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Will more taxes on the super-rich help India's fiscal health?

Shweta Punj     January 17, 2013
It is a question millions of Indians are asking ahead of the 2013/14 Budget to be unveiled at the end of February: will Finance Minister P. Chidambaram increase taxes on wealthy Indians to tame the fiscal deficit?

Increasing taxes on the rich certainly makes political sense ahead of next year's general election. But economists involved in pre-Budget meetings oppose the move, saying it is more important to widen the tax base and improve compliance. "This is a lazy way forward. It seems more like a populist measure. There is so much to be done to increase compliance," says Rajiv Kumar, an economist who was part of the pre-Budget meetings.

The Chairman of the Prime Minister's Economic Advisory Council, C. Rangarajan, has suggested the government hike taxes on the super-rich to increase the tax-to-GDP (gross domestic product) ratio. The definition of super-rich is not clear, but economists say the number of declared wealthy tax-payers is too small to make a substantial difference to the country's fiscal health. India has nearly 35 million taxpayers, but only 1.7 million have a declared income of more than Rs 10 lakh. Nearly 89 per cent say their income is under Rs  5 lakh.

A back-of-the-envelope calculation shows that if the government increases the tax rate for individuals earning more than Rs 20 lakh a year by five percentage points to 35 per cent, it will only raise an additional Rs 4,500 crore, or 0.05 per cent of GDP, says Samiran Chakraborty, Head of Regional Research, South Asia, Standard Chartered. Just 400,000 people declare an income of more than Rs  20 lakh. "It is one of those experiments, you push something and you don't know how many dominos will fall. There is a cost benefit analysis that needs to be done," says Chakraborty.

Economists say higher taxes encourage evasion, and empirical evidence suggests the direct tax-to-GDP ratio goes up when tax rates are slashed. They suggest widening the tax net instead to increase revenues. Nearly 60 per cent of the economy is out of the tax net and tax collections from services, which account for more than half of the economy, are less than one per cent of GDP. "There is a negative list of services which are not yet taxed. We should have horizontal and vertical taxation parity," says Devendra Pant, Head, Public Finance, India Ratings. But horizontal parity is not an easy target because many sectors are outside the tax net.

A committee headed by former finance commission chairman Vijay Kelkar has recommended doubling the number of tax payers through better tax administration. "If you go back to Kelkar tax reforms, the whole philosophy was to go back to simplicity, lower tax rates and eliminate or substantially reduce exemptions. This would lead to ease of tax administration," says Ajit Ranade, President and Chief Economist, Aditya Birla Group.

{blurb}But tax administration is not easy. Economists say the government is likely to toe the global tax rate line which it has done historically. Tax rates in India were more than 90 per cent in the early 1970s when Britain's rate varied between 75 and 90 per cent. The US pegged taxes at 90 per cent in the 1960s. Today, India taxes income at three rates - 10 per cent, 20 per cent and 30 per cent (excluding cess and surcharges).

Chidambaram slashed the peak rate to 30 per cent in 1997 and tax rates have remained unchanged since then.

The current global tax sentiment is again in favour of higher taxes for the rich, point out economists. US President Barack Obama recently reached a 'fiscal cliff deal' that raised taxes on the wealthiest two per cent Americans to get the economy back on its feet. "There is no fiscal logic. Taxation approach needs to be different for low income and high income countries," says Ranade.

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