Is it worth abolishing personal income tax to save over-taxed middle class?

India is the world's most populous country. The real growth engine of this seventh-largest country by area is its surging middle class, which represents 31 per cent of the population. However, they are the most taxed category in the country, with the salaried class paying a disproportionate share of personal income tax (PIT) as salary is easily traceable and much of the business income of proprietors and partners is hidden from tax authorities.

As per the official records, the net PIT collection (including STT) for FY23-24 grew 25.23 per cent to Rs 10.44 lakh crore, while the net Corporate Tax collection grew 10.26 per cent to Rs. 9.11 lakh crore over the same period of the previous year. Meaning, individuals, mostly the salaried class, paid more taxes than Indian companies. The complaint is that the middle class, which first pays tax from income, are taxed again while spending that post-tax income and capital gains from the sale of shares and property.

Public expenditure on public services such as the rule of law, public health, infrastructure, etc., leads, and private investment follows. A developed economy is like an adult who requires nutrition only for energy, whereas a developing economy like India is like an adolescent who requires nutrition for energy and growth. So, reducing the quantum of tax collected is not an option. But is it possible to find a more equitable distribution of tax burden?

Why not abolish/slash personal income tax?
If PIT is abolished, the government must raise GST or CIT to bridge the shortfall. Both may not produce the desired results.

In FY 23-24, GST collections were Rs 20.18 lakh crore. If the government were to forego Rs 10.44 lakh crore in PIT, the goods and services would have to be hiked by 50 per cent. But this assumes that the same quantity of goods and services will be sold at higher tax rates and, hence, at higher prices. But at higher prices, chances are there will be a reduction in sales, and collections won’t go up proportionately. And even if the I-T payers spend the bounty of Rs 10.44 lakh crore (unlikely, as people will look to save some), the GST collected will be only a fraction of that. Such a steep hike is unthinkable when the existing rates are considered excessive.

Then again, if the GST rates are hiked, all classes of people (middle-income and lower-income groups) will be hit hard, while the rich will only feel a slight pinch.

Thus, shifting PIT to GST may reduce tax collections and shift the tax burden from rich to poor. So, slashing/abolishing PIT and shifting the burden onto GST is not an option.

What about corporate tax, then?
Corporate income tax (CIT) rates are lower than PIT rates. At 38 per cent, the share of CIT in income taxes is way below that of PIT at 62 per cent (for current FY). The latest Economic Survey also says ‘corporates are swimming in profits’. So, shouldn’t CIT be hiked?

A lower CIT means higher net profit, higher stock prices and dividends for shareholders. Individuals also benefit when pension/provident funds and insurers invest in shares of listed corporations, and higher corporate profits benefit them via higher pensions and lower premiums. Also, a higher CIT rate may lead to India losing investments to nations with lower CIT rates, resulting in job losses. Though corporates have earned higher profits post-COVID, revenue and profits have tumbled in Q1 of the current financial year. So, high profits may not be the norm.

Corporate taxes were lowered to increase their investment, but the expected investments never materialised. But which businessman will invest if he doesn’t see enough demand, and which businessman won’t if he sees strong demand? Thus, low corporate investments are a symptom of tepid demand, and what needs to be addressed are its causes.

Also, is CIT the only tax flowing from corporate profits? Dividends and capital gains from shares are taxable. So, these taxes, too, should be added to CIT to arrive at total corporate taxation. Moreover, most PIT-paying employees work with corporations. Thus, a CIT hike may not be the best idea.

What now about PIT?
So, what remains to be addressed is the alleged hidden income of non-corporate businesses. PIT on salary, rent, and interest is easy to track, and through tax deduction at source (TDS), the payer deducts taxes from such payments. However, businesses earn profits from hundreds or thousands of customers, so TDS is impossible. So, it is easier for a businessman to hide income. Data from GST returns and Annual Information Statements can be used to plug these leakages.

And that leaves us with the final option of increasing the PIT payer base and then slashing PIT rates. For that, we need to increase the taxable income base. That can happen only if the economy creates many well-paying jobs requiring high growth and is biased towards labour-intensive sectors. That can happen only if we have a highly skilled workforce and an economy where business is easy. Hence, that is where our policymakers should focus on and not on tinkering with taxes or tax rates.