With GST on course, here’s why government must set up panel to cut income tax burden

Those in the know of the deliberations at the top level in the government post-demonetisation point out that prime minister Narendra Modi was extremely unhappy with the results because of the slack handling by the agencies responsible for the implementation during November 9 and December 30 last year, especially the banks. And, why not—despite taking one of the biggest political risks in the history of independent India, thinking that demonetisation of Rs 500 and Rs 1,000 notes will bring out huge sums of black money, there was not much to show on the ground.

What saved him though is the fact that public opinion throughout the country remained in favour of demonetisation even though it meant a lot of hardships for the common man because of the shortage of cash—the record success of the Bharatiya Janata Party (BJP) in the Uttar Pradesh assembly polls bears testimony to this. The encouraging part is that PM Modi is still keeping the government machinery on toes to not only reap the benefits of demonetisation by getting hold of those who have deposited their unaccounted income kept in Rs 500 and Rs 1,000 notes, but also extending the reach of digital transaction to curb the cash-economy, which is at the root of black-money creation, through efforts like promotion of BHIM-Aadhaar payments.

While the ease of transaction that linking with the biometric identification system, Aadhaar, provides to the people can potentially revolutionise the payments ecosystem in the country, the income tax (I-T) department has the dual responsibility of catching past tax evaders and coming out with the reforms of the tax system to stop the generation of fresh black money. It is already on the job with regard to its first responsibility, through its Operation Clean Money that was launched on January 31 for e-verifying the cash deposits made during the demonetisation period.

In the first phase, 17.92 lakh persons, involved in cash transactions not matching their tax profile, were asked to file their response on-line. Considering only 9.46 lakh persons responded, the department is now in the process of reaching out to the rest and also those providing responses that are not acceptable. The I-T department has made it clear: “It has been decided to close the verification in cases where the explanation of the source of cash was found to be justified. In cases where the cash deposit has been declared under Pradhan Mantri Garib Kalyan Yojna (PMGKY), the verifications would also be closed.”

In the next phase, the operation is becoming more focussed based on credible information—more than 60,000 persons, including 1,300 high-risk persons, have been identified for investigation into claims of excessive cash sales during the demonetisation period—and more than 6,000 transactions of high-value property purchase and 6,600 cases of outward remittances will be subjected to detailed investigations.

The message appears to be loud and clear—those who thought they have escaped the taxman’s lens by just depositing the old notes may have got it wrong. Reaching them with the help of information gathered during the demonetisation phase is now one of the primary jobs of the Central Board of Direct Taxes (CBDT). But the more critical responsibility of the tax department and the government here is to look at a longer-term solution to deal with the creation of black money.

With the goods and service tax (GST) all set to become a reality this year—the government is still looking at the July 1 date—the countrywide indirect tax system would only need the required modifications in terms of rates and structure going ahead. The government, therefore, must initiate the process for reforming the income tax structure in the budget next year, which is one of the major steps needed to curb the creation of black money, along with the GST.

PM Modi has already stressed on the need to lower the income tax burden on individuals and finance minister Arun Jaitley will do well by initiating this process at the earliest. The government still has enough time to do it, perhaps with the help of a committee consisting of representatives of all stakeholder groups—tax experts, the public, CBDT, and tax professionals. This panel should be assigned the job of formulating a draft report on the changes required on the lines of the Direct Taxes Code (DTC), which has been junked by the current government. The draft report then should be put up for extensive consultation before it is shaped into a final report to be presented in Parliament, preferably in the monsoon session, to seek the view of the standing committee. The idea has to be to firm up the final contours of the changes during the winter session of Parliament so that they can be introduced in the Budget next year.

A close look at the personal income tax structure over the years (see table) suggests that even though tax burden has moderated after reaching extortionary proportions in the pre-1991 phase, there is still a need for major restructuring. Though the biggest problem with such restructuring is that of it has to be done along with the removal of exemptions, which is a politically sensitive matter. There is no reason why PM Modi should hesitate in doing this now, especially after taking a big risk like demonetisation.

This will help him in raising the floor for imposing the top income tax rate of 30% from the current Rs 10 lakh—the low floor leads to tax evasion . It will be a good idea to revisit the DTC 2009 proposal of taking it to Rs 25 lakh with the phasing out of exemptions. If PM Modi succeeds in re-hauling the personal income tax structure, along with GST, it will constitute the biggest tax reform done by any government after independence.

It will be a big gain for the country’s business environment if the pending corporate tax changes—reduction in the rate to 25% with the weeding out of tax deductions—are also made part of the overall direct tax reform in the 2018 Budget. Being the fourth year of the government, 2018 is the best time to go for big-bang reforms.