THE POLICY LAB-33
NOVEMBER 20, 2023

By J B Mohapatra

A structural trait that India’s income tax shares with many other significant jurisdictions is the relative stability of its tax policy, trajectory and momentum of its tax reforms under that policy, and relative stability among components that make for the tax policy, for example the two salient features of the tax policy - (a) tax rate and tax slab and (b) fixed sum deductions and allowances.

Tax slab and rate first. For every individual, HUF, association of persons, body of individuals tax rate and slab remained identical for each of the years between 2001 and 2005: nil for total income not exceeding Rs 50,000, 10% of the amount exceeding Rs 50,000 for total income in the slab of Rs 50,000 and Rs 60,000, Rs 1,000 plus 20% of the amount exceeding Rs 60,000 for total income in the range of Rs 60,000 and Rs 1,50,000, and Rs 19,000 plus 30% of the amount exceeding Rs 1,50,000 for total income in excess of Rs 150,000. Between 2018 and 2023 too, the tax slab and rate for resident individuals, HUF, association of persons and body of individuals remained identical for each of these years: nil for total income not exceeding Rs 2,50,000, 5% of the amount exceeding Rs 2,50,000 for total income in the slab of Rs 2,50,000 and Rs 5,00,000, Rs 12,500 plus 20% of the amount exceeding Rs 5,00,000 for total income in the range of Rs 5,00,000 and Rs 10,00,000, and Rs 1,12,500 plus 30% of the amount exceeding Rs 10,00,000 for total income in excess of Rs 10,00,000. In between these 2 time -blocks, changes with regard to threshold levels of taxation, slab for maximum marginal tax, new rates for a tax slab, or new tax slabs were legislated. Thus, threshold taxation level went up to Rs 1 lakh in 2006, Rs 1,10,000 in 2008, Rs 1.50 lakh in 2009, Rs 1.60 lakh in 2010, Rs 1.80 lakh in 2012, Rs 2 lakh in 2013, and Rs 2.50 lakh in 2015. Highest tax rate of 30% for the tax slab which started at total income of Rs 1.50 lakhs in 2001, Rs 2.50 lakhs in 2006, Rs 5 lakhs in 2009, Rs 8 lakh in 2011 now starts at Rs 10 lakhs.

Fixed sum deductions and exemptions for resident individuals likewise either do not change over long periods or never change at all. For example, quantum of deduction under section 80TTA in respect of interest on deposits in saving bank (Rs 10,000) introduced in 2013 has never been altered since the year of introduction. Deduction under section 80C (on payment of life insurance premia, contribution to a provident fund or a superannuation fund) did not exceed Rs 1,00,000 from 2006 till 2014, and did not exceed Rs 1,50,000 from 2015 till date. Deduction under section 80D for payment of medical insurance was a maximum of Rs 10,000 from 1997 till 2007, a maximum of Rs 15,000 from 2008 till 2015 and a maximum of Rs 25,000 from 2016 till date.

Stability in rates of tax, tax slab, fixed sum deductions and exemptions while bringing certainty to current determination of tax and for future projections for taxpayers and governments alike, if is allowed to remain un-aligned to serious extraneous influences- inflation for example- for substantial lengths of time has its flip sides too. Inflation erodes standards of living, brings distortions in economic choices people make, retards efficiency of investment, and importantly for taxpayers degrades their purchasing capacity when every unit of currency they expend fetch fewer and fewer units of goods and services. All things being equal- gross total income, tax payout, post tax remainder of income- between 2 consecutive years, a 5% inflation year-on-year will roughly translate to a 5% decline in purchasing capacity in the later year qua the disposable income in hand. India’s inflation derived from the CPI data ranged year-on-year an average of 3.98 between 2001 and 2005, 8.68 between 2006 and 2010, 8.0 between 2011 to 2015, 4.48 between 2016 to 2020 and stood at 5.1% for 2021 and 6.7% for 2022. While consistently high to moderate inflation erodes the real value of taxation for the governments (the Oliver-Tanzi effect), the effects for the taxpayers are more devastating, salient among them being erosion in purchasing capacity.

