Indian Exceptionalism: The Case For Abolishing Income Tax For Individuals 

The soaring levels of demonetised notes flooding the banking system – just shy of Rs 12 lakh crore against a potential inflow of Rs 15.44 lakh crore – tells us an essential truth. Indians find a way to work around the law any which way they can. And they believe the law is a matter of negotiation about the price of compliance, and not something to be respected in itself. Post-demonetisation, some rogue Indians have found a way to convert black cash directly into new notes, while others have deposited unlikely amounts into bank accounts and decided that they will take their chances with the taxman.

The one thing Indians have not done is accept losses stoically. This was the mistaken assumption made by the NDA government when it went in for demonetisation, and presuming that Rs 2-3 lakh crore would not come back. This raised the possibility of the government receiving a juicy dividend from the Reserve Bank of India after these liabilities were reduced on the central ‎bank's balance-sheet.

To extract tax from those who deposited all their demonetised notes in large numbers, especially undeclared incomes, the Modi government will have to unleash coercive tax measures on them, which can perpetuate corruption. Most people will bribe the taxman to avoid harassment. The tax collecting fox is being put in charge of the tax-evading henhouse.

It may result in higher tax collections, but it will also make the system less trustworthy than before.

My simple starting point is that our tax system should suit the culture of the nation. This means India should be gradually reducing and abolishing income taxes and focusing on indirect and transaction taxes, apart from cesses and tolls. This will not only increase overall tax collection, but also be more painless and universally accepted.

In the Abrahamic system, it is criminal to evade tax. Thus you are a good guy if you pay tax, and a bad guy if you don’t. The outcome is binary. In the Dharmic mindset that most Indians operate in, we both pay taxes and attempt to evade them, depending on what we think is just and acceptable. Tax is a matter of individual judgment and negotiation. Punishment for not paying tax is karmic – outside the ambit of the state.

To be sure, nobody in the world may like paying income taxes, but Indians are particularly loath to do so. However, the same degree of reluctance is not evident when it comes to paying indirect taxes, transaction taxes or cesses or tolls.

Western-trained economists will come up with their usual theories to combat this idea. Among these will be the following: direct taxes are redistributive and progressive, making it easier to fund safety nets for the poor. Indirect taxes are regressive, since they tax rich and poor equally. This offends one’s sense of justice. Transaction taxes hinder economic activity, and hence bad.

These are valid concerns in a purely theoretical context, but not in the Indian cultural context. In an ultra-diverse country, there is high distrust of direct taxation for the simple reason that people do not know who will benefit from them eventually. This is unlike monocultural nations in Northern Europe and Scandinavia, who are happy paying high taxes (tax-GDP ratios are in the range of 40-50 per cent), since people are secure in the knowledge that their money will benefit them later, or at least their close race relations.

In India, direct taxes are about one group appropriating something that may belong to another. This can be justified in the name of redistribution of incomes from rich to poor, but that does not make direct taxes any more palatable.

On the other hand, indirect taxes have worked brilliantly. This is because Indians have different attitude to taxes that are not visible to them, or when a tax is seen as a one-off. This is why indirect tax collections have been growing more robustly than direct taxes, despite huge increases in indirect tax rates recently (like the excise on petro-goods, etc). This is one reason why the goods and services tax (GST), once the initial hiccups are seen off, will become a goldmine.

Consider all the taxes that have caused little heartburn, and those that have.

The securities transaction tax (STT), a tax on stock exchange transactions, has no one complaining. So too the commodities transaction tax, or the dividend distribution tax (which is collected whenever companies pay dividends).

The two tricks that work are the following: collect the tax from some source that can’t evade them (stock exchanges, companies, etc); and two, make it seem like the tax is part of the price of what you are buying.

The one-time tax on vehicles, though significant, causes two-wheeler and car buyers no anxiety, for it is seen as part of the vehicle purchase price. Stamp duties, howsoever extortionate, are paid up when buying a property, because they are part of the sunk cost of the buy.

Cesses, which ride on top of existing taxes, also go under the radar, for they are subsumed into the price of a product or service. Consider the sheer number of cesses we collect: we have the basic education cess, the secondary and higher education cess, the cess on petrol and diesel, the cess on crude, the national calamity contingency fund cess, the infrastructure cess, the clean energy cess, the Krishi Kalyan cess, the Swachch Bharat cess, and so on. I have named only the big ones. The smaller cesses (on bidis, sugar, etc) few people have even heard about, though they are still collected.

Accustomed as we are to corruption, we also are willing to pay tolls. It seems like the bribe you pay to get past the peon at any government office. Indians know that there is a price to pay to get some things done. If you want to use the road ahead, pay toll.

Then there is the most ubiquitous tax of them all, now almost accepted as a way of life: the tax deduction at source (TDS). Tax is deducted at source for anything and everything, from purchase of property to payments for contributions to newspapers, interest payments on your bank deposits, and payment to vendors.

Most interesting: millions of people do not bother claiming this TDS back.

In fiscal 2013-14, there were 3.9 crore people who filed tax returns, but the government collected taxes from 5.5 crore people – the 1.6 crore additional taxpayers probably being TDS cases who didn’t file returns even though they had paid taxes. Indians are willing to forgo taxes deducted at source, since what they want is freedom from the taxman’s unwelcome attentions.

The short point is this: if you want to raise more taxes, you need to make them indirect.

Farmers and agriculturists pay no income tax; net result is that there were millions of Indians claiming agricultural incomes that are greater than India’s agricultural output. Indians are clearly willing to go to any extent to avoid paying income tax, even though they have no problems paying indirect taxes, TDS and cesses. Little wonder these are the fastest-growing taxes in India.

This is the case for a gradual abolition of tax, and Budget 2017 should make a beginning by raising, first, the basic exemption limit to Rs 5 lakh, and then quickly to Rs 10 lakh and at some point to Rs 1 crore. Taxes should be collected only for incomes above this limit.

On the other hand, GST needs to become the main tax, and it can be supplemented with transaction taxes and cesses, including cash transaction tax, and possibly a banking transaction tax, once 90 per cent of all payments migrate to banking channels. There is no need to rush into unknown transaction taxes; they can be tested and then adopted, as was the case with STT and dividend distribution tax.

The only income tax that should remain is the corporate tax, which is easy to collect since the number of companies will always be smaller than the number of Indians.

The income tax is not suitable for Indian culture. We need to bid goodbye to it as soon as possible.