[Burning Issue] Flat Income Tax Rate in India

Why in News?

  1. Recently, the central government had formed a task force to draft a new Direct Tax law which seeks to replace the existing Income Tax Act, 1961.
  2. The Task Force will submit its report to the government on how to fix the more-than-50-year-old Income Tax Act, 1961.

What is the flat tax rate?

It is an income tax system in which everyone pays the same tax rate irrespective of income level. Therefore it is also named as proportional taxation system.

What is the Need?

  1. India’s current tax system is progressive in nature, with tax rates going up when the income level goes up. To meet the changing economic needs of the country, and to fix the more than 50-year-old Income Tax Act, 1961 which is not consistent with present times, a flat tax rate system is necessary.
  2. To reinstate the Direct Tax Code (DTC) in a new structure.

Arguments in favour

  1. A flat tax rate of 12% would be appealing even for low-income people.
  2. The compliance rate will increase by eight percentage points to 33%.
  3. While simplification and better administration of the law are major reforms that India needs, according to economists, some even suggest going for a flat tax system or lower tax system.
  4. The classic case of the flat tax system is of Hong Kong, Russia and New Zealand.
  • One of the poorest country during the World War II, Hong Kong adopted a flat tax in 1947 which led to higher compliance and dramatic economic growth.
  • Russia adopted a 13% flat tax, which went into effect in 2001 and Russia’s economy has expanded by about 10 percent since then. Russia’s income tax revenue has grown to more than 50% as people found it fair and easier to pay.
  • New Zealand is called BBLR — broader bases and lower rates — country. In New Zealand, the tax law experts focus on taking a lot of actions at a low rate, or flat rate and most importantly at the simpler tax code. New Zealand in 1980 did away with deductions and write-offs and instead applied the lowest rates on average workers. With higher compliance, New Zealand is one of the countries with the best income tax practices. Instead of imposing a progressive tax scheme, it gives it as an option for people.

Arguments against

  1. India’s current tax system is progressive in nature, with tax rates going up when the income level goes up. India is a democratic country and is expected to invest in social welfare and infrastructure. Hence progressive tax rate is necessary.
  2. For a developing country like India, which is in the lower middle-income bracket, a flat tax structure may not be an equitable one. Income inequality in India is one of the highest, with 22 per cent of the national income going to top 1 per cent.
  3. Only with a progressive tax system, such wide income inequalities can be addressed. Hence a flat tax system will be regressive, considering India’s current situation.
  4. A system prescribing the higher rate of income tax for a higher income group helps garner revenue without becoming burdensome on lower income taxpayers
  5. The great success of Russia not just through the imposition of flat tax rate but through several changes in both the structure and the administration of taxes. The reforms widened the tax base by eliminating many exemptions and deductions as well as increasing taxes on capital income.

India’s attempts to impose a flat rate

  1. An attempt to redraft the Income Tax Act made by the ex-finance minister P. Chidambaram in 2009 through the Direct Taxes Code (DTC). It proposed a simpler tax code and did away with unnecessary exemptions and created space for lower tax rates. However, the bill lapsed with the dissolution of the 15th Lok Sabha in 2014.
  2. The NDA government, since coming to power in 2014, has already implemented general anti-avoidance rules GAAR.
  3. In 2016 Finance Minister promised to lower corporate tax rate to 25% in 5 years.
  4. Currently, income up to Rs 2.5 lakh per annum is exempt from tax for individuals.

Way forward

Flat income tax rate has many success stories from many countries. Hence it is high time that India also adopts it. However, it should be implemented as a pilot project to monitor various impacts and come up with effective solution to prevent various challenges in the actual implementation. And the government should also ensure that the poor are not affected from this reform.

Practice question

  1. What do you understand by the flat income tax rate? Discuss whether implementing a flat income tax rate in a democratic country like India is feasible or not.

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