(T)ax (D)ismissed at (S)ource

Taxes. We are besieged by them: The government takes away a chunk of our earnings through personal income tax. And when we use the reduced earnings to buy goods at the store or get a facial uplift at the salon, we are taxed again. Can we ever get this income tax monkey off our back?
What if the government were to take a bold step and abolish personal income tax? You heard us. Zero income tax.

On first impressions, even the most ardent tax evader would dismiss this as an impractical suggestion. How can the government cope with the loss of such huge income? Why should the rich and elite walk away with all the income? Is it not unfair to the poor?

Hold on. A deeper examination throws up some surprises.

Studies globally have shown that an increase in disposable income usually leads to two things — an increase in consumption and a propensity to work harder. That means abolishing income tax will lead to a surge in economic activity that will create jobs along the way.

Zero tax rates would also be a magnet for highly skilled professionals who will choose to work in India rather than anywhere else. They will spend money and pay taxes on consumption. Lower taxes have already achieved that to some degree. Singapore (20 percent tax) and Hong Kong (16 percent) have managed to draw the best talent in Asia.

When audit and advisory firm KPMG did a study in October 2008 across 87 countries including India, it found that the average peak personal income taxes declined globally from 31.3 percent in 2003, to 28.8 percent in 2008. India though, bucked the trend — its peak tax rate in 2008 remained at 30 percent throughout.

India could do a disruptive one-up on the world by doing away with income taxation and instead tax only consumption. Because the inevitable use people put most of their incomes to, savings excluded, is consumption (food, houses, transport, vacations). It is a cleaner and more logical way of taxing people. Doing so could probably enable India to emerge fastest out of the global slowdown.

Eliminating income taxes also does away with the unfairness of multiple taxation — taxing a person’s income, taxing the money he makes by investing his salary and even taxing consumption (manufacturers usually pass on taxes like value added tax, sales tax and octroi to consumers through pricing).

Eliminating income tax and taxing consumption will be socially progressive because it allows the government to better target its policy initiatives. Of course, the main consumption items for the poor should be free of such taxes. More tax for cars, none for milk.

Let us do the math. India’s budgeted collection from personal income tax was Rs. 138,314 crore in 2008-09. That means one out of every five rupees of tax income to the government came from individual earnings.

On the other hand, private consumption expenditure in India during the same year was estimated at Rs. 2,913,386 crore. Imposing an additional average tax of just 4.8 percent on that is more than enough to recover the revenue lost from income taxes.

But because income tax is abolished, people will spend even more and the net revenue to the government would increase rather than decrease.

By eliminating personal income tax, India’s monstrous tax system (the Income Tax Department alone employs close to 60,000 people) can be cut down to a leaner shape to monitor only sellers of products and services, reducing their powers and hopefully, corruption.