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As Finance Minister P Chidambaram gets ready to present the Union Budget, much of the attention will be focused on whether he will impose a tax on the "super-rich".
The debate on whether the rich or the "super-rich" should be taxed at a higher rate, however, is misplaced. The real issue is who should pay tax and how much.
Turgot, the French economist and minister in Louis XVI regime, said, "The expenses of government, having for their object the interest of all, should be borne by everyone, and the more a man enjoys the advantages of society, the more he ought to hold himself honoured in contributing to those expenses."
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It is apparent that everyone ought to pay tax, and those who benefit from governance more should pay more. A tax rate structure must, first, be objectively analysed to arrive at an equitable solution.
The structure must consider the minimum taxable income or, where it is zero, the income up to which the lowest tax rate is applicable, and the income above which maximum marginal tax rate is applicable. It must also consider the minimum and the maximum tax rates and the number of income brackets.
India, today, has moderate tax rates. In 1973-74, the highest rate was 97.75 per cent.
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It was reduced to 40 per cent by 1992-93, and then to 30 per cent in 1997-98. It has continued at this level since then. It is suggested to keep the minimum and the maximum tax rates at two and 40 per cent, respectively.
The number of income brackets may be kept at seven. In other countries, it varies from four to nine. The Gini coefficient that measures inequality - one representing maximum inequality and zero the minimum - would swing towards one if there are fewer income brackets causing greater inequality.
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Also, keeping the number of income brackets low would make the progression from minimum to maximum steep, and encourage the people make all efforts to keep the income within the lower income bracket to avoid tax.
Having too many income brackets, on the other hand, would render it complex for calculation. Lowering the tax rates at the middle income level would serve twin objectives. It would increase voluntary compliance and not only undo the parallel economy, but also add to the revenue as explained by Laffer Curve.
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But the more important effect would be on the economy. Increasing the disposable income in the hands of middle and lower income groups of people would flood the market with consumer demands and spur industrial growth, which in turn would create employment opportunities.
It is well understood that beyond a certain level, any addition to income in the hands of a person does not create additional demands for consumption. This is partly the reason for the slowdown of economy in the rich countries and scramble for markets in the developing countries.
The author is a former Chief Commissioner of Income Tax. These views are personal
ak@kurotax.co.in
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