By Nageshwar Patnaik, Bhubaneswar, January 31, 2020: All eyes are on the tax proposals in the Budget 2020 to be presented by Finance Minister, Nirmala Sitharaman on Saturday. No one likes to pay taxes. Even the rich don’t want to pay taxes. But as Benjamin Franklin had once said, in this world nothing can be said to be certain, except death and taxes. Taxes are an indispensable part of life. Without taxes, the nation will come to grinding halt without any development activities.

Sitharaman will present the Budget at a time when the economy, India as well as global, is showing signs of stress. India’s estimated Gross domestic Product (GDP) growth is pegged at 6-6.5% by the Economic Survey tabled by Sitharaman on Friday.

However, it will be really challenging as the demand cycle is yet to pick up in India. There is a dip in the private investment and consumption demand is falling. The FM has limited fiscal space with the tax revenue collections below expectations. A forward looking Budget 2020 with the right policy steering reforms in the tax sector may help India achiever this stiff growth target.

It is worth mentioning here that during the time when demonetisation was in effect, there were some talks around abolishing income tax and bringing a consumption-based tax system. Rationalisation of tax rates with phasing out of obsolete exemptions / deductions, with more focus to make the economy more tax-compliant will be key to lift India from the present economic slump.

Some politicians as well as income tax experts had in the past pitched for the abolition of income tax in India. For instance, senior BJP leader Dr Subramanian Swamy had some time back said that “one of the important ways to put the economy on a double digit expansion mode would be to raise savings and abolish the Income Tax.”

The tax-Gross Domestic Product (GDP) ratio of the country (after including the Centre and states’ tax revenue) was 17-17.5 per cent till 2018-19. This is almost half of the average tax-GDP ratio of Organisation for Economic Corporation and Development (OECD) countries, which was 34.3 per cent in 2018.

There is a common myth about India’s tax policy that its tax-GDP ratio compares rather unfavourably with other nations. An analysis of direct taxes-to-GDP ratio vs per capita GDP of 130 countries for 2017 shows that India’s ratio of 5.7%, does better than its peer group of countries at the same per capita GDP level. India outperforms or has similar direct tax-to-GDP collections when compared to countries like China, Russia, Indonesia, Spain, Germany and Sweden, despite having a lower per-capita income ($2,000) than these countries.

In fact, India has come a long way in achieving the objective of a rational and moderate tax rates regime. For instance, in 1971, the personal tax system had as many as 12 tax brackets, with tax rates ranging from nil to 85%. With surcharge, the highest tax burden worked out to an astounding 93.5%. The effective burden of personal taxes was reduced in successive years as governments recognised that moderate rates, a wider base and better compliance made for a better tax policy as opposed to high rates.

In post liberalization, privatization and globalization (LPG) era, particularly in 1992-93, the tax rates were considerably simplified to have only four tax brackets, with the peak tax rate of 40%. The 1997-98 Budget cut the peak personal income-tax rate from 40% to 30% and the corporate income-tax rate from 40% to 35% for domestic firms. This announcement set the new peak tax rate for personal income tax that continues till today, although the additional surcharges mean that the highest tax burden is 42.7%.

The tax cuts resulted in a sharp dip in the tax-GDP ratio in the immediate term. But the moderation in tax rates resulted in better compliance, combined with the base broadening measures consistently undertaken by the government, led to a rise in the tax-GDP ratio in the medium to long term.

This sustained increase in the tax-to-GDP ratio was achieved despite India facing global economic headwinds and experiencing a three-year growth slowdown between FY2000 and FY2002.

This clearly suggest that the income tax cuts did not lead to a fall in tax revenues as it resulted in a positive behavioral response with better compliance leading to an increase in the direct taxes-to-GDP ratio in the long run. At the same time, there is an urgent need to widen the tax base and improve tax-GDP ratio by rationalizing the current tax rates and creating better regulatory framework.

How much tax you pay on income depends less on how much you earn and more on how much you can hide – or show income as non-taxable. The salary-earning class is the most disadvantaged because 100 per cent of income tax is taken away even before the salary reaches them. It is also not allowed certain tax-free expenses that non-salary earners are allowed.

The differential treatment of the two classes of taxpayers is not unique to India, but the large and widening gap in tax liability between the two is. An average salary earner pays three times more income tax than a non-salaried taxpayer. If non-salary income earners pay even 70 per cent of what the salaried class pays government earnings would go up by Rs 50,000 crore a year. Sitharaman needs to address this issue when she presents the budget on Saturday. In the past, finance ministers have failed to correct this anomaly, leaving the system that penalises the honest.