The Indian middle class is a diverse set – professionals, public servants, skilled factory workers, the self-employed in the gig economy and smaller business folk who earn enough for daily needs, educate their children, access healthcare adequately and still have a surplus after consumption. High aspirations are what distinguish them from the hopelessness of the poor and the inherited arrogance of the rich.
Governments delight in extorting the private surplus available with the middle class via tax, purely because it is easier done than unravelling the legal defences and accounting labyrinths which protect the income and wealth of the rich.
The income tax anatomy of the middle class
Budget 2017-18, vicariously defined the middle class as having an annual income between Rs 5 to 50 lakhs. The rich got a surcharge of 10 per cent on top of the marginal top income tax rate of 30 per cent plus an additional cess of 3 per cent, increased subsequently to 4 per cent, for an annual income above Rs 50 lakhs.
A punitive, marginal tax rate of 20 per cent plus cess, on income above Rs 5 lakhs distinguished the middle class from the poor Annual income up to Rs 2.5 lakhs (around Rs 4000 per head per month for a five member household) is not taxed. This is where being poor ends. Income above this level and till Rs 5 lakhs is taxed at a moderate 5 per cent plus cess. This low-tax, income slab provides a platform for inducting the poor, who are gritty enough to claw themselves into higher incomes levels, into the tax paying habit.
Income tax rates are reasonable
How a tax matrix affects real households is where the rubber meets the road. So how does the government’s tax policy look from the household upwards? Assuming a household of five persons, income per head per month of less than Rs 8,000 or more than Rs 80,000 is either too poor or too rich to qualify for being middle class. This taxonomy captures the middle class fairly accurately.
GST rates are arbitrary
Problems arise if the impact of the Goods and Services Tax on the lower end of the middle class is computed. The effective tax rates have increased for most items of middle class consumption – branded products, white goods, eating out and holidays in homestays and mid-range hotels. For the large numbers of the middle class who provide services as consultants or on contract in the gig economy, the GST summarily appropriates 18 per cent of the billed revenue if it exceeds Rs 20 lakhs a year. Small suppliers of services do not have the market power to get their corporate customers to bear the tax, even though the latter are legally responsible to pay the GST on receipt of services. Reducing prices to fully or partly absorb the GST is their only choice.
Why is there no standard deduction for costs in services?
There are no standard deductions of costs available for services. Even depreciation on a vehicle is not allowed as a cost. Oddly small retailers with a turnover of up to Rs 1 crore can claim a standard deduction of 30 per cent for costs. Such glitches are disincentives to declare revenue and completely contrary to the GST dharma of incentivising tax compliance.
Progressivity in GST on services is poorly designed
Oddly the GST is not imposed on the marginal amount of revenue from services exceeding Rs 20 lakh. It applies across the entire revenue. The message it sends is that it is foolish to use banked transactions for revenue from services beyond Rs 20 lakhs annually. The income effect of such taxation illustrates the absurdity of the structure. The net income, after deducting notional costs of 30 per cent, from an annual billing of Rs 21 lakhs is Rs 17.5 lakhs. The imputed tax imposed by GST on net income is 26 per cent. Add to that income tax of 20 per cent. The post-tax disposable income gets slashed to just Rs 14 lakhs or 54 per cent of gross income. In comparison someone who keeps her billing of services restricted to Rs 20 lakhs pays no GST and therefore has a higher net disposable income of Rs 16 lakh!
Why does cross border supply of services not have a free-of-tax limit?
Arbitrary taxes on turnover are highly discriminatory and inhibit competition. Consider that no GST is payable if services are provided within a State up to Rs 20 lakhs. But all cross border supply to another State attracts GST. In the United States, cross border online supply of services are not taxed, creating a converse unfair advantage for such supply, versus local supply. This was struck down last week by the US Supreme Court. What can possibly be the logic of inhibiting competition by taxing cross border supply below the annual taxable limit of Rs 20 lakhs?
Fuzzy economic assumptions on the relative merit of public or private expenditure & savings
By taxing both income and consumption at punitive rates, the government drains the surplus available with the middle class, which could have been used more efficiently for higher consumption – triggering higher production or more savings, leading to more investible funds. We are fuzzy about a fundamental trade-off between being an efficient, rationally-taxed, private sector-led economy — a mantra which every government since Prime Minister P.V. Narasimha Rao’s has sworn by — and a punitively-taxed, state investment led, low efficiency economy — which is what we have become.
It does not help that the tax base remains despairingly low and the same law-abiding citizens and entities get taxed ever more by each succeeding government. The tax base of individual assesses of Income Tax is around 60 million. The tax loophole of agricultural income being tax exempt is a major inhibitor for growing the base significantly. The GST has around 11 million registrants. But tax compliance is said to be a low 70 per cent. The tax buoyancy is coming from bleeding the already compliant.
Despite extortionist taxes for the middle class, the tax to GDP ratio is stagnant at just below 12 per cent, because of massive evasion and statutory loopholes for avoidance. Inequality is increasing with income and wealth concentrating within the top 1 per cent. Inequality and tax impunity are “dhili” (loose) foundations for building a sharing economy.
This summer, as our political elite relax in the soothing cool of the leafy and shaded Lutyens’ Delhi, spare a thought for the middle class and show them some love. They also vote, you know.
Adapted from the authors opinion piece in The Asian Age, June 30, 2018 http://www.asianage.com/opinion/columnists/300618/its-time-govt-shows-the-middle-class-some-love.html