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Whether Income Tax can be Abolished ?

Income Tax Vs. Bank Transaction Tax

  • There are excellent arguments in favour of abolishing the income tax in India. Given the chaos that surrounds the system currently, the leakage, it doesn't even pass the usual equity desires of making sure that the richer people carry a larger part of the tax burden and as we all should know an income tax is an inefficient method of taxation to boot. So, the start of this idea is just fine, that perhaps India should cut through the Gordian Knot by just abolishing that income tax system altogether.
  • However, there is then the question of where to gain that necessary revenue from in the absence of that taxation system. And that's where this idea fails and fails horribly. A bank transaction tax--any transaction tax in fact--would be far worse than even the current income tax system. Plus, of course, a bank transactions tax would push everyone back into the cash and black money economy we've all just spent so much time and effort trying to destroy.
  • So, good marks for describing the problem, none at all for the solution: The most damning evidence of evasion was the fact that out of 7.6 million individuals who declare incomes above Rs 5 lakh, 5.6 million are in the salaried class, for whom the taxes are deducted at source. Clearly, it cannot be the case that India has only two million businessmen and self-employed people who earn incomes above Rs 5 lakh. Tax evasion is rampant in the country and is especially high among the non-salaried class.
  • That's the evidence of the failure of the current system. As Adam Smith remarked there's nothing wrong, indeed much just about, with insisting that those with higher incomes should carry a more than in proportion burden of the tax system. Thus we're just fine with the general concept of a progressive income tax. Yet as we can see the current system isn't in fact progressive, we all know that the salariat is making less than those (at least, some of those) running their own businesses but it's the salariat paying the income tax. Thus we fail that equity test of the tax system.
  • Once we've agreed that then we want to go and look at the efficiency of the system. And India's tax system is not greatly known for that in any manner. However, in economic terms we do have a spectrum of taxes, from high efficiency to low. That spectrum runs land value tax, consumption tax, income tax, capital and corporate tax, transactions taxes.
  • For those who don't quite get the jargon here, a consumption tax is a sales tax, perhaps a VAT like the GST just coming. Yes, it's collected upon transactions but a sales tax is once only at the retail point, a VAT (or the GST) is collected in stages but it amounts to just the one rate in total at that retail point. A transactions tax is quite different, it's a tax on each and every transaction. Say it was of 1% on each transaction, just to invent a number. So, the miller buys the wheat from the farmer, 1% is paid, the miller sells the flour to the baker, 1%, the baker to the shop, 1%, the shop the bread to the consumer, 1%. But now think about a more complex and possibly more efficient economy. The farmer to the grain trader, the grain trader to the miller, the miller to the flour trader, the trader to the baker, the baker to the wholesaler, the wholesaler to the shop and so on. We've more transactions and thus more tax points and thus more tax being paid upon the same process, turning wheat into bread.
  • Say the VAT or GST or sales tax on bread was 10%. The consumer would be paying 10% whatever the system, however many transactions there were in the process of bringing the bread to where it may be eaten. A transactions tax charges different amounts dependent upon how much division and specialisation of labour we've got in that supply chain. Worse, the more we have the more the tax rate is in total. And that's really not something we want to do, tax the division and specialisation of labour, that's the very thing which makes us richer (Adam Smith again).
  • Transactions taxes are thus a very bad idea. They're worse than other forms of taxation in terms of efficiency. But the suggestion is that instead of the income tax we should have a transactions tax:
  • Also, a loss of over Rs 3 lakh crore that the move would entail can be easily replaced with much more efficient mechanisms. A banking transaction tax can be considered. A small tax on any banking transaction in an economy can vastly increase the government's tax base and revenue compared to the current inefficient method.
  • No, that's much more inefficient, a terrible idea. We want to move left along our spectrum, to more efficient taxes, not right to less. Raise the level of the GST perhaps, have a land value tax maybe, but replacing an income tax with a bank transactions tax is not something we want to do.
  • Quite apart from anything else we get less of whatever it is that we tax. And we've just gone through great pain to encourage people to stop using cash and use banks instead. Taxing bank transactions would entirely reverse that, wouldn't it?


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