If there were no taxes, will we pay more?

Tuesday February 04, 2014, New Delhi

Seldom did political parties entangle into technical discussions during pre-election debate. When the principal Opposition party BJP announced considering scrapping income tax in election manifesto, other parties were found scrambling to offer logical response to an idea that has so far been alien to peoples’ collective wisdom.

Tax has been a sensitive issue primarily for the middle class that has traditionally been at the receiving end of the stick yet the debate throws open a few revelations worth contemplating.

As it stands today, total tax receivables by the Government stands at around Rs 10,38,000 crores. Of this, some Rs 5,65,000 crores comes from Indirect Tax, which represents tax collected from business activities taking place in the country including excise, custom and service tax. It is called indirect tax because it does not impact our pockets directly, in which case it is called Direct Tax. This is where the debate gets interesting because the subject of Direct Tax receives significant political attention.

The total Direct Tax collection stands at Rs 2,48,000 crores, which primarily comes from personal tax you and I pay. If India were some other law-abiding country, we would probably assume that personal tax collected represents total tax paid by the working populace. Oddly enough, out of more than 30 crore that are working, only four crore people paid tax.

The political flavor around personal tax is strangely strong and can be understood from the fact the Direct Tax is essentially is a ‘zero-sum’ game for the government. Notably, the middle-class enjoys a total subsidy of more than Rs 1,50,000 Crore. If we include additional subsidy of Rs 68,000 Crores from various tax breaks (80C, loan interest waiver etc.), not much is left for the Government. The political hubris over Direct Tax is at best a clever maneuver of perception intended to impress the largest voting populace.

It is obvious, if personal tax is abolished completely, there would hardly be any impact on exchequer. Alternatively, it would be easier for the Government to collect tax from middle class by using other tricks. Take, for example, the case of Service Tax. As of 2013, the total collection from services has been around Rs 1,32,000 crore. Interestingly, services started getting taxed since 1994 and has clocked highest growth in collection compared to other classes of tax. Levying tax on services was a masterstroke by tax department in connecting businesses with consumers. On the surface, service tax seems to apply on businesses, but in reality, it is consumers (you and I) that pay for it. Whether you eat out in restaurant, go on vacation or buy a real estate, as a consumer, you are paying service tax to the Government on almost every transaction.

Indian middle class has emerged as formidable spending force in recent years. This class may make screeching noise anytime personal tax structure is negatively altered, but it does not mind paying 30 per cent service tax while dining out in restaurants.

By deliberately increasing the base of services, the Government can quickly catch up on the loss made from personal tax, if it ever were abolished. Probably the best way to control the bull is to catch it by the horns. The horn of financial bull is the end transaction. While many were surprised when BJP supported levying insignificant service tax on every banking transaction, it was by no means just a political statement. Since most transactions you and I make eventually go through banks, in one stroke, everyone having a bank account would be paying tax.

As they say, there is a vast difference between theory and practice. Theoretically, Indian Government can easily increase tax collection multifold by applying simple controls, but political fallout would prohibit them from doing it practically. To that effect, personal tax, at best, is a potent political whip to sway middle class voters; never mind its financial futility. However, political discussion on sensitive issues, such as tax, is a welcome sign for the middle class.

(Samar Vijay is Director, InvestCare, a leading fund management company. You can reach him on twitter @samarvijay.)

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