Apropos Nitin Desai’s article “What the FM must do” (February 21), his argument on tax progressivity suffers from an isolationist approach since any other aspect of income tax, except progressivity, has not been considered. Progressivity of tax is not an end in itself. The objective is to promote growth and equity, and on these, the score of a highly progressive income tax is not impressive. To argue that India’s richest individual who receives more than Rs 1,000 crore as dividend to pay tax at the same rate as a pensioner who gets a few thousand rupees is against the principle of tax progression is more emotional than rational from the economic point of view.
This argument has recently been nicknamed the Buffett Rule. Warren Buffett famously said his personal assistant paying at the same rate as him was unfair. But, in economic parlance, fairness is understood as what is better for the economy as a whole. Even after Buffett’s statement, US President Obama has not unilaterally jumped into imposing a super tax on the super rich. The main issue is what tax rate will boost investment. It is called the tax-equity and tax-growth trade off in a policy design. There is no unanimity in the favour of high tax as a promoter of either growth or equity. On the other hand, there is a growing theory, known as the flat tax theory, which advocates one rate of tax for its simplicity and and being less prone to evasion. Many developed countries have adopted the flat tax system, and its supporters claim that it encourages economic growth by avoiding a system in which one is penalised in higher taxes for being productive and earning more money.
The highest rate for the rich is not necessarily friendly to growth because the rate may be 16 per cent, but a pensioner will not pay any tax at all if his total income is within the initial exemption. Second, the relatively poor taxpayer pays a total of a few hundred or thousand rupees as tax, while the rich pays Rs 160 crore of tax on a dividend of Rs 1,000 crore, using the author’s example. The rate may be the same but the total is mighty different. Third, the author has not taken into account the cost of collection and wastage, which are higher in under-developed countries like India. Last, the lack of capacity of bureaucrats in matching businessmen in entrepreneurship is well known.
All literature on the subject taken together come to the conclusion that higher tax on the rich is not a free lunch. The evidence is that the reform that closes loopholes and broadens the tax base is a more efficient way to bring in more money than higher taxes for the rich. The latest trend is not to see the value-added tax or income tax as regressive or progressive in isolation, but in combination, that is, as a part of the total tax structure, along with excise on luxuries and on demerit goods and pro-poor expenditure policy.
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