COMMENTARY

Income Tax Policy

Critique of the Economic Survey 201516
Kavita Rao

There can be an alternative

perspective to the questions
raised about the tax system by the
Economic Survey 201516. Within
the limits of the present tax
regime, the number of taxpayers
cannot be significantly larger
than at present. Further, while
tax incentives provide benefits
only to those liable to pay taxes,
a criticism of such incentives as
pro-rich needs to also address
the question of whether the
incentives serve the purpose for
which they have been provided.

n recent years, there has been an increased focus in the union budgets
on the system of taxation. The budgets
have been proposing a reduction in tax
incentives so that a more broad-based
tax regime is in place with a larger number of economic agents coming within
the ambit of taxation.
In Budget 2016, in the realm of corporate taxes there are proposals to reduce
the statutory tax rate alongside a reduction in the exemptions provided. In personal income tax, while there are some
pronouncements in terms of tax policy
(an increase in the tax liability of individuals earning more than Rs 10 lakh
from dividends), there is also a conviction that not enough people are paying
taxes in the country. This point of view
finds articulation in the Economic Survey
for 201516 in Chapter 7 where it is
argued by means of cross-country comparisons that the number of taxpayers
in India is considerably lower than what
it should be. Earlier in the survey, in
Chapter 6, it is argued that tax incentives in the income tax regime, especially
the incentives for savings, should be
phased out since they deliver benefits to
the rich. These are interesting positions
on which there is need for an extended
debate. In what follows, an attempt is
made to spell out some of the contours of
such a debate.
Number of Taxpayers

Kavita Rao (kavita.rao@nipfp.org.in) is at the

National Institute of Public Finance and Policy.

14

There is considerable discussion in India

today regarding the number of people
filing income tax returns. It is often
argued that this number is too small
compared to the population of India.
The Economic Survey explores this issue
in some detail. Chapter 7 examines the
position of India in comparison to some
countries of the Organisation of Economic Co-operation and Development

(OECD) and non-OECD countries using

per capita gross domestic production
(GDP) and indicators of democracy to
suggest that there are too few taxpayers
in India. In fact, the survey suggests that
while at present about 4% of citizens
who vote pay taxes, the percentage
should be about 23% (p 114, para 7.32).
The chapter concludes by saying that it
is evident from the analysis in this chapter that India has not fully translated its
democratic vigour into commensurately
strong fiscal capacity. The Economic
Survey suggests that the government
should refrain from raising the exemption threshold to allow for natural expansion in the number of taxpayers.
This point needs to be debated for
three reasons. First, how robust are
these numbers: are GDP per capita and
democracy the only variables which
determine the number of voters who pay
income tax or should other variables
be taken into account? The survey does
recognise that corruption too can play a
role in the extent to which people are
willing to pay taxes. In an attempt to
explore the sensitivity of such estimates
to the choice of variables, Table 1 (p 15)
presents the predicted value for India for
three different ways of normalising the
number of taxpayersby voting population as used in the survey,1 by citizens as
reported in the OECD volume which is
the source of cross-country information
on the number of taxpayers and population above the age of 15 as an approximation of the contemporary working
age population. The results suggest that
depending on the specification used, the
predicted value for India can vary widely
from negative numbers to values as high
as 8.7% of voting population as taxpayers.
While we could not replicate the figure
of 23% as reported in the Economic
Survey2 as what proportion of Indias
population should be taxed, Table 1 does
suggest that the number of 23% or any
other such number needs to be treated
with a degree of scepticism.
Second, from the analysis and the
conclusions drawn by the survey, it is
not clear whether the problem of too few
taxpayers is a result of tax policy or poor

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tax administration. To illustrate the

point, it would be useful to reproduce
results from an analysis of the number
of taxpayers undertaken by the National
Institute of Public Finance and Policy
for the Central Board of Direct Taxes

(NIPFP 2015) (Table 2). The analysis

was undertaken using the India Human
Development Survey (IHDS) for 2003
04 and the National Sample Survey on
consumption for 201112. Table 2 indicates that while the actual number of

