Understanding effectiveness of Income Tax in India

India is growing currently at the rate of approximately 5% per annum (as against over 6% in the previous year) as per the revised estimate by the Central government. Although Reserve Bank of India’s main concern now is the current account deficit (CAD), the fiscal deficit requires a lot of attention.

What is fiscal deficit? Fiscal deficit simply means spending more than the income. We all understand that even in our family budget, we need to be in a comfortable position in terms income over expenses or the going will become tough over the long term. Currently, the Central government is going through the same situation. Government has many commitments on the social services front as there is a huge gap in terms of income distribution. Many people are still below the poverty line and so are unable to meet their basic human needs. The government has recently been pushing for the ‘Food Security Bill’ which will only further increase the government commitment on expenditure.

Interestingly, in India hardly 3% of the population files income tax return compared to 53% of the American population. In India, the salaried class employees account for a majority of this 3%. Does that mean that 97% of the population is below the current income tax threshold of Rs. 2,00,000 annual income? Unbelievable, isn’t it? There are many factors that contribute to this gap. Some of these are:

a. Complicated income tax rules

b. Tendency of people to avoid paying their tax dues

c. Non-tracking of activities through unique identification number

d. Allowing cash based transactions

Though the government has taken several measures to bridge the gap over the years -- including introduction of PAN based TDS -- we are yet to see a drastic increase in income tax returns as a percentage of population. On the other hand, government spending has been showing a tremendous increase, boosting industries like FMCG, consumer durables, consumer vehicles, etc. All these point to one factor: we have more people who can afford to spend more than the income under income tax threshold. Still they will not file tax returns or pay any taxes which are genuinely due to the government.

So where is the GAP? The current method of identifying taxable income based on receipts (salary, business income, housing income, capital gains, etc.) need to be modified to include the other group of individuals who spend more but report Nil Income for tax purposes. There should be one more group under the Income-Tax Act to catch the high spenders without any taxable income. Tax brackets based on the money spent on different categories need to be identified. An ‘Advance Tax’ concept should be brought in so that high spenders also brought into the taxable fold.

Bringing all the legitimate people into the tax group will effectively reduce the overall pressure on the fiscal deficit, which means more spending by government on development than on social services.

By:  Suresh S Anandham

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Suresh S Anandham
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Category Income Tax   Report

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