Budget 2013: Worry about those not paying tax, not rich taxpayers

By R Jagannathan

The case for taxing the rich more - something that the finance minister and other policy-makers have been mumbling about for some time now - is falling apart in the light of closer scrutiny.

While no one disagrees with the apparently egalitarian proposition that if you are rich, you can pay more taxes, the economic case for it is quite debatable. In an interview to The Economic Times today, Planning Commission Deputy Chairman Montek Singh Ahluwalia makes three telling points.

One, it is not that the rich don’t pay more taxes. They do. They are taxed at the highest rate of 33-and-odd percent. The problem is that not all the rich pay their taxes. He said: “There is no doubt that not enough rich people are paying the tax they should be paying.”

Evidence: there are only 400,000 people declaring incomes of over Rs 20 lakh, and only 1.4 million above Rs 10 lakh. Ahluwalia’s take is this: “The number of people declaring income over Rs 10 lakh is very low. A lot more people in professions and commerce are in that range. Whatever we can do to expand that net is absolutely vital and should be done.”

Translation: the real evasion is in income brackets above Rs 10 lakh, and many of them are non-salaried professionals.

Two, the rich seem to pay less taxes than they can because their incomes come from dividends and capital gains - which get taxed lower than salary or other income. Here, Ahluwalia’s argument is that it is not easy to track dividend and capital gains incomes at the individual level - hence the levy of dividend distribution tax at the corporate end at 15 percent, and short-term capital gains tax at the same rate.

So what does this mean for the budget? One can’t rule out a marginal hike in dividend and short-term capital gains taxes to get the rich to pay more. But both these moves will upset the market, which P Chidambaram cannot afford. So keep your fingers crossed.

Three, and this is the most telling point, the problem isn’t income tax, but indirect taxes. The fact is income taxes are growing robustly, and India’s rich, despite a large element of evasion, have been paying more as a class. As Ahluwalia observes, “the problem of tax shortfalls is not because of direct taxes but indirect taxes. As I recall, the ratio of direct taxes to GDP has been rising but the ratio of indirect taxes has fallen.”

Translation: The exchequer’s revenue problem is unrelated to taxing the rich, but the slowdown in the economy. Indirect taxes are directly correlated to economic activity, while direct taxes (corporate and individual) are related to incomes alone. Incomes rise with inflation, but indirect taxes may not rise if sales fall due to inflation and economic slowdown.

To get taxes up, India needs to get the economy moving again. Taxing the rich is not going to help much.

Parthasarathi Shome, professor with ICRIER and the man who called for putting off the General Anti-Avoidance Rule (GAAR) for foreign investors, says that India’s tax-GDP ratio is not as low as it looks.

According to him, the most recently available tax-GDP ratio figure is around 18 percent (for 2009), but the real figure is much higher if one were to exclude the incomes of the very poor, who can’t be taxed.

He said in an article in Business Standard last month: “If we use only the poverty-based concept - that is, non-poverty GDP (NPGDP) - India’s effective tax-GDP ratio rises by more than three percent, to almost 20 percent from 16.5 percent in 2005. Extrapolation would result in an effective tax/GDP ratio of approximately 22 percent in 2007 and 21 percent in 2009.

He concludes: “India’s effective tax/GDP is not as low as is usually made out to be when one considers from whom tax revenue can be realistically collected. This, of course, does not imply that the taxpayer population cannot be expanded since many under-report and some do not file tax returns, thereby failing to contribute their due share to the exchequer.”

Shome is also saying the same as Ahluwalia. Get those who are not paying tax, or paying less than they should, to pay more.

Taxing the already taxpaying rich more is not much in favour.