GST done, what next for Modinomics – Direct tax?

Post the traumatic experience of standing in queues for months to withdraw own money and tasting mixed fruits of increased/decreased prices due to GST, India (especially Middle class) is looking forward towards the next reforms from NaMo and Arun Jaitley.

Currently we are witnessing the weakest growth in last 3 years. This is due to destocking prior to GST, after effects of Demonetization, currency appreciation and so on. The biggest reason which we ignore is weak demand and low utilization (~70%) of existing plants. Since the demand is weak existing factories are enough and hence no corporate is putting new factories. Due to this employment generation is also low.

To improve the demand we have two ways: either reduce the price by reducing tax or increase the spending power of the ordinary citizens. Since government has just implemented GST chances of merging 12% & 18% is dim in the next few months. So that left only 1 option of increasing spending power of citizens.

Easiest way of increasing the spending power can be directly making it available in the hands of the people by reducing the DIRECT tax.

My proposals for Finance Minister with the rational and expected benefits/loss is:

1. Effective 0 % IT rate for Gross Income of less than 5 lakh.
2. Creating a tax slab of 10% for 5-7 lakh.
3. Introducing a new tax free bond of 50000 for infrastructure.
4. Removing few exemptions like Medical bill, Travel allowance or Telephone allowance.

Rationale for these proposals:

1. Effective 0 % IT rate for Gross Income of less than 5 lakh: Since this is gross Income which means people can’t claim 1.5 lakh as 80 C deductions but will pay 0 taxes. Currently an average family need atleast 35000 per month to survive in a city and whatever excess income left is saved. Let people decide how much they want to save rather than forcing them. Surviving today is bigger priority than saving for future.

2. Creating a tax slab of 10% for 5-7 lakh targeting the middle class: A big jump from 5% to 20% is making people state lower income. This is Aspirational class who wants to spend to upgrade their lifestyles. Lowering the tax here means jump in spending in various other sectors (Automobiles, Tourism, Mobile & Accessories, etc).

3. Introducing a new tax free bond of 50K (max) for infrastructure: Government needs money for improving railways and roads so they can re launch the earlier tax free infrastructure bonds with a lower Interest rate (say 6.5%/yr). These bonds will still give return of ~8-9% post tax for Higher Middle class/Higher class i.e income of more than 7.0 lakh

4. Removing few exemptions like Medical bill (15000/yr) & Travel allowance (19200/year): Rational behind this suggestion is that most of the people produce fake bills in case they are not able to spend genuinely. Also this will help reduce unnecessary efforts taken by Corporate and Individuals to claim to the exemptions. Also if a person is sick than he will spend more than 15000 on medical. Similarly if someone has to go to office and he needs to spend more than 1600/month he will spend. Similarly telephone allowance should be removed with unlimited data/calling available at 200/month.

FINANCIAL FEASIBILITY OF THE ABOVE RATIONALES:

This year in budget speech Mr. Jaitley revealed that 37 million Individuals filed IT returns in 2015-16.

Gross Income\Year2013-142014-152015-16
0       1,55,501       2,28,627       1,98,216
>0 and <=2,50,000 1,47,75,316 1,44,82,520 1,35,16,945
>2,50,000 and <=  5,00,000     84,14,290 1,15,17,749 1,38,47,402
>5,00,000 and <= 5,50,000       8,67,289     11,94,171     13,78,870
>5,50,000 and <= 10,00,000     31,22,753     41,41,207     51,30,691
>10,00,000 +     15,90,449     20,21,020     24,40,910
 2,89,25,598 3,35,85,294 3,65,13,034

Or in other words Distribution look likes:

Gross Income\Distribution2013-142014-152015-16
00.5%0.7%0.5%
>0 and <=2,50,00051.1%43.1%37.0%
>2,50,000 and <=  5,00,00029.1%34.3%37.9%
>5,00,000 and <= 5,50,0003.0%3.6%3.8%
>5,50,000 and <= 10,00,00010.8%12.3%14.1%
>10,00,000 +5.5%6.0%6.7%
Total100.0%100.0%100.0%

From this distribution we can categorise people in 3 different categories:

  1. Lower Middle class (People with Gross Income of <5 lakh)
  2. Middle class (People with Gross Income of 5-10 lakh)
  3. Higher Middle class & Higher class (People with income of >10lakh+)

Let’s see what the net effect will be of these changes to each group:

In 2015-16, the income tax distribution tells us that almost 37.5% have gross income of less than threshold (2.5 Lakh) and hence pay 0 taxes. Next category (2.5lakh -5 lakh ) we have close to ~1.4 Cr (38%). Remember here we are talking about Gross Salary i.e Income before 80 C deduction of 1.5 Lakh. So effectively this set of people is going to pay tax on max 1.5 lakh (assuming 1lakh average deduction i.e 2.5+1=3.5 lakh tax free). From this 1.5 lakh govt would be getting something like 10800 cr as tax (1.4 Cr people*1.5 Lakh *.05*1.03) at 5% tax rate. Additionally govt. also gives a rebate of 5000 in IT under section 87A if income is less than 5 lakh, which basically means govt would be getting only 5000-7500 cr from these set of 1.4 Cr IT payers. So if we implement the 1st recommendation we are looking at loss of 7500 cr to govt.

Let’s move to second category of Middle class:

In 2015-16, we have close to ~65 lakh as IT payers in Middle class. Current bucket is 20% for Income b/w 5-10 lakh post 80 c investments. So govt approximately would be getting ~8000 cr as 5% tax. I am assuming that here people would be using the full 1.5 lakh exemption limit plus some additional benefits like 80D, 80DD, 80E or 80G. Based on these I am assuming average 50000 as tax which will yield ~33000 cr as Income tax as per current tax slabs of 20%.

If we introduce a new slab of 10% for 5-7 lakh than average tax will be reduced to 35000 which mean a loss of another 10,000 cr to Finance minister.

Increasing 50,000 limit of new Infrastructure bond will nullify the effect of removing Medical bill & Transport allowance (34200).

For Higher Middle class & higher class:

This is the class which actually drives the personal IT collection of India. Also these are the people who drive the consumption in India in luxury space. Currently my estimation is that Govt collects 1.4-1.5 lakh cr from this category of people. If we implement all the recommendations than govt has to forego close to 12,500 Cr due to new 10% IT rate. Removing exemptions will almost negate the new tax free infra bonds introduction.

So if Finance Minister introduces these points the department will lose ~30,000 CR (7,500+10,000+12,500). This forego revenue will surely effect the fiscal consolidation path taken by Modi govt but current need is to create demand in the economy. On a lighter note if Govt sells its holding in ITC they can fund this 30,000 cr.

Best way of communicating & achieving is not to wait till Budget 2018, PM should come back on National TV on 20 September (Just before the Festive season of Navratri starts) and announce new IT rates of next year. This will create the immediate spending spree with Middle & Higher class which can take back our growth to 8% in Q3.

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