After the noon on 23 July 2024, criticism of the new personal tax proposals was all over social media – particularly, criticism for long-term capital gains. It was also debated aggressively on the floor of the house. This made one believe that long-term capital gains tax must be significant in terms of revenue for the government and affect a large section of society.
About 400,000 individuals reported long-term capital gains of more than Rs5 lakh (above which taxes apply) in 2023. Compared to India’s adult population of nearly 1 billion registered voters, this is a mere 0.04 per cent. Further analysis shows that almost 60 per cent of these 4 lakh individuals report income up to Rs15 lakh and contribute a meagre 0.001 per cent of the total direct tax collection.
In contrast to this, GST (Goods & Services Tax) collected on the sale of commodities like sugar affects almost the entire adult population of 1 billion people. This includes those barely making ends meet. In India, with a high disparity in income and wealth distribution, should our
policy-makers really be focussing on personal income taxes?
Another interesting statistic is that barely 3 per cent of India’s adult population paid tax in 2023, less than half of the number of cars registered in India. This suggests that not all people falling within the tax bracket are paying taxes. The main reason for this is the parallel cash economy that is thriving in India, supported by unorganised sectors. With cash, the buyer avoids paying GST and the seller avoids paying income tax. This makes the cash economy a win-win for both.
Consider a business that books revenues of Rs1,000 and expenses of Rs500, reports income of Rs500 and pays tax on it. Assuming an 18 per cent GST rate on sales and no GST leakages, the government collects about Rs305 in taxes (Rs180 as 18 per cent GST on sales and R125 as 25 per cent in corporate taxes). This is the ideal economy with no tax evasion. Now consider a business that invoices only the partial value of the products, say, Rs600 and allows the customer to pay the balance in cash. Here, the government collects only Rs133 in taxes (Rs108 as 18 per cent GST on sales and Rs25 as 25 per cent in corporate taxes) instead of Rs305, a loss of Rs172 to the exchequer.
By focussing on expanding the tax net, both GST and corporate tax, the tax burden could be more evenly distributed, and collections increased. This may also promote consumer spending and provide a cyclical impetus to the economy
Goods and services are prized at a lower value to save GST and corporate taxes across the supply chain. Therefore, the loss of revenue to the exchequer is higher. This is a key reason the cash economy thrives in India; it’s a win-win for everyone. If we reward the ultimate consumer to seek a GST invoice and pay GST, evasion of the entire supply chain can be stopped. The exchequer would not only gain Rs172 in the above example, but also prevent loss of taxation at each layer of the supply chain.
Personal taxes can be used as a carrot and stick to solve India’s cash economy problem. Allow individuals to claim GST paid on their personal consumption against their personal income taxes. Alternatively, allow a deduction of the expenses itself against the income, provided expenses have been subject to GST. The aim should be to allow individuals to enjoy tax-free income up to Rs15-20 lakh, provided they pull businesses around them out of the cash economy by seeking a GST invoice. To avoid fake deductions, the robust GST system can be integrated with the income tax system. To ensure that this does not affect small local shops, the deduction may only be limited to buying of non-daily essentials.
Once the cash in circulation is reduced, many businesses will fall under the tax net, which were earlier managing their businesses in cash. The proposal aims to make the tax system more equitable by ensuring that those who can afford to pay taxes do so and also remove cascading effect of multiple taxes for those paying income taxes as well GST on purchases. By focussing on expanding the tax net, both GST and corporate tax, the tax burden could be more evenly distributed, and collections increased. This may also promote consumer spending and provide a cyclical impetus to the economy.
A move like this could seem radical at first sight, but it is worth considering, given the challenges of the Indian economy. With Indian income tax law being shaped and ready to be unveiled in the next six months, this is a system worth considering