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Ahead of the Union Budget 2018, there was a lot of anticipation about possible tax relief for direct taxpayers with either a change in the income tax slabs; lowering of the tax rates; or an increase in the income tax exemption limit from the current Rs 2.5 lakhs to Rs 3 lakhs or even to Rs 5 lakhs. With a rise in personal disposable income post 7th pay commission, SBI’s Ecowrap report also pitched for a rise in tax exemption limit by Rs 50,000. Much to everybody’s surprise, no such announcement was made in the Union Budget 2018-19. However, a standard deduction of Rs 40,000 was announced for the salaried individual taxpayers with no change in tax structure for the individual business income earners. The policy of standard deductions seems to be opted looking at India’s present fiscal and macroeconomic situation.

The revenue impact of standard deductions of Rs 40,000 in place of travel and medical reimbursement, which has a present limit of just under Rs 35,000 , is estimated to be Rs 8,000 crore. On the other hand, increasing the tax exemption limit could have had a higher impact on the government’s tax revenues even with a modest rise of Rs 50,000 from the present exemption limit of Rs 2.5 lakhs. Regulation and minimisation of tax expenditure could be one of the measures to achieve the fiscal deficit target of 3.3 percent in 2018-19.

Need to increase tax revenue

India’s present tax to GDP ratio is 17.2 percent which includes both Union and states taxes. This is low compared to many developing and developed countries. The average tax to GDP ratio for OECD countries was 34.3 percent in 2015; it was 26.4 percent for the USA and 32 percent for Canada. Brazil’s tax to GDP ratio was 32 percent as of 2015. Most of the countries in Europe have tax revenue more than 40 percent of GDP. India needs to perform better on this indicator in order to avail more funds for the developmental programs. A broader income tax base would help improve total tax revenue. There is a continuous effort of the present government to bring more people in the tax net with an aim to improve country’s tax to GDP ratio. Raising the tax exemptions limit to even Rs 3 lakhs could lead to exclusion of many people from the tax net.

The tax system in India is less progressive, as indirect taxes constitute a larger share in total tax collections in the country. In the total tax revenue of both union and states, the share of indirect taxes is close to 70 percent. However, in the gross central taxes, the direct taxes share has been above 50 percent in total tax revenue since 2006-07. In the year 2016-17, this share has declined to 49 percent. Most of the developed countries have a progressive tax system with the larger share of direct taxes in their total tax revenue. For example, in the USA direct taxes constitute over 80 percent and in the United Kingdom, its share is closer to 70 percent in total tax revenue. In India, there is a constant effort from the governments to improve the tax structure with a higher share of direct taxes in the revenue basket. Therefore, policies with regard to direct taxes collections are taken with care and with lot of responsibilities.

Tax buoyancy remains unimpressive

The buoyancy in income tax in India is not impressive. In the year 2016-17, it was 1.95 and in 2017-18 (revised estimates) it is estimated at 2.11. The average buoyancy in income taxes was 1.1 in the last seven years before 2016-17. The Union Budget 2018-19 has an estimated tax buoyancy of 2.7 with an expected GDP growth of 7.4 percent. This could become possible with a higher tax base and thus, there is effort to bring more individuals in the tax net.

The past experience of the government shows that growth in income tax revenue is elastic to any revision of tax exemption limit. In the year 2014-15, the rise in tax exemption limit from Rs 2 lakhs to Rs 2.5 lakhs witnessed a fall in income tax revenue growth to 8.1 percent in 2015-16 compared to 9.4 percent in its previous year. The challenge of fiscal discipline could not possibly allow the government to tinker with tax exemption limit.

Standard deduction is not that bad

The Central Board of Direct Taxes’ return filers data shows that for the assessment year 2015-16, over 10 lakhs salaried people fall under the income bracket of Rs 3 lakhs to Rs 3.5 lakhs. The standard deduction of Rs 40,000 for this lower bracket of salaried income class is nothing but raising their tax slab to Rs 290,000. Therefore, it would directly provide a cash benefit of Rs 2,000 to these low salaried class families, who are the honest tax payers of the country. This cash benefit may be small but it would generate a positive impact on their livelihood.

The concern about the policy of standard deduction is that it may raise income inequality as it benefits unequal taxpayers unequally. The standard deductions of Rs 40,000 would provide a tax benefit of Rs 2,000 to an Individual having annual salary of Rs 3 lakhs while it would provide a tax benefit of Rs 12,000 to an individual with annual salary income over Rs 10 lakhs. Both World Bank and Oxfam report on inequality have presented a clear picture of high income inequality in India in 2017. However, as total incomes tax payers in the country is less than 4 percent; the policy of standard deduction could generate a minimal impact on income inequality.

The present government has undertaken various measures related income tax with an aim to benefit the taxpayers by providing various reliefs in its every budget since 2014-15. Finance Minister Arun Jaitley might have weighed on the above issues to arrive at a decision to introduce standard deductions in place of raising the tax exemption limit in the present budget.