Surely I am not the only one? Don’t all of you, dear reader, hate paying income tax, especially when it is cut right from your salary? Haven’t all of you had the same dream sometime, of not having to look at another income tax form ever again in your life?
People, you are in august company. Former US president Jimmy Carter called income tax "a disgrace to the human race". In the matter of taxation, every privilege is an injustice, said Voltaire. But, naturally. Income tax started off everywhere as an emergency measure during war, with the citizens told to make a special contribution. It was introduced to the world by England fighting Napoleon (see box) and then increased at will, often unconstitutionally, to fight more wars and/or to replenish a treasury depleted by it. American politician Bill Archer said: "I am convinced that if most members of Congress did their own taxes, we would’ve had tax reform long ago." In India, we can go a step ahead and declare that income tax would have been abolished long ago if even a fourth of our rhino-skinned politicians paid any. Since they, and countless other privileged members of society, declare subsistence-level incomes, the remaining 28 million of us cannot shake off our great obligation, our raison du travailler. We work because we have a government to support!
"The hardest thing in the world to understand is income tax."— Albert Einstein
Income tax is just a bad idea that got progressively worse. It gives government a claim to your labour, just as a slave owner had a claim to the slave’s labour. Yet, the maximum that could be extracted from a medieval serf was one-third. But during world war times, tax rates in most countries varied from 77 per cent to 90 per cent. In India, Indira Gandhi raised the top rate to 97.5 per cent (which only a handful paid), yet collections barely exceeded one per cent of gdp. Even two years ago, the highest tax rate was 33.5 per cent including surcharge. No wonder that despite desperate efforts by the government to raise direct tax revenues, they are stagnant at 3 per cent of gdp, with the share of personal income tax (PIT) stuck around 1.4 per cent and corporate tax contributing 1.6 per cent.
Notice that only a fraction of India’s population contributes almost the same amount paid by its entire corporate world! Notice also that the recently added tax base of paanwallahs, doctors, architects, lawyers and other small businesses, claimed to be around 20 million, under the one-by-six criterion (anyone who owns a house, car, telephone, credit card, or has a club membership or travelled abroad, has to pay income tax mandatorily) has contributed a pathetic Rs 1,000 crore to the tax revenue (or 0.26 per cent of last fiscal’s income tax collections of Rs 37,300 crore)! Sixty per cent of India’s PIT revenue comes from TDS (Tax Deducted at Source)—the inescapable axe on salary income.
By contrast, America has 127 million taxpayers, paying in $1 trillion to the federal government. And perhaps an even more regressive system. The US ‘tax army’ is bigger than the US army that went to Iraq. Income taxes there are so complex that there are up to 1.2 million paid ‘tax preparers’ in the country—six times more than the number of troops in Iraq—with a total compliance cost of $192 billion. As the number of tax shelters grew, the number of IRS (Internal Revenue Service) tax forms went up to 526 in 2002 (402 in 1990) and the number of pages in the tax code and regulations doubled from 26,300 in 1984 to 54,846 by 2003. In India, in 1939, we had a 67-section tax code, same as in small low-tax, high-compliance countries like Hong Kong and Singapore. We now have a long convoluted code that allows many companies to get by without paying any tax.
These papyrus administrators don’t understand a simple fact: income tax goes against the grain of human nature. It violates the inalienable right of an individual to her own property/income and interferes with her right to dispose of that property/income in the manner she chooses. In concept, income tax smacks of socialism—"from each according to his ability"—and thus triggers human beings to become poor producers. Why expand my business, why work overtime when my increased income will leave little for myself? Secondly, it violates the principle of equality—that all men are equal in the eyes of law or government—though in terms of extraction, its administrators are as impartial as the highway robber! Third, income tax doesn’t distinguish between wealth obtained by privilege and wealth obtained by production.
The government is as strong as its income, right? But surely this ought to be true of its people too? Why do all developing countries tax heavily? Because they have the largest government debts and the largest expenditures. Governments borrow on the security of their power to tax; the more its borrowing, the greater is its compulsion to tax the income and savings of its people. In a way, that’s getting back a part of the public debt. The Indian government is richly convicted of this crime; its entire borrowing goes to meet half of its spending on itself.
