Reform of Personal Income Tax Welcome

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Finance minister Nirmala Sitharaman has indicated that personal income-tax reform could be on the agenda. It would be useful to see restructuring of personal income tax as a structural reform rather than as a means of boosting short-term demand. The reality is that salaried employees bear the bulk of the burden of paying personal income tax, even as high-income earners among professionals, traders, and producers in the unorganised sector get by without paying tax. Effective use of GST and extending the reach of formal finance to all users of credit can bring all such people into the tax net. There is a cost to non-compliance.

There is the cost of trying to hide your transaction trail. You might need to pay bribes and accountants’ fees. There is the expected cost, given the probability of being caught by the tax authorities, of penalties. If the cost of compliance is in the neighbourhood of the cost of non-compliance, rational people would pay up. The two kinds of costs can be made to converge by raising the cost of noncompliance, by lowering the cost of compliance or by both. It is preferable to raise the cost of non-compliance by intelligent analysis of data and reducing the scope for evasion, thereby raising the probability of getting caught. Listed companies have no incentive to hide their income, because they want to maximise their market capitalisation. Follow up the sales of basic and intermediate goods producers down the transaction chain rigorously enough and much of the current evasion of GST can be stopped.

Extend the reach of formal finance sufficiently to dry up the need for high-cost informal funding. When the bulk of production comes under GST, tracking personal income gets simpler. A company’s value-added breaks down into gross profits, and wages and salaries. Distributed profits, and wages and salaries are personal income. When companies and their owners have to pay tax on their income, they are more readily inclined to make formal payments to professionals and providers of finance. The wider the tax base, the lower the rate could and should be.

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