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Indian Elections, and the Rs. 3 lakh tax Exemption

12th April, 2009

Yes, the great Indian Election circus is on.

Whats really interesting is how political parties campaign these days – reaching out to the campus voters, online advertisements (have you seen L.K. Advani staring at you, from your humble computer screen?), and autorickshaws driving around town with blaring yet incomprehensible audio thrown right at you!

Amongst all the manifestos being thrown around, a few lines did catch my eye. In this blog post, I’ll talk about this, from one political party:

Exempt personal Income Tax for those earning up to Rs 3 lakh per annum. For women and Senior Citizens, the exemption will be Rs 3.5 lakh per annum. This will benefit over 3.5 crore people.

Increase Income Tax bar? Hell Yes!

Now who isn’t excited to hear that their income tax would be reduced (without working hard towards securing a grand tax evasion scheme for that financial year!). With the tax burden being lightened, a large population will suddenly go below the tax bar!

Lets imagine the current tax-paying population (presently 3% of India’s population) as a pyramid of many layers – from the supremely rich on the small perch on top, to the extremely large base flanking on the bottom (like me) who have to cough up no matter what! By raising this tax bar, you suddenly relinquish control over the largest portion of the tax-paying population. A vast majority will feel “liberated” that they don’t have to pay tax anymore (pun intended).

Though nothing has been said about the tax slabs for those with fortunes above this minimum taxable income, we can still conclude that a lot more people will have a lot more money. And that, my friends, will drive demand. People will suddenly realize that a considerable chunk of their hard-earned money is still with them, and they will spend. And spend they will. Tata Nanos will be flying off shelves like refrigerators, and refrigerators like toasters.

This new-found money is a good thing, isn’t it?

Oh Hell No!

We can always look at the other side of the coin – that money earned by tax-payers is money lost by the government. And currently India’s fiscal deficit is pathetically bad (Really great podcast on LiveMint here!), and our government spending is considerably larger than government funding. Some say that India’s fiscal deficit will continue to be around 10.3% of our GDP in FY09-10. It certainly will be a challenge to fund this large fiscal deficit in a market-friendly manner.

In India, tax revenues account for approximately 18% of national GDP, much lower than the 37-45% figure in OECD countries. Assuming that in India tax revenues are a major source of government funding (pun intended), we have a government severly dented with funds. This always results in poor infrastructure and low wages to public servants (who inturn seek other sources of revenue) (luckily this time no pun was intended).

Is India in a position to lose a large (in number, not value!) tax-paying population, and hope to make up for that loss by other means? This move may drive demand in the short-term, but would lose on the ability to spend and invest in infrastructure, and projects that require extremely large amounts of capital, and dent India’s growth story, right?

Another point to note here. A populist tax change like this is extremely difficult to reverse, if and when required. Coming back to the previous tax slabs from this new Rs. 3 lakh limit is going to attract a lot of public agitation – especially in a country like India where thousands can aggregate and protest against anything and everything. Even when the government desperately needs money, I’m sure the Indian public would never give in so easily. Bargaining, it seems, is inbuilt in our culture.

Or .. Err .. Maybe Yes?

I’d like to confuse you even more. An interesting point to note here – as pointed out by my friend – is that by increasing this minimum taxable bar, you’re bringing in more white money.

By increasing the tax bar, more people, who earlier claimed to have an income below the previous limit, will now claim this higher limit. In other words, more money, which was stacked away as tax-evaded money, will appear in the white monetary system. This tax-evading population is a small fringe population, true, but the amount of money they hold is unimagenable (and they won’t mind putting some into white)!

Ideally, this shouldn’t be the case, the Indian population should be all white angels and stuff. But what difference would this really make? Can you expect someone who evaded his tax by claiming a Rs. 1.5 lakh income to change to Rs. 3 lakh just as this tax scheme is rolled out? Pulling more money out of them isn’t the solution, putting them into jail is!

To Conclude ..

Either way, I still feel strongly against this populist move. Losing long term funding might adversly affect our Indian government to make sound infrastructural investments! But we should always keep a benefit of doubt here – I am not backed up by statistics, and maybe those who have access to it, could decipher its viability.

Anyways, till the next “Indian Election” series – adios!

4 Comments leave one →
  1. 14th April, 2009 10:33 PM

    Basicly, taxes represent the funding for all public investments.Tax evasion affects us all.

  2. 20th April, 2009 1:42 PM

    Interesting, I`ll quote it on my site later.
    Thank you

  3. Gaurav Shetty permalink
    24th April, 2009 11:05 AM

    Hey i am not an economist or anything but by increasing the disposable income of the general population dont we create a sure in demand for products sold in the marketplace on which we pay a variety of taxes and also increase the profits of companies who manufacture these goods which in turn increases the amount they pay in taxes and and as u urself have pointed out it also increases the amount of white money in the system.

  4. kranium256 permalink*
    24th April, 2009 11:14 AM

    your assumption here is that increase in disposable income is *directly* proportional to increase in sales, and that is *directly* proportional to increase in corporate taxes. can’t be so easy, can it?

    But let us assume there is an increase in corporate taxes, is it worth the offset from losing a considerable amount of personal income tax?

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