The government needs a fine balance between rationalising income tax rates and maintaining revenue collection. Comment.

The Finance Minister has recently spoken about the government considering lowering and rationalising of personal income tax (I-T) rates. This announcement was made among other measures to boost economic growth.

The Budget 2020-21 will see changes to the personal income tax rates for the lower and middle income groups. It may be done through changes in the tax slabs. Those having annual income between Rs. 2.5-10 lakh may be taxed at the rate of 10%, while individuals earning between Rs. 10-20 lakh may pay tax at a rate of 20%. However, the tax exemption limit may remain unchanged at Rs. 2.5 lakh. The economic growth has slowed to 4.5% in the second quarter of the current fiscal year.

Reasons why government needs to revisit & rationalise income tax – 

• A simplified tax structure has a better chance of improving collections in medium to long run.
• It would be the next logical step after reduction in corporate tax rates done in 2019. 
• It would take the process of direct tax reforms forward.
• It will provide opportunity to rationalise taxes for different category of taxpayers while removing distortions
• Lowering tax rates for individual taxpayers is expected to result in the increase of their disposable income and help boost consumption

Need for caution – 

The idea of rationalising income tax rates needs to be welcomed, however the government needs to do a balancing act as it is in a difficult position in terms of revenue collection. 

A sharp reduction can affect revenues and weaken the government’s fiscal position. The result can be , an impossible target for the government to contain the fiscal deficit under the target of 3.3% of GDP in the current year. In the near term, the economy is also unlikely to witness a sharp recovery and given this, the revenue collection next year could remain under pressure.

Measures to be taken – 

The need is to remove distortions, rationalise exemptions along with tax rates to minimise the impact on revenue mobilisation.

For example, July 2019 Budget saw the government raised the surcharge for “super-rich” taxpayers resulting in a complicated I-T structure. These measures need to be avoided as a significant increase in tax rates, even for a small group of taxpayers can raise the possibility of evasion.

There is also a lack of clarity over a tax cut translating into more spending during as during difficult times there is a tendency to save more.

A simpler regime with reasonable tax rates can be expected to help improve compliance and increase the base.

While, the government needs to work on building  institutional capacity and use better technology to check on tax evasion. It will help improve revenue mobilisation and help reduce the tax burden on honest taxpayers in a sustainable manner.