Again, income tax is not only a tax on income but on capital too (as savings are also taxed). By taking away a part of capital or by allowing that part of income not to be spent, the government reduces capital investment or hits demand-driven spending, either way impacting growth. Stanford economists Robert Hall and Alvin Rabushka, the pioneers of the flat tax, estimate that this barrier to productive economic activity reduces annual economic output by $750 per person in the US. As government spending grows, it expands, becoming the largest political force, employer, financier, buyer of goods and services, you name it. And as government grows, people’s power diminishes. They tend to form lobbies for tax shelters or become corrupt. Research shows that businessmen view direct taxes as a business cost, and seek to pass these on to consumers or take their money abroad, legally or illegally. Lastly, income tax is undemocratic because popular will doesn’t support it. Left to themselves, humans will always work to satisfy themselves, not to help redistribute wealth.
"The avoidance of taxes is the only intellectual pursuit that still carries any reward." —John Maynard Keynes
In most countries, to a greater or smaller extent, the income tax system suffers from huge litigation, arrears, corruption, evasion and punitive action. In India, computes tax expert S.S. Bagai, it’s possible to earn 10 times current revenues on prevailing rates of tax. But that’s possible only when people pay up voluntarily, a contradiction in terms and therefore impossible.
Let’s take the top rate of 30 per cent to show how the Indian tax system has become regressive, extortionary and evasion-encouraging over time. This rate is applicable to income above Rs 1.5 lakh now, but the ceiling used to be Rs 6 lakh in 1959 (at the current value of the rupee) and Rs 60 lakh in 1939! During Indira Gandhi’s time, as mentioned above, rates had become well-nigh intolerable for higher income groups, but two-third of the individual taxpayers were still paying tax at 3 per cent and 6 per cent only, compared to 20 per cent now. By encouraging avoidance and evasion, income tax thus also distorts financial planning and business investment and encourages unreported income, or the shadow economy. A recent study by economist Friedrich Schneider finds India’s shadow economy at 23 per cent of the official one.
Says Rajiv Gandhi Foundation director Bibek Debroy: "There are probably 200 million households in India. Today agricultural income, including non-agricultural income of farmers, is outside the tax net. That probably leaves around 65 million urban households. Almost 28 million already submit returns. Given the exemptions, this number won’t rise in a hurry. The problem thus is with under-declaration, rather than with non-submission of returns. How do we fight under-declaration?"
We don’t. We simply get rid of income tax. Dramatic as it may sound, economically, it’s perfectly possible to abolish income tax. Maverick economist-politician Subramanian Swamy has argued for long for abolition of income tax. He says in his book India’s Economic Performance and Reforms: "After abolition (of income tax), the rate of savings will shoot up, the stockmarket will boom and the growth rate will increase. And indirect tax revenues will be double the loss of direct tax revenue. We must know how to take actions which look risky but have high rewards." He’s right; indirect tax (like customs and excise) revenues are already almost double direct tax (like income tax and property tax) revenues.
Even industry supports it. Says cii’s T.K. Bhaumik: "We can have an expenditure tax or a consumption tax with a more stringent administration. For example, a higher tax on sales of luxury items like cars, ACs or air travel. There are many benefits of abolishing PIT. One, it will legalise all the black money floating around. There will be a surge in savings and expenditure because disposable income will increase. If one saves, it will go indirectly or directly to the exchequer. If one spends, the expenditure tax can bring in revenues."
"We contend that for a nation to try to tax itself into prosperity is like a man standing in a bucket and trying to lift himself up by the handle." —Sir Winston Churchill
In fact, the world is already moving towards less or no income tax. There are two options: an expanding value-added tax (VAT) regime or a flat income tax. Even in the US, along with tax cut proposals, the flat tax is gaining popularity. Harvard economist Dale Jorgenson has also suggested distinguishing between income or property that is accumulated, and earned. Some countries like Russia, Croatia, Estonia and Latvia have successfully adopted flat tax—Russia reported 50 per cent rise in collections in two years with a 13 per cent tax.Even China, faced with 40 per cent evasion and more among the wealthy, despite a peak rate of 20 per cent, has published the flat tax book to popularise the concept.
