It is time to re-examine the concept of tax on total income with the attendant hassles of inclusion and exclusion of incomes. We need to divert the income streams at source for public purposes. That would cut the tax tentacles at the root
Income tax (I-T) originated in most countries as a means of filling the war chest. In India, the first income tax act was in 1860 to meet financial difficulties caused by the mutiny and was in force for five years. It imposed tax on each component and aggregation was not material. The great famine brought a revival in 1876 as a license tax on traders and continued for 10 years. From 1886, aggregation of income was material only for the initial exemption limit. The 1918 Act followed by the 1922 Act introduced the concepts of total income of the previous year as a measure of income of the assessment year. The 1961 Act made total income as computed as taxable income with advance tax system along with tax deduction at source (TDS) to collect the tax in the previous year itself!
The method to achieve this was recommended in 1956 by Nikolas Kaldor in his report
. It was a tight system with income tax, expenditure tax, wealth tax, and gift tax and estate duty. The tax chased you from womb to tomb. Earn and pay tax, spend and pay tax, save and pay tax, gift and pay tax and die and pay tax. The objective was socialistic distribution of excess wealth and all together, the maximum marginal rate went up to 97.75%
, though Kaldor himself had recommended a ceiling of 45%.
When we look back, we find that the entire system has slowly changed to something else without anyone being aware of it or planning it. Let us see how this incrementation has happened. Expenditure Tax was abolished within three years of its introduction in 1956 and again revived in 1987 to tax expenditure in hotels, Gift tax was omitted with effect from 1 October 1982, Estate duty was abolished in 1984, and Wealth tax was reduced to tax on non-performing assets from 1 April 1988. However, we have other taxes such as Banking Cash Transaction Tax (BCTT), Fringe Benefit Tax (FBT) [withdrawn later], Securities Transaction Tax (STT) and Service Tax. But they do not make any system as such. Studies have shown that instead of reducing inequalities the result has been a great divide between haves and have nots
So it is time to look at the concept of tax on total income and its necessity. It is because of this concept, and the perception that there can be progressive tax on higher incomes, that we have the system of filing returns, which has developed the strangling tentacles. There is a choice-blindness in operation here - lack of awareness of our own decisions and preference
. People often fail to notice glaring mismatches between their intentions and outcomes, while, nevertheless, being prepared to offer introspectively derived reasons for why they chose the way they did. Tax on total income is not the system followed the world over. Most of the countries follow only withholding of tax, without requirement of filing returns by individuals other than self-employed such as UK
and only few countries have this return filing system. Even there, the prefilled return system is adopted by most of the European countries.
Evidence Based Policy
If we want to design a system with the main object of channelling the income of individuals for public purposes, we should first see which system will be effective. The present system of requiring individuals to file returns is burdensome and tempts evasion. What we need is a system of gathering the data, determining the tax and collecting it in the most effective way, with easy compliance. If, instead of computing the total income with the attendant hassles of inclusion and exclusion of incomes, we can divert the income streams at source for public purposes that would work effectively and efficiently. This will cut the tentacles at the root and bring the change we need while retaining the present order.
It is not difficult for the department to get data to find out the outcomes of the present system. The return forms themselves are designed to sort them according to the income stream
. ITR 1 is Sahaj for taxpayers with salary and interest income only. ITR 2 for those having income from property and capital gains also. In respect of income from business, ITR 3 is for firms, ITR 4 Sugam is for presumptive business ITR 5 for individuals and ITR 6 is for companies, which are not trusts. If only the number of returns filed under each type is analysed there will be evidence to indicate which stream of income requires what kind of treatment.
(This is fourth part of a multi-part series on the vexing Indian tax system and the path to genuine reforms, adapted from Justice S Rangarajan Memorial Lecture in Bangalore delivered recently)
Tomorrow: Part5 - A New Approach Based on Streams of Income
You may also want to read…
(Justice TNC Rangarajan is a former judge of Madras and Andhra Pradesh High Courts. Earlier, for more than 20 years, he was a Judicial Member of Income Tax Appellate Tribunal