not the only surprise on that day) declaring the demonetization of ₹500 and ₹1,000 currency notes revealed his unconventional manner of governance. It established that he is unafraid to think outside the box, unlike the narrow-minded, minority-appeasing and vote-bank dependent socialist leaders that preceded him. Interestingly, the Pune-based trust Arthakranti Prathisthan that had suggested the idea of demonetization to Mr. Modi is the same trust that recommended the abolishment of income tax.

Moreover, a nationalist hardliner and member of the BJP since 2013, Subramaniam Swamy, has long claimed that he would have abolished income tax in seven days had he been a part of the government.

Despite this tremendous support, let us first consider the mathematics behind this dramatic leap to the Right before drawing any conclusions.

The Indian government collects more than ₹3 trillion from income tax, despite the fact that less than 4% of Indians file income tax returns (the U.S. collects over 90%). This is mainly because of the agriculture sector, which composes about 50% of the workforce, is exempt from the income tax by the Central Government. Therefore, it is relieving to know that the abolishment of income tax would affect less than four of every 100 Indians.

Tax evasion in India is overwhelmingly rampant. Out of the 7.6 million individuals who claim incomes greater than ₹500,000, 5.6 million belong to the salaried class. It is unlikely that there are only 2 million wealthy entrepreneurs in a population of 1.2 billion producing more than $2 trillion every year. The abolishment of income tax removes the sole motive behind tax evasion, making all of the unaccounted money in India’s economy white.

When consumers have greater after-tax incomes, their propensity to spend and save accelerates. This means that income earners will have more money under their control if they are not liable to pay taxes on it. The ₹3 trillion will then be spent on the purchase of goods and services or saved in bank accounts rather than being used by incompetent politicians. Whether spent or saved by income earners, the money lost by the government is not irrecoverable.

With all money being legal, income earners would be less hesitant to deposit their money in banks. As Professor Kaushik Basu points out, if a small tax is levied on deposit interest, the government would have tapped into a very lucrative source of revenue. For example, The State Bank of India’s 2016 balance sheet shows deposits of ₹17.3 trillion. If a 10% tax is levied on 8% interest, the government would have recovered more than 4.5% of its lost income from just one bank.

The largest source of recovery, however, would be the consequent expansion in revenue collected through indirect taxation. Ronald Reagan’s income tax cuts in the 1980s resulted in an almost $400 billion increase in government revenue over the span of eight years. Of course, it would not be fair to compare present-day India with Reagan’s America without taking into consideration the situational differences. Revenue through indirect taxation might not be as significant in India where the informal sector accounts for 45-50% of the output, whereas, according to research from The Urban Institute, the informal sector in the United States began expanding only after the 1980s and produced anywhere from 5% to 10% of the GDP in the mid-1990s.

As far as principles are concerned, one should not overlook the sharp contradiction between India’s historic values of economic equality which are expressed even in the Constitution’s Preamble and the modern day principles of economic freedom. However, the Indian voter has a choice between the stagnant agrarian India and the free-market prosperous India.

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