5 ways to change the 'P' in Personal Income Tax

The short answer is: It must become more lucrative for people to be part of the formal economy than remaining outside its purview. This seems counter-intuitive as paying taxes implies a reduction in an individual's wealth; so, how can it become more lucrative for anyone to pay taxes? To achieve this, we need to make significant changes to our existing tax code as outlined below:

Also read: ITR filing last date for FY 2022-23 (AY 2023-24): Due dates for income tax returns filing, TDS, advance tax payments

1) Cap on Income Tax:

The personal income tax to be paid by an individual must be capped at a reasonable amount. (I would suggest something around Rs12 lakhs per annum.) How did I arrive at this number? If the cap is too low, the government will lose too much revenue; if the cap is too high, the individuals benefiting from this will be too few, and the cap becomes inconsequential. There are many reasons why this is useful.

   

1. First, if an individual contributes Rs1 lakh per month for nation-building (Rs3,000 per day), we must recognise that they are doing their fair share. A PIT cap makes participating in nation-building more equitable. Someone cannot be held responsible for Rs20 lakhs of tax while another pays little to nothing. One of the goals must be to ensure that the judicious taxpayer does not feel aggravated and develop a mindset that the government is taking a significant chunk of their hard-earned money.   
2. Second, once an individual has paid this cap amount, it is evident that no further checks will then need to be conducted by tax officials on their income to determine if they have short-changed the system, thereby freeing up resources. In today's environment, it is not uncommon for a taxpayer to receive notice of unpaid dues of a few thousand or a few hundred rupees after they have already paid several thousand in taxes. It is a complete waste of time for a tax official to pursue such measly amounts from an already existing taxpayer (already a part of the formal economy) instead of focusing on bringing the vast segment of non-taxpayers into the formal tax bracketing system.
3. Third, take the example of an individual who perhaps is liable to pay a large tax in the current system and therefore avoids paying taxes entirely by hiding part or all sources of income. The cap would ensure that such individuals would comply with the law as paying the cap amount may be palatable, and therefore there is no need for them to be outside the formal system. (The FY2018-19 data shows that only ~ 5 lakh taxpayers are above the Rs50 lakh threshold, which seems unusually low for a large country like ours.)
4. Fourth, the tax laws must work for all sections of society, including the elite. As the old saying goes, "You cannot legislate the poor into prosperity by legislating the wealthy out of prosperity", and a PIT cap ensures that such a thing does not occur. If the elite begins to feel that the government only cares about the poor, and the poor begin to realize that the government will always take care of them irrespective of whether they put in their fair share of work, this will lead to a complete breakdown of our tax and societal norms.

 

2) No Capital Gains Tax:

This is not a new idea and already exists in many other countries such as Singapore. It is a worthwhile idea because it will pull individuals into investing (out-of-sight) money into FDs, stocks, and so on, for which, once again, they must engage with the formal economy. It improves transparency in the system, provides visibility to the government on actual savings, will skyrocket the banking and financial systems upwards (which in turn will bring in more people to invest as they will make huge profits), and thereby making it more attractive to be part of the formal economy. This is where being part of the formal economy becomes lucrative even after applying PIT.

 

3) Improve Reward/Risk Ratio:

The government must start thinking like corporates and act accordingly. So, how does a company attract non-customers (who are either not interested in the product or are buying from a competitor)? Well, they use a variety of mechanisms, and one such lever is to entice (potential and existing) customers with "reward/loyalty points". How do we apply this in the tax context? Thinking aloud, let's say that if an individual pays the maximum cap amount continuously for five years, then the taxpayer will be exempted from all income tax in the 6th year (or some such clever idea). Conversely, the penalties for egregious non-compliance must be very high, and we must put IT officers to track and prosecute individuals who are not filing taxes despite these proposed advantages; in tandem, this reward/risk ratio will funnel everyone into the formal tax architecture. This also sets priorities for IT officials to engage with only serious offenders and ignore the pittance collections.

 

4) Territorial Tax Structure: 

India is one of those countries with a large, well-qualified, highly professional workforce based overseas. Many of these individuals continue to be Indian citizens. They may be assigned internationally for some time and then return to India. (With a changing global economy, it is not uncommon for many of them to also have several stints abroad.) In such instances, they set down roots in a foreign land (buy a home, grow savings, make long-term investments for their children, and so on), and some of their wealth will likely remain there when they relocate back home. They have paid their fair share of taxes when living abroad, and we must respect the tax laws of that country, be it for savings or investments (which may accrue after they return to India). In a country where a significant percentage of the population does not pay tax, applying "global tax" on the very few once again penalises the ones who already exist in the formal economy instead of focusing resources on the bigger problem.

 

5) Technology for Tax Compliance:

Technological advancements—such as AI/ML improving audit and tax compliance—are forever growing, but having so much data, information, and insights is useless if we have poor priorities. After all, sophisticated algorithms can only track transactions of the ones already in the formal economy and provide no visibility towards those avoiding the formal route. The Income Tax department will likely end up burrowing into low-hanging, low-impact rabbit holes instead of focusing on real game changers that will upend the tax system that we know today and set us on a path towards becoming a truly developed nation.   

In conclusion, one might think that in every one of these suggestions, I am advocating lesser personal income taxes to be levied, and therefore, why should the government think along these lines? I say again that the government must think like a multinational corporation: Why do companies routinely offer discounted sales? How do they make money by reducing prices? It is a "volume game": The perceived loss of revenue for the government from the existing taxpayer base will be more than adequately compensated by an increased share of taxpayers in the system. This is perhaps the defining reason for setting these rules in place: There must be no incentive for people to be outside the formal economy; on the contrary, we need to create a tax structure that will get buy-in from across all sections of society and bring in a large swathe of taxpayers into the formal economy.

Such structural changes to our tax code will also pivot us from pinching pennies to pocketing pounds: it's time to change the 'P': move from "personal" to "prioritized" income tax and set the agenda for a progressive taxation policy that will benefit the nation for years to come.

The author is a Professor of Decision Sciences at the Indian Institute of Management in Bangalore. The views expressed in this article are personal and are not related to his professional commitments.