Table 1: Alternative Predictions for Number of Taxpayers in India

Specification

Dependent Variable
Personal Income
Taxpayers by
Citizens
4.4%

Personal Income
Taxpayers by
Voting Population
3%

Actual

1 Log GDP democracy index

Personal Income
Taxpayers by
Population Above 15
3.9%

1.2

-1.3

-0.019

R square 0.40

R square 0.46

R square 0.46

2 Log GDPppp democracy index

5.5

2.9

5.3

R square 0.39

R square 0.44

R square 0.44

3 Log GDP, corruption

5.6

1.7

-0.45

R square 0.45

R square 0.48

R square 0.49

4 Log GDPppp, corruption

3.5

0.2

-2.45

R square 0.45

R square 0.38

R square 0.5

5 Log GDP, corruption, democracy index

8.7

3.7

6.18

R square 0.43

R square 0.47

R square 0.49

6 Log GDPppp, corruption, democracy index

7.2

4.7

4.89

R square 0.43

R Square 0.46

R square 0.49

The first row in each specification gives the predicted value of the number of taxpayers for India while the second row gives
the R square for the specification as an indicator of goodness of fit.
Source: Corruption perception index as reported by Transparency International, http://www.transparency.org/research/
cpi/cpi_2009.

Table 2: Potential and Actual Number of Taxpayers as a Percentage of Total Population

Exemption Limit

Half of households with one earner and half with two earners
in the household
Three-fourths of households with a single earner and one-fourth
with two-income-earners
All single-earner households
Actual number of taxpayers

Non-agricultural Income
Actual
Rs 50,000

Total Income
Actual
Rs 50,000

2.23

10.01

3.25

13.66

2.57
2.90
2.17

10.52
11.52

3.81
4.36

14.82
17.06

Source: NIPFP (2015).

taxpayers was 2.17% of the population

in 201112, the potential number of taxpayers is somewhere between 2.23%
and 2.90%.3 Further, if the exemption
threshold were considerably lower at
Rs 50,000 instead of Rs 2 lakh than it
actually was, the number of taxpayers
would be considerably higher, between
10% and 11.5% of the population. Looking at another feature specific to the
Indian context, if the base for taxation
was not non-agricultural income but
total income, it could go up further, to
above 14%. In other words, within the
limits of the present tax design, the
potential number of taxpayers may not
be dramatically different than the existing numbers.
This then raises questions about whether the countries used for comparison
in the Economic Survey are really comparable. Table 3 provides information
on the exemption threshold for some of
the countries included in the analysis.
Table 3 indicates that in reference to per
capita GDP, the Indian exemption threshold is considerably higher than in the
other countries. For a number of these
countries, the filing requirements bring
within the system a number of taxpayers
who have incomes below the exemption
threshold. The extent to which taxpayers filing nil taxes exist in the system can
vary from country to country, depending

Table 3: Exemptions and Filing Requirements in Different Countries

Country

Personal Allowance
(Year)

UK

10,600 (2016)

US

$4,000 (2015),
$6,300 (2015)
for single earners
Canadian $11, 138
(2014)

Canada

Personal Allowance as
Percentage of GDP Per Capita
LCU (Year) (%)

Personal Allowance as
Percentage of PPP Per Capita
Incomes (Year) (%)

35 (2014)

41

7 (2014)

18

20 (2014)

22

Australia

AU$18,200 (2014)

27 (2014)

37

Malaysia

9,000 RM (2015)

37 (2014)

16

India

25,00,003 (2014)

258 (2014)

71

Examples of Cases Where Return Has to Be Filed with Income below Personal Allowance

In case an individual is self-employed or has rental other income from

property or other income that is not taxed before it is received, the individual
is not exempt from filing of return.
In case an individual has to claim EITC or is self-employed and has more than
$400 in earnings from self-employment during the year.
An individual who wishes to apply for the GST/HST credit, to begin or
continue receiving the Canada child tax benefit payments, to carry back or
forward unused amounts of tuition, education or textbooks amounts to
another tax year must file a return.
An individual entitled to receive or pay child support or self-employed will
have to file a return.
Individuals who do not qualify for non-filing of personal tax returns include
employees who change employers during the year and individuals who have
non-employment income such as business income, rental income, etc, during
the year.
Individual taxpayers do not have to pay taxes and file returns if their gross
total income is below the exemption limit.

