All those who are out of the tax net

In Economy, Macro Economy, The Hindu by Praveen ChakravartyLeave a Comment

It is not entirely surprising that only 3% of Indians pay income tax

Of nearly 127 crore Indians, only 2.6 crore pay income tax. The fact that less than 3% of Indians pay income tax is automatically construed to imply that a large majority avoid paying income tax. The Finance Minister, Arun Jaitley, made a sweeping statement in his Budget speech this year claiming that India is “a tax non-compliant society and too many people evade taxes”. Not only is the perception entrenched that too few pay income taxes but also that most Indians under-report their incomes.

What data say

Prime Minister Narendra Modi Exclaimed in his New Year’s eve speech that “only 24 lakh Indians reported an income greater than 10 lakh rupees. Who can digest this?” This perception that India is a land of tax avoiders and black money hoarders was first mooted by former Finance Minister P. Chidambaram who, in his 2013-14 Budget speech, emphatically asserted that “only 42,800 persons admitted to an income of more than Rs.1 crore per year”. The insinuation was that there is massive under-reporting of income. Most readers will perhaps endorse this growing chorus that India has too few honest taxpayers. Except that data belies this claim. That a large majority of Indians are tax dodgers may well be an urban legend.

India’s per capita GDP is roughly Rs. 1 lakh, i.e. the average Indian earns a lakh of rupees every year. Given India’s large income inequality, it can also be inferred that when the average income is Rs 1 lakh, a greater majority of Indians earn less than Rs 1 lakh while a small number at the top earn large amounts. However, the income tax exemption threshold in India is Rs 2.5 lakh, i.e. anyone earning below Rs 2.5 lakh need not pay income tax. This implies that only those who earn more than 2.5 times the average income of Rs 1 lakh will fall under the tax bracket. When a majority of Indians earn less than Rs 1 lakh, an income tax exemption threshold of Rs 2.5 lakh is sure to leave a vast majority out of the tax bracket. We also know from recent research by the National Sample Survey Office (NSSO) and Peoples Research on India’s Consumer Economy (PRICE) that the average income of the richest 20% of Indians is Rs 95,000. This means that even a large majority of the richest 20% of Indians do not qualify to pay income taxes. In this context, it is not entirely surprising that only 3% of Indians pay tax. This is not a function of a large number of Indians avoiding tax, as portrayed, but merely a reflection of the fact that India is a terribly poor country with an extremely high income tax exemption threshold.

Global comparisons

India is the only large economy with an income tax exemption threshold that is 2.5 times the average national per capita income. In most countries, including in emerging economies such as China, Brazil and Argentina, anyone earning more than half the average national income falls under the income tax bracket. India has increased the income tax exemption threshold on seven occasions, from Rs 40,000 to Rs 2.5 lakh in the last two decades. Contrast this with China, where the exemption threshold has just doubled from 10,000 yuan to roughly 20,000 yuan in the same period even though average incomes grew much faster in China than in India. If India lowers its income tax exemption to, say, Rs 1 lakh from the current Rs 2.5 lakh to be more in line with the rest of the world, nearly 1.5 crore more Indians will fall under the tax bracket. To be clear, such a move will not fetch any meaningful extra tax revenues for the government but will merely bring more people into the tax bracket. It is thus misleading and specious to conclude that India’s small number of taxpayers is entirely a result of some genetic and cultural trait of dishonesty of Indian society at large.

Further, the Prime Minister’s claim or Mr. Chidambaram’s assertion is also not peculiar. Rs 10 lakh equals 10 times India’s per capita GDP. Even in the much richer United States, only 12.5 lakh people out of nearly 20 crore adults reported an income greater than 10 times the per capita GDP of the U.S. In the United Kingdom, only 2 lakh people out of an adult population of 4 crore reported an income of greater than 10 times the average annual income. Similarly, an annual income of Rs 1 crore in India is equal to 100 times the average annual income. What proportion of people in other countries earn more than 100 times the average annual income? Just 43,000 people in the U.S., 5,000 in the U.K. and a few hundred in Canada. The number of people earning 100 times the average national income in most nations is extremely small. Against this backdrop, out of 68 crore adults in India, 24 lakh people earning more than Rs 10 lakh per year or 42,800 earning more than Rs 1 crore is not as abnormal as the Prime Minister or Mr. Chidambaram suggest. This is not to imply that there is no tax evasion in India but to say that the number of Indians paying income tax or earning high incomes is not nearly as outlandishly small as claimed.

Political rhetoric

Most urban Indians are unable to fathom the scale and size of India’s poverty. Their immediate, lived experiences lure them into this belief that a significant majority of Indians earn more than Rs 20,000 a month to qualify to pay income taxes. Casting aspersions on all of Indian society solely on the basis of the small number of taxpayers is plain egregious. The political compulsions of such class rhetoric are obvious as it serves as a good alibi for seemingly “tough” actions such as demonetisation. But the Finance Minister’s grand proclamation that India is a tax non-compliant society can be true only if India is much richer than her GDP numbers reveal and is merely hiding behind a veil of feigned poverty.

Published on 07 March, 2017 in The Hindu