Income tax abolition is a highly debated and controversial proposal in the country today. About one fourth of the central government’s revenue comes from personal income tax collection. While some economists argue that the loss of revenue for the government would be detrimental, others opine that more money in the hands of people would result in expansion of the economy. This article shall explain the consequences if income tax were to be abolished.
Revenue Sources for the Central Government
The government mainly collects two types of taxes—direct and indirect. More than half of the revenue collected comes from direct taxes and the rest come from indirect taxes like GST and excise duties. An approximate breakup of how much each type of tax constitutes in the total government’s income is given in the diagram below.
The Positives of Income Tax Abolition
Suppose income tax gets abolished in the union budget. What would be the advantages of being a zero income tax state? First, more money in the hands of people. When people have some excess cash in hand, there is a natural tendency to spend a little more apart from saving. When a significant percent of the population does this extra spending, it results in some additional income to some percent of the rest of the population. Suppose a person earns 50,000 rupees a month. He pays an income tax of 5,000 rupees according to the tax regime of 2021. If income tax is done away with, then such citizens would spend more, resulting in more money circulation in the economy.
Second, there is a possibility of bringing black money back into the economy. According to the National Council for Applied Economic Research (NCAER), illicit wealth accumulated in India amounts to anywhere between 384 billion dollars to 490 billion dollars. This is approximately equal to 14% of India’s GDP. Many argue that a significant percent of this wealth got stashed because of high tax rates, and evading Income tax alone made more financial sense. Abolition of Income tax could make this money legitimate, increasing the circulation of money in the economy.
The Negatives of Income Tax Abolition
If personal income tax is abolished, then the central government loses about one fourth of its income immediately. India recorded a fiscal deficit of 9.3% of the GDP in the year 2020-21 according to the Comptroller and Auditor General of India. This figure would skyrocket as a consequence.
One primary reason governments tax is to fund building of public infrastructure and spend on welfare programs. Direct taxes are the easiest way of revenue collection for establishments across the world. In developing countries like India, there still remain a large number of people who lie below the poverty line. There is a natural obligation for the state to support them through various welfare programs. To make up for a huge revenue shortage caused by IT abolition would not be easy, and a lot of welfare programs could be put temporarily on hold.
To manage the revenue shortfall, the government may increase GST rates on commonly consumed goods, making them costlier for the common person. The central government recently hiked excise duty on petroleum products to make up for the revenue shortage caused due the ongoing COVID-19 pandemic. This is an indicator of potential government responses to manage a fall in government income.
Is it practically possible to abolish Income Tax?
No government would want to lose a fourth of its revenue overnight. Especially in India’s case, direct taxpayers are so less that they are not a significant vote bank for any party. Rather, it would only hurt them if welfare programs are put on temporary hold because beneficiaries of these programs are significant in number to influence an election.
Income tax cannot be abolished until the government finds alternative sources of revenue. There is a caveat here—it should not directly impact the common man. One suggestion given by noted economists is introduction of inheritance tax. Simply put, this is a tax levied on people who inherit their ancestral properties/savings. Many western countries like the UK levy inheritance tax of anywhere up to 40% on their citizens.
As any other policy, a zero income tax regime has both advantages and disadvantages. In the short run, the fiscal deficit would shoot up. Several welfare programs and infrastructure projects could be stalled due to dip in revenue. On the other hand, increased circulation of money could result in rapid expansion of the economy. Surely, the idea of doing away with income tax is not a preposterous one!
Sushameendra Balaji is a second-year student at the Jindal School of Government and Public Policy.