India’s long-term vision for taxation should be ‘one nation, one tax rate’ for both income and GST
One of the few missteps in Nirmala Sitharaman’s first budget was the temptation to tinker again with the personal income-tax structure for high earners when the basic direct taxes code is not yet ready. It may sound good to soak the rich with higher taxes, with those in the ₹2 crore to ₹5 crore bracket and in the ₹5 crore-plus range paying an effective rate that’s 3 and 7 percentage points more , but this will do nothing but encourage more evasion. While the wealthy may have heaved a sigh of relief that the budget made no mention of an inheritance tax, it makes little sense to arbitrarily raise income taxes for a handful of individuals without first indicating your basic approach to taxation.
This is thus as good a time as any to try articulating one comprehensively. The principles underlying any tax code, whether direct or indirect, must be stated upfront and not added as an after-thought. Here are four of them. First, basic income and product taxes must be low and not just moderate. The assumption is that no government spends money more efficiently than its citizens. Hence, leaving more money in the hands of citizens is better than leaving it in the hands of bureaucrats or netas.
Second, taxes on income from labour (physical or mental) should be the same as those on earnings on capital investment. This is to ensure that when planning production, entrepreneurs don’t use disproportionate amounts of capital at the cost of employment just because capital is taxed lower. Third, inheritance should likewise be taxed moderately, with generous exemptions so that incentives to create wealth are retained. The logic of this proposal is simple. We live in a society where high average levels of disparity between the rich and the poor can be socially and politically destabilizing. However, applying the same logic that money left with individuals will probably be spent more efficiently than what passes through the exchequer, an inheritance tax law should allow for the creation of charitable trusts in specific social-priority areas such as health and education. Legacies left to charitable endowments can then be exempt, subject to public and social audits to ensure that they do not degenerate into tax-avoidance avenues.
These principles yield a direct question: What should this low level of taxation be? While anyone is free to suggest a number, my own preference is for a 15% flat rate of tax. The number 15 should be seared into tax codes, both direct and indirect, either as a current objective or a long-term one, to be achieved in stages. The 15% tax rate is also similar to the one-sixth “bhaga” of production that Chanakya suggested as the state’s share of taxes.
Fifteen makes a lot of sense for both direct and indirect taxes. Take indirect taxes first. The two current middle rates are 12% and 18%, which leaves 15 as the “middle middle” rate. First, the rates need to converge towards three, which could be 5%, 15% and 25%, and later towards 15% for all products. Instead of a zero rate for commonly used goods, we could have a universal 0.15% goods and services tax (GST) for these items, with the buyer paying the tax and reclaiming it later through input tax credits. This will not only broaden the GST ambit but also make it universal while sparing the aam aurat (common woman) the need to register with the GST system.
For direct taxes, 15% should be the new flat tax rate one should attempt to achieve over, say, a decade. Right now, direct taxes are a bit of a mess, with a 5% low rate, followed by a 20% middle rate, and a top rate of 30%, with various surcharges for the higher earners. This does not make sense: if you have 5% as the low initial rate, the logical next two rates are 15% and 25%, not 20%, 30% and 30%-plus. Also, if corporations are ultimately going to pay only 25%, the 30-plus rates for individuals is extortionate. We need to move towards the 5-15-25% regime and finally to a single rate of 15% flat tax.
It is worth noting that 15% is roughly the midpoint now between various kinds of tax deduction at source, which range form 10-20%. As ₹5 lakh is now the tax-free income limit, over 10 years this base should move towards ₹15 lakh. This figure is not something that I plucked out of thin air. At ₹15 lakh per annum per household (and more for multiple income families), the per capita annual income per household of five would be over $21,000 at current exchange rates, which is a per capita income of $4,000-plus, roughly where India would be as a middle-income country after 10 years.
As for income from capital, we now have three tax rates—10% for long-term capital gains, 15-30% for short-term capital gains depending on whether securities transaction tax is paid or not, and 20% for non-equity long-term gains. This kind of structure is far from simple and needs correction. Why not let all capital gains be taxed at 15%, with long-term capital gains getting the benefit of cost indexation?
There is value in having a number, just one number, by which all incomes, products and services could be made uniformly taxable. Those who think low tax rates will reduce the exchequer to penury need not fret. When you pay less income tax, you tend to spend more on products and services. GST collections will boom after a lag.