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In Praise of Income Tax

Baba Ramdev and Arthakranti have it backwards. What we need is more income tax, and zero indirect taxes...

Over the last couple of months, a lot has been written, said and spoken about a radical tax proposal to abolish all taxes. Under this proposal, all current taxes will be replaced by a banking transaction tax. Some people have liked the idea and some haven't.

My idea is the exact opposite. I think all form of taxes except personal income tax should be abolished, and the scope of personal income tax, as well as it's percentage should be increased to compensate. Everyone should have to pay income tax no matter how little they earn and how they earn it. In fact, begging should be the only form of income exempt from income tax. Yes, this means taxing farm income, as well as taxing very small incomes. In return, all other taxes and cesses should vanish.

I believe such a change would once and for all solve all macro-economic problems in India. Here's my logic. Recently, after the AAP government announced a series of subsidies in Delhi, I was discussing these with someone I know-someone who is at the bottom lower middle-class income bracket. This person earns `14,000 a month and his household consists of himself and his wife and he doesn't pay any income tax. He voted for AAP (like me) and is happy that he will be paying less (or nothing) for his electricity and his water.

During the discussion I told him that it wasn't a big deal because we'll be paying for these goodies from our taxes. And that the government would in any case either not pay for something else, or it would borrow money to pay for these things. If it borrowed money then we would later pay not just principle but also the interest on the borrowing. To this, he said that it was OK because he didn't pay tax.

I told him that he did and explained about indirect taxes. I explained to him the entire chain of indirect taxes that was built into almost everything that he paid for. He was quite surprised. He literally had not known anything of this. He had thought that unless he asked for the cash memo and the shopkeeper added sales tax, he wasn't paying taxes. The only thing for which he remembered ever having done so were his TV and his phone.

I then worked through his monthly expenses and showed him how out of his `14,000 monthly expenses (he doesn't save anything), he was probably paying around `700 to `1,000 as tax. I told him that if the government was to pay for his electricity and water, it would eventually have to tax him more. He wasn't that enthusiastic about getting free electricity in the future. In fact, he told me that he would rather the government spend on better schools and hospitals than electricity. You see, he and his wife are starting a family and it's the quality of the municipal hospital and the private doctor's high fees that are his bigger worries.

This was like magic. Just by showing someone that he was a taxpayer, I had instantly converted him from a subsidy-loving freeloader to a responsible citizen who was making quality trade-offs between alternative things that the government should do with HIS money. He'd rather run his cooler a little less if it meant having a good government hospital where his child would be born.

I believe that the whole problem of state, central and local government's expenditure is completely distorted by the fact that the vast majority of Indians think it's all free. Some two per cent of Indians pay income tax and the other 98 per cent think that that tiny majority is paying for them. In reality, the invisible hand of indirect taxes is squeezing them dry while keeping them under the illusion that it's all free. Or that it's paid for by the people after whom different schemes are named. I mean, it must seem self-evident that the houses built under the Rajiv Avaas Yojana are paid for by the said Rajiv's family, no?

What would happen if they knew that they had paid for it? Or that (since the government now borrows more than a third of what it spends) it had already been borrowed in their children's name?

It's clear to me that only taxpayers-those who know that they are taxpayers-can make sensible decisions about governments. There are two solutions to this. One option is that only taxpayers should be allowed to vote. But that sounds horribly elitist and probably is. It'll be like nineteenth century England when only property owners had the vote.

Or the second option, which is that almost everyone must pay taxes. Of course, as we have seen above, everyone already pays taxes. So what I mean here is that everyone must know that they pay taxes. They must feel the cash slipping out of their pockets and into the governments'. Which means personal income tax.

I think the lower limit of personal tax should be set to about `30,000 a year with no exemptions and a tax rate of say, five per cent Someone who earns `2,500 a month can pay `125 as tax. Plus, all incomes should be taxed, including agricultural income and capital gains.

In today's context this sounds excessive. But remember, we are abolishing all other taxes. We are even abolishing taxes pretending to be something else-telecom license fees, for example. In fact telecom license fees are a great example of the indirect tax subterfuge because it is doubly indirect. Even educated taxpayers seem to think that this is something that the telecom companies pay. That's just bunkum. It's a tax on phone and internet usage that we consumers pay.

Everything will be that much cheaper. And what's more, this taxation system will be far more just and progressive. Today, someone who earns `50,000 a year would effectively be paying perhaps `5,000 to `7,000 as indirect tax which is 10 to 14 per cent. However, someone who earns `10 crore a year would likely invest most of it, get it back as capital gains and could well be paying less than 10 per cent of total income. In the arrangement I'm suggesting, the tax rate would have to higher in the higher brackets.

I said above that only the truly destitute-those who subsist on begging, for example-should be exempt. Amazingly, when come to you think of it, even beggars pay taxes now. The other day, I was walking outside the railway station late at night and I noticed a pavement food stall which seemed to be patronised by the multitude of beggars in the area. I hung around a while and saw that they seemed to be paying `15 for a small amount of boiled rice with a some dal on it, served on a piece of cardboard. The guy selling the meal had a stove and some basic cooking utensils. If you think of all the inputs here, you'll realise that out of the `15, at least a rupee or so could be indirect taxes.

Is this realisable? It doesn't appear to be. After all, the main attraction of the Baba Ramdev-Arthakranti scheme is that it would rid us from having to deal with the tax authorities. That scheme would actually increase indirect taxation and would possibly be even more regressive.

My scheme is the opposite--it would hugely increase the role of the tax authorities but would be fully progressive. However, it would require honest and competent tax administration and a populace which would pay taxes in the same spirit. Possible? Alas, no. Sorry, can't be done.