Govt plans income tax revamp to offer relief for middle class

income tax
Facing sluggish economic activity, the government is considering changes to the income tax regime to ease tax burden on the middle class and incentivise spending.

The government plans to refine the income tax system introduced in 2020 to offer some relief to the salaried class. The tax structure is expected to be revamped with fewer tax brackets and new tax slabs. Tax officials are assessing the viability of adjustments to maximise benefits for the Indian middle class. This effort is part of the ongoing budget preparation process by the newly elected government. However, as the government and officials are still considering the implications of an overhaul, a concrete decision may take time and could be announced in either the July 2024 Budget or the February 2025 Budget.

The presentation of the Union Budget for 2024-25 comes at a time when the country is witnessing a slump in household consumption and subdued private sector investments. The middle class, in particular, has been disenchanted with the last two NDA governments for not providing any tax concessions. This class strongly desires a reduction in personal income tax, believing the government has left them to do the heavy lifting on tax collections. According to estimates, individual taxpayers face a peak tax incidence of 40% or more.

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Need to overhaul the income tax regime 

The rising cost of living has left the salaried class struggling, particularly those migrating to cities for work. Their income barely covers basic needs, making the new tax system feel unrewarding. Many taxpayers who qualify for deductions under the old system find the new regime less beneficial. This may be a reason why the government is revisiting the tax structure and acknowledging the need for policy intervention. Reducing tax burdens for lower-income earners is likely to stimulate household consumption, which could also lead to increased private capital expenditure in consumer-focused sectors, ultimately boosting overall economic activity.

However, further deliberation is needed before taking such action. Newspaper editorials call for a scrutiny of the existing capital gains tax regime and aligning the tax rates, as holding periods currently vary across asset classes.

The government may also look into GST rate rationalisation, which, unlike changes in specific income tax slabs, affects a wider segment of the population. The government has acknowledged this issue, and the 45th meeting of the GST Council promised to address it. Future actions may include merging some tax slabs and incorporating items like petroleum products within the GST ambit.

Over the years, the government has taken various steps to increase the tax base, reduce the tax burden, and ease compliance. The recent FY24 Budget offered some improvements to the new tax regime, including a rebate under Section 87A for incomes up to Rs 7 lakh and a standard deduction of Rs 50,000. Currently, the new tax regime is the default option for taxpayers, although the old system with its deductions and exemptions is still available. Around 60% of taxpayers have switched to the new regime.

The number of direct taxpayers has also surged in recent years. On the direct tax side, the number of taxpayers has nearly doubled, from 5.26 crore in 2013-14 to 9.37 crore in 2022-23. This growth is primarily driven by individual taxpayers, whose numbers have risen from 4.95 crore to 8.9 crore during the same period. Indirect tax collection also shows a positive trend. As of June 30, 2023, there were 1.4 crore active Goods and Services Tax (GST) taxpayers, a notable increase from 1.12 crore registrations in June 2018.

Despite this, the new tax regime has not found the wide adoption the government had hoped for. Officials have said that further improvements will aim to simplify the tax system and lower tax rates to compensate taxpayers. Tax experts have suggested increasing the income ceiling subject to the 30% tax rate from Rs 15 lakh to Rs 20 lakh. The basic slab at Rs 3 lakh in the new regime is too low and has not kept pace with inflation. The government must consider raising the zero-rated slab to at least Rs 5 lakh, which would provide tax relief to a larger group of taxpayers. Simplifying the tax structure for everyone is another crucial improvement.

Tax experts emphasise that the government must design a more attractive personal income tax scheme. This would involve minimising deductions for housing, health insurance, and pension contributions. Additionally, young people saving for the future are ditching traditional options like the Employees Provident Fund (EPF) and Public Provident Fund (PPF), instead looking for investments that offer higher returns, such as those tied to the stock market. A high standard deduction would give them more money to invest in these preferred options.

While there is discontent with the surcharge on incomes exceeding Rs 50 lakh, the government should not yield to pressure, as it is a necessary levy. India faces significant income inequality; by requiring the highest earners to contribute more towards social programs that help the less fortunate, the government may avoid harsher measures like imposing wealth taxes.

Developing countries like India face challenges in implementing effective income tax regimes due to limited administrative capacities and large informal economies. Nations like India and Brazil have been working towards modernising their tax systems to improve compliance and broaden the tax base. India’s recent shift to a new tax regime is an example of such efforts aimed at simplifying tax filing and make the system more transparent. However, these countries often struggle with tax evasion and a lack of taxpayer trust, which hampers revenue collection and economic development. As they strive to enhance their income tax regimes, these countries must balance the need for increased revenue with the imperative to foster economic growth and ensure social equity.