A better alternative is a well-orchestrated value-added tax. Explains economist Ashok V. Desai: "A VAT is a proportional income tax. If it can cover everyone selling anything in the market including one-woman businesses, then it would be possible to abolish the lowest bracket of income tax and raise the threshold considerably, say, to Rs 5,00,000 or so." Adds editor-economist Swaminathan A. Aiyar: "The distinction between direct and indirect taxes is a blurred one. We will do well to get the vast bulk of our tax revenue from a comprehensive VAT, and relatively little from income tax." Oxus Research president Surjit S. Bhalla goes a step ahead: "Team the VAT with a consumption tax and you have enough arsenal to replace the regressive income tax system." (see interview)
VAT works on a simple principle. The value of a product is the share of incomes of participants in its production. These are wages, rents, interest and profits. A complete VAT will therefore tax all forms of income. Why then have a separate income tax or corporate tax? VAT also has several advantages over income tax. One, it’s easily collectible and minimises evasion since every stage of production is accounted for. Says Parth J. Shah, president, Centre for Civil Society: "In income tax, the more a person earns, the more she or he hides. In VAT, the more the manufacturer or the retailer earn, the more they declare, because they want refund. If they hide, they don’t get refund, so they pay a sort of tax anyway." Two, VAT’s easily payable. You pay the tax at the cash register. No forms, no fuss and no intrusion into your personal finances by the ITO. Three, VAT is levied on consumption, not savings, and therefore encourages savings and investment—the less you buy, the less tax you pay. Four, even farmers pay VAT!
Some may worry that a national VAT would make shopping trips more expensive, but most economists note that the income tax, corporate income tax and excise already make goods more expensive. Since these taxes will go, the price of consumer goods could actually fall as a result. Also, getting rid of the taxes that penalise investing and saving will fuel an increase in economic growth, which means increased business competition and lower prices.
The second worry is that the poor will have to pay a larger share of their income for essentials like food and clothing, so indirect taxes hit them more. This is the redistribution or equity principle that favours income tax. There is merit in this argument. So, most countries have kept items like uncooked foods out of the net—even in India, under the proposed VAT, essentials like salt, life-saving drugs, fruits and vegetables etc are exempt.
The most clinching argument is trade policy. Under wto rules, a country can refund exporters’ indirect taxes, like VAT, they have paid on goods, but not income or corporate tax on export profits. These rules have opened a window of opportunity for India. Says Aiyar: "India needs to aim for a flat income and corporate tax rate of say 15 per cent, with a high exemption limit of Rs 5 lakh. This will exempt the middle class from income tax, and the rich will happily pay 15 per cent with no hassles or litigation. Best of all, no IT companies (or other exporters) will migrate. " From this to no income tax is but a story of a few years!
It won’t even affect the budget! Personal income tax collection is only 9 paise out a rupee earned by the government, while subsidies take 10 paise out of a rupee spent. The one paise saved can go to politicians to subsidise their people-friendly programmes. On the other hand, savings would be enormous. There will be an immediate direct rise in disposable incomes by 10, 20 and 30 per cent as per the current PIT rates. Second, it is estimated that there will be an immediate rise in household savings from 23 per cent now to at least 26 per cent. That is because some of the income freed from tax will go to savings, while a significant part of the hidden wealth can now be saved and money earned on it. While most of the black economy is notional and partly accounted for in the gdp, Bhalla estimates at least 10 per cent increase in the value of the gdp with the end of the black economy.
So why don’t politicians prefer VAT over IT? Simply because the former is a more transparent system. The tax would be clearly stated on the purchase receipt and it would be hard to raise it without people noticing. That scares most politicians. The government governs best when it governs least. But income tax makes this country an oligarchy of bureaucrats who live by extortion. Let’s have freedom from their power. Let’s reverse Benjamin Franklin’s words. Let only death be certain in this world, not income tax.