Personal allowance is the same as exemption threshold in India; there is no tax liability on incomes below the personal allowance.
Source: Compiled from http://www.investopedia.com/ask/answers/ 07/taxtipfederal.asp; https://www.humanservices.gov.au/customer/enablers/do-you-need-lodge-tax-return;
http://www.cra-arc.gc.ca/nwsrm/txtps/2013/tt130415-eng.html;
https://www.citizensadvice.org.uk/tax/how-to-pay-income-tax/tax-returns/;
http://www.thestar.com.my/business/business-news/2013/11/01/budget-impact-on-taxation-to-file-or-not-to-file-a-personal-tax-return/.
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COMMENTARY

on the benefits that the country seeks to

provide within the tax regime. For
instance, in some countries, there exist
provisions of Earned Income Tax Credit
(EITC), where the benefits in the forms
of refunds accrue to individuals provided they work and file returns. It
may also be mentioned that in many
of these countries, agricultural income
too is subject to taxation.4 In other
words, there are limits to which such
inter-country comparisons can be used
to assess or comment upon the participation of Indian population in the
tax system.
Third, implicit in the discussion is the
assumption that in a democracy, people
would want to pay more taxes and/or
governments would be more successful
in raising more taxes. The literature on
the relation between taxation and democracy, however, does not conclusively
argue for a positive relation either in
theory or in empirical literature (Profeta
et al 2013). At a common sense level,
democracy could be viewed as a government where people participate in decision-making and hence would be willing
to pay taxes. Alternatively, democracy
might require governments to provide
more sops for remaining in power. The
latter could undermine the former if the
taxpayers are not the ones receiving the
sops. Thus, drawing conclusions about
the tax system by controlling for democracy may be stretching the argument a
bit too far.
Incentivising Savings
In the sphere of personal income tax
(PIT) in India, it is axiomatic that any tax
incentive within the income tax regime
will always benefit only those who have
incomes above the exemption threshold.
Such incentives will reduce the tax liability for individuals who have a liability
to pay tax in the first place. For someone
with income below the exemption
threshold, no benefit accrues from the
tax incentives for savings, housing, childrens education or healthcare, etc. Further, since the Economic Survey places
the poor within the last three deciles
of the population, in effect referring to
people below the poverty line, it is easy
to conclude that the entire range of
16

benefits provided within the income tax

law are only for the rich. In that event,
all tax exemptions should be done away
with. Indeed. But the rationale for most
tax incentives is not to provide benefits
to the poor alone. In practice, tax incentives are given to achieve various objectives. Arguing therefore that all tax
incentives need to be done away with
would amount to suggesting that tax
policy should not be used as an instrument to achieve some goals that governments seek to achieve. It is indeed
possible to argue that all tax incentives
need to be done away withbut for this
one needs to investigate whether or not
the tax policy is a suitable instrument to
achieve the stated goals. Or taking the
argument further, one can explore
whether there exist alternative instruments with the government which can
be used to achieve the stated goals. But
the argument about the intended benefits not reaching the poor is not adequate
to make the point.
Dealing with the incentives for savings, which are examined in Chapter 6
of the survey, one can possibly think of
three broad reasons. The first is that
taxing incomes can result in a disincentive to save and thereby reduce savings
and investment in the economy. Therefore, some incentive may be required to
encourage savings. One could also
argue that incentivising savings may

induce myopic individuals to save for

retirement or for investment in lumpy
expenditures like education and/or purchase of a house. This can reduce the
burden of publicly provided pensions on
society as a whole. A third argument
put forward is that such incentives encourage saving in the form of financial
instruments with a long lock-in. These
initiatives can have a favourable impact
on deepening and diversification of the
financial system. While the primary
objective of the savings incentives within income tax in India cannot be ascertained, the evidence globally seems
to suggest that while such incentives
can influence the portfolio of investors,
they are not uniformly successful in
raising the rate of savings in the economy (Jappelli and Pistaferri 2002). Following from the 2016 budget speech, if
the objective of the exercise is to influence the portfolio choices of agents,
then this instrument can be useful and
hence cannot be dispensed with on the
ground that the benefits accrue only to
the rich.
Two further issues in the manner in
which the Economic Survey presents its
arguments need to be noted. First, it
presents a comparative table on the
effective returns from different instruments where instruments are classified
into actually small savings instruments, not-so-small instruments and

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not-small-at all instruments. For the

