The new personal income tax regime will spur economic growth as it leaves more cash in the hands for people
In Budget 2023-24, Finance Minister Nirmala Sitharaman has made some radical changes in the structure of personal income tax (PIT). To get a sense, let us first take a look at what she did in her Budget 2020-21. Then, Sitharaman had announced the Modi Government’s intention to move towards a regime that was simple, free from a plethora of exemptions and deductions, and reduced the tax liability of assesses, thereby leaving higher disposable income in their hands.
From the perspective of the economy, the idea was to give a boost to aggregate demand and drive growth. Under the old regime (prior to 2020-21), a person having an income of Rs 250,001-Rs 500,000 per annum was required to pay tax of 5 per cent, those earning more than Rs 500,000 but less than Rs 1,000,000 paid 20 per cent tax, whereas someone having an income higher than Rs 1,000,000 paied 30 per cent. However, individuals enjoyed a variety of exemptions and deductions which offered the possibility of significantly reducing their tax liability.
For instance, a person having an annual income of Rs 1,500,000 and availing tax breaks of Rs 375,000 (Section 80C: 150,000; Section 80D: 25,000; Section 24: 200,000), pays Rs 150,000 as tax; without these, she would have paid Rs 112,500 more. But this comes at the cost of blocking Rs 375,000 in long-term investments—necessary for availing tax break. Plus, Rs 150,000 being the outgo on tax, a total of Rs 525,000 is knocked off from her income, leaving only Rs 975,000 for meeting current consumption needs.
Individuals earning less, especially those with annual income less than Rs 1,000,000, don’t have surplus funds to invest; they end up paying much higher tax as they can’t avail tax breaks. Apart from hampering the ability of assesses to lead a better living, this tax regime also impacts economic growth by compressing demand.
To address these concerns, in the 2020-21 Budget, the FM gave another option. Even while retaining 5 per cent tax for annual income in the Rs 250,001-Rs 500,000 range, on income higher than Rs 500,000, the government levied: 10 per cent on Rs 500,001-Rs 750,000; 15 per cent on Rs 750,001-Rs 1,000,000; 20 per cent on Rs 1,000,001-Rs 1,250,000; 25 per cent on Rs 1,250,001-Rs 1,500,000. For income above Rs 1,500,000, the 30 per cent tax continued. No exemptions and deductions were allowed under this regime.
However, individuals were given the choice to go either for the new regime or continue with the old regime. The Budgets of 2021-22 and 2022-23 left the PIT unchanged.
The new regime didn’t make things any better. Under it, a person earning Rs 1,500,000 had to pay tax of Rs 187,500 which is much higher than Rs 150,000 payable under the old regime (albeit with tax breaks). This is because under the former, the cut in rates was not enough to make up for the denial of exemptions and deductions.
In Budget 2023-24, while making no changes in the old regime, Sitharaman has altered the new structure to provide for nil tax on income up to Rs 300,000; 5 per cent tax on income in the Rs 300,001-Rs 600,000 bracket; 10 per cent in the Rs 600,001-Rs 900,000 bracket; 15 per cent in Rs 900,001-Rs 1,200,000; 20 per cent in Rs 1,200,001-1,500,000; and 30 per cent on above Rs 1,500,000. Furthermore, there won’t be any tax on annual income up to Rs 700,000.
This is a significant improvement over the 2020-21 package. Under it, a person with an annual income of Rs 1,500,000 needs to pay Rs 150,000 as tax, down from Rs 187,500 payable under the 2020-21 package. But this amount being exactly the same as the tax payable under the old regime, a natural question arises as to why would she go for the new (albeit modified) regime?
The big advantage of the new (modified) regime lies in the person having cash-in-hand of Rs 1,350,000 (after paying tax), whereas under the old regime she would be left with only Rs 975,000. Under the former, salaried persons can also claim standard deduction of Rs 50,000 which is not available under the latter. This gives an added advantage to the new regime.
For persons earning less, especially those having an income of Rs 1,000,000 per annum and without surplus funds to invest, a case for the new regime becomes even more compelling. This is all the more because of the higher exemption limit of Rs 300,000 under this regime (under the old regime, it remains at Rs 250,000) and significantly lower tax rates under the applicable slabs. Thus, a person earning Rs 900,000 pays Rs 45,000 or 5 per cent of the income as tax.
Furthermore, the tax liability will be ‘nil’ if her annual income is Rs 700,000. On the other hand, under the old regime, she would end up paying Rs 52,500 as tax.
In September 2019, the FM had announced a steep reduction in corporate income tax (CIT) rate to 15 per cent for new manufacturing enterprises and to 22 per cent for existing firms. The PIT then remained high, this created an anomaly vis-à-vis CIT. The reductions in PIT as per Budget 2020-21 didn’t help much in addressing this anomaly. A further lowering of tax rate under the modified regime has brought PIT more or less on par with CIT.
Thus, individuals with income in Rs 900,001-Rs 1,200,000 pay tax @15 per cent, whereas those earning in Rs 700,001- Rs 900,000 range pay tax @10 per cent and nil for Rs 700,000.
In Budget 2020-21, the FM had abolished dividend distribution tax or DDT. From April 1, 2020, the dividend is taxed in the hands of shareholders. But they didn’t gain from this shift as the tax rate under the old PIT regime at 30 per cent for income Rs 1,000,000 was higher than 20 per cent DDT payable prior to 2020-21. Even the tax rate of 20 per cent on income in the Rs 500,001-1,000,000 range was the same as the 20 per cent DDT.
Under the new (modified) regime wherein the tax rates are 10 per cent in the Rs 600,001-Rs 900,000 and 15 per cent in Rs 900,001-Rs 1,200,000, the shareholders will stand to benefit from the transition to taxing dividend in their hands.
To conclude, the Modi Government has made the new PIT regime sufficiently attractive to propel en mass shift of assessees to it. It will also bring an end to the era of exemptions and deductions. It will give a massive boost to the aggregate demand spurring investment and growth.
However, it also needs to look into the regime for capital gains tax (CGT). At present, the capital gains tax (CGT) rate varies widely depending on the asset such as equity share, bonds (there is further differentiation depending on whether the bonds are listed or unlisted), real estate, holding period, etc. Such a highly differentiated tax structure is prone to arbitrage/misuse, evasion and protracted litigation. There is an urgent need for a simple and standardized CGT regime.
Irrespective of the asset an individual deals in and the holding period, whether the bonds are listed or unlisted, the capital gains arising there from are an addition to his income in the relevant year. Therefore, tax should be levied at the rate applicable to the slab his total income falls in (all sources put together).
(The author is a policy analyst)
https://www.dailypioneer.com/2023/columnists/budget-revolutionises-personal-income-tax.html
https://www.dailypioneer.com/uploads/2023/epaper/february/delhi-english-edition-2023-02-21.pdf