Annual inflation adjustments for personal income taxes to maintain consistency in tax system in real terms has been attempted in few jurisdictions- Canada, France, UK,USA and India too- invariably favoring a partial adjustment regime so as to arrest and offset the inflation induced distortions, mostly through partial adjustments to nominal elements in tax systems such as personal exemption threshold, standard deductions, tax brackets for preventing economic inefficiencies and the phenomenon of bracket creep. In essence, certain parts of tax statute and code are configured to inflation to prevent rising prices eat into disposable post-tax income. The most salient part of Economic Recovery Tax Act, 1981 of the USA for example- inflation indexing of personal income taxes -which till date is administered by the US IRS through the annual Revenue Procedure is one such example of a government’s attempt at correcting inflation induced distortions in the tax system. Operative parts of section 104 of that Act (adjustment to prevent inflation caused tax increase) read as follows:

"(a)

(1) IN GENERAL- Not later than December 15 of 1984 and each subsequent calendar year, the Secretary shall prescribe tables which shall apply in lieu of the tables contained in ------- with respect to taxable years beginning in the succeeding calendar year.

(2) METHOD OF PRESCRIBING TABLE- The table which under paragraph (1) is to apply in lieu of the table contained in ----- shall be prescribed-

(A) by increasing

(i) the maximum dollar amount on which no tax is imposed under such table, and

(ii) the minimum and maximum dollar amounts for each rate bracket for which a tax is imposed under such table
by the cost-of-living- adjustment for such calendar year,

(B) by not changing the rate applicable to any rate bracket as adjusted under sub-paragraph A(ii), and

(C) by adjusting the amounts setting forth the tax to the extent necessary to reflect the adjustments in the rate brackets.

--------------

(3) COST OF LIVING ADJUSTMENT- For the purpose of paragraph (2),the cost of living adjustment for any calendar year is the percentage (if any) by which-

(A) the CPI for the preceding calendar year exceeds

(B) the CPI for the calendar year 1983

(4) CPI for any calendar year- For the purpose of paragraph (3), the CPI for any calendar year is the average of the consumer price index as of the close of the 12- month period ending on September 30 of such calendar year

(5) CONSUMER PRICE INDEX- For the purpose of paragraph (4), the term ‘consumer price index’ means the last consumer price index for all-urban consumers published by the Department of Labor

(b) ----

(c) PERSONAL EXEMPTIONS- For the purposes of this section, the term ‘exemption amount’ means with respect to any taxable year ,000 increased by an amount equal to $ 1,000 multiplied by the cost -of -living adjustment as defined in section 1(f)(3) for the calendar year in which the taxable year begins."

This is the leverage given to the government through the legislative route that allows US IRS to facilitate changes to the Revenue Procedure on an annual basis on elements such as standard deduction, threshold levels of taxation, alternate minimum tax exemption, certain personal exemptions, threshold levels of estate tax exemption and such like.

Inflation indexing to taxation in India in some instance is explicit- for example through section 48 of the Act to allow indexed cost of acquisition and improvement as an allowable expenditure for determining long term capital gains, aligning the index to the average rise in the consumer price index (urban) via an annual notification of the CBDT to that effect. In some instance, inflation indexing can be sensed implicitly in the statute- marginal relief to resident individuals through section 87A for example- Rs 2,000 of tax deduction for 2014 to 2016, Rs 5,000 for 2017 to 2019 and Rs 12,500 for 2020 till date in all such cases where total income does not exceed Rs 5,00,000 and taxpayer having exercised the option for the old tax regime; and maximum marginal tax rebate of Rs 25,000 for those who have opted for taxation under section 115BAC. Barring these two instances: an explicit inflation adjustment under section 48 in respect of long term capital gains, and an implicit adjustment under section 87A, there is insufficient evidence in the tax statute to demonstrate any efforts at synchronizing the tax payouts to inflation levels on a yearly basis. Even otherwise, the marginal tax rebate under section 87A is a fixed sum rebate, its effect is minimal at medium and higher levels of income category, and dependent on parliamentary approval for any future change and modification.

Challenges for adoption of a comprehensive annual inflation adjustment regime for personal income tax are enormous, and for that reason alone, that most jurisdictions have favored partial adjustment procedures. However certain parts of the personal tax regime in India, untouched so far from any indexation, deserve a relook. Indexing the threshold levels of taxation, as also configuring the minimum and maximum income for any particular tax slab (without disturbing the rate for any slab) or indexing certain essential exemptions and deductions to the current levels of inflation on year-on-year basis through the government/ administrative route (and an enabling legislative sanction to begin with) as done in the case of structuring the cost inflation index for long term capital gains via a government notification will introduce that element of flexibility in decision making , contribute to the horizontal and vertical equity , and further the cause of distributive justice across all income ranges.

If the goal is to maintain consistency in tax system in real terms and avoid distortion, inflation indexing has been a tried and tested method across many jurisdictions. How we do it with what periodicity and with what instrument are all that matter in any discussion on the topic.