actually small instruments which include post office savings accounts, the
survey argues that the tax treatment is
deposits/contributions have been taxed
(T), interest earned is taxed (T) and
withdrawals are taxed (T) or TTT.5 It
should be noted that even if the treatment
is TTT, the tax would apply only if the users of these accounts are taxable. For
those below the threshold level, the
treatment in effect would be exempt (E),
exempt (E) and exempt (E) or EEE at each
stage, since there is no question of any
tax in such cases. Another way to classify
these instruments would be to examine
the lock-in period for the three categories consideredthe actually small
instruments are savings accounts with
no lock-in, the not-so-small instrument,
Public Provident Fund (PPF) has a lockin of 15 years with only partial withdrawals allowed after the sixth year,
while the not-small-at all has a lock-in
period of five years. Instruments with a
longer lock-in period normally would
attract higher returns than those with a
shorter or no lock-in. If viewed from this
perspective, the differences in the rates
of return would appear to have some
justification.
Second, the Economic Survey suggests
the introduction of an EET regime for
savings in place of the existing incentive
regimes. Whenever it is suggested that
savings should not be taxed, it essentially
means that as long as the resources are
locked up as savings they would not be
taxed. However, they can be taxed when
they are brought back in circulation for
consumption. This is what the EET
scheme impliesin effect this is a tax on
expenditure rather than on income.
While it is argued at length that the EET
regime represents best international
practice, it may be mentioned that no
country achieves complete neutrality in
the taxation of savings.
To explain, ideally, if it is argued that
savings should not be subject to taxation,
then within the EET regime, all savings
should be exempt from tax, irrespective
of the instruments or forms in which
the savings are locked up. However,
such provisions would potentially be
open to disputes in interpretation
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april 2, 2016

for example, would purchase of a painting constitute consumption or investment? Hence, tax laws incorporate
two kinds of limits, one, the amount of
savings that is eligible for the EET
scheme and, second, the kinds of instruments that these can be channelled into.
With these limits, the schemes do not
achieve comprehensive neutrality that
the proposal suggests (Jappelli and
Pistaferri 2002).
Since this proposal is in the context
of reducing bounties to the rich so as
to provide benefits to the needy, it is
interesting to ask if the switchover
would indeed produce any tangible
benefits to the exchequer. All savings
in periods prior to the introduction of
such a scheme would remain beyond
the purview of this regime. Going forward, the exemptions would continue
to result in lower revenues in the short
run. It is only a few years into the regime, when people consider withdrawing from the scheme that the government can hope to realise some taxes. In
other words, in the short run, there are
no additional revenues that government
can hope to garner.
Here it is useful to return to the original question and ask whether the purpose of these incentives is to encourage
savings alone or to make available
resources for long-term investments such
as in infrastructure projects and going
further, whether such resources as are
mobilised from these instruments are
required for the infrastructure investment in the economy or not. Without
answers to these questions, we might
not have a comprehensive argument for
eliminating these incentives.

Notes
1

The Economic Survey uses voting-age population from the International Institute for
Democracy and Electoral Assistance. This data
provides information corresponding to the last
election reported which may not correspond to
the year for which taxpayer data is used.
This could be due to the inclusion or exclusion
of countries from the sample available in the
OECD publicationwhile that publication provides information for countriesthe Economic
Survey indicates that the analysis is for 54
countries.
Since the study used household data, some
assumptions needed to be made on the number of working members in the household.
Varying this assumption yields different estimates of the potential number of taxpayers in
the economy.
Income from agriculture or farm incomes are
subject to taxation in most countries selected
for the present analysis. While the treatment of
the income varies across countries the income
is taxable in the US, Canada, Australia, the UK
Germany, France, Ireland, Switzerland and
Italy (Anderson et al 2002).
In a footnote, it is stated that if the instrument
is taxed at first stage it is deemed to be taxed at
the stage of withdrawal. The rationale for this
treatment is not clear.

ReferencES
Anderson, G Finn, L J Asheim, K Mittenzwei and
F Veggeland (2002): Taxation of Agriculture in
Selected Countries, Study of the United States,
Canada, Australia, Germany, United Kingdom,
Ireland, France, Switzerland and Italy with Relevance to the WTO, Oslo: Norwegian Agricultural Economics Research Institute, http://
www.esiweb.org/pdf/bridges/kosovo/4/14.pdf.
Jappelli, Tullio and L Pistaferri (2002): Tax Incentives for Household Savings and Borrowings,
World Bank, http://siteresources.worldbank.
org/DEC/Resources/23654_chap_4_taxation.
pdf.
NIPFP (2015): Study on Development of an Analytical Model for Widening of the Taxpayers Base,
Tax Research Cell, National Institute of Public
Finance and Policy, New Delhi, http://www.
nipfp.org.in/media/medialibrary/2015/10/Development_of_an_Analytical_Model_for_Widening_of_Taxpayers_Base.pdf.
Profeta, P, R Puglisi and S Scabrosetti (2013): Does
Democracy Affect Taxation and Government
Spending? Evidence from Developing Countries,
Journal of Comparative Economics, Vol 41, No 3,
August, pp 684718.

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