GST done what next for Modinomics – Direct tax???

Post the traumatic experience of standing in queues for months to withdraw own money and tasting mixed fruits of increased/decreased prices due to GST India(especially Middle class) is looking forward towards the next reforms from Namo and Arun Jaitley. In the previous week GDP data for last quarter came and it was weakest in the last 3 years. Underlying reason for the weakness is weak demand and low utilization (~70%) of existing plants. Due to weak demand corporate’s are not setting any new plants despite increase in public spending by government.

Can NDA govt change this in the next 20 months? Perception is very important in politics. Today Narendra Modi has the image of a leader who is putting 24 hours a day to improve the India’s image and economy. Today Jaggi pointed out that we need a stimulus of 1-1.5 lakh cr to increase demand but remember helping banks (by recapitalizing) can help opposition in making “Suit Buit Sarkaar” again. So what is the other alternative? Simple Cut the Taxes both Direct & Indirect and let the money flow in the system to create demand. With demand inflation will be back and probably INR will depreciate in longer term to help Indian corporate in competing with rest of the world.

Let’s talk Direct tax first.

Last year Arun Jaitley told that we have 37 million Individuals IT filers in India.

Gross Income\Year 2013-14 2014-15 2015-16
0        1,55,501        2,28,627        1,98,216
>0 and <=2,50,000  1,47,75,316  1,44,82,520  1,35,16,945
>2,50,000 and <=  5,00,000      84,14,290  1,15,17,749  1,38,47,402
>5,00,000 and <= 5,50,000        8,67,289      11,94,171      13,78,870
>5,50,000 and <= 10,00,000      31,22,753      41,41,207      51,30,691
>10,00,000 +      15,90,449      20,21,020      24,40,910
Total  2,89,25,598  3,35,85,294  3,65,13,034

Or in other words Distribution look likes:

Gross Income\Distribution 2012 2013 2014
0 0.5% 0.7% 0.5%
>0 and <=2,50,000 51.1% 43.1% 37.0%
>2,50,000 and <=  5,00,000 29.1% 34.3% 37.9%
>5,00,000 and <= 5,50,000 3.0% 3.6% 3.8%
>5,50,000 and <= 10,00,000 10.8% 12.3% 14.1%
>10,00,000 + 5.5% 6.0% 6.7%
Total 100.0% 100.0% 100.0%

From this distribution we can categorize people in 3 different categories:

  1. Lower Middle class (People with Gross Income of <5 lakh)
  2. Middle class (People with Gross Income of 5-10 lakh)
  3. Higher Middle class & Higher class (People with income of >10lakh+)

My proposals are:

  1. Effective 0 tax for people with Gross Income of 5 lakh. This means you can’t claim 1.5 lakh as 80 C deductions. So effectively increasing 4 lakh slab (2.5 lakh+1.5 lakh) to 5 lakh. This is applicable specifically for lower middle class
  2. Creating a tax slab of 10% for 5-7 lakh targeting the middle class
  3. Introducing a new tax free bond of 50K (max) for infrastructure. But here the Interest rate would be 50 bps less to Govt bonds but will still give return of ~9% post tax for Higher Middle class/Higher class.
  4. Removing few exemptions like Medical bill (15000/yr) & Travel allowance (19200/year)

My proposals are tailor made for each category. Let’s see what will be the net effect of these changes:

Lower Middle class: This distribution tells us that almost 37.5% have gross income of less than threshold (2.5 lakh) and hence pay 0 taxes. Next category (2.5 lakh -5 lakh ) we have close to ~1.4 Cr (38%). Remember here we are talking about Gross Salary i.e Income before 80 C deduction of 1.5 Lakh. So effectively this set of people is going to pay tax on max 1.5 lakh (assuming 1 lakh average deduction i.e 2.5+1=3.5 lakh tax free). From this 1.5 lakh govt would be getting something like 10800 cr this year as tax (1.4 Cr people*1.5 lakh *.05*1.03) at 5% tax rate. Additionally govt gives a rebate of 5000 in IT under section 87A  if income is less than 5 lakh, which basically means govt would be getting only 7500 cr from these set of 1.4 Cr IT payers. So if we implement the 1st recommendation we are looking at loss of 7500 Cr to govt.

Let’s move to second category of Middle class:

We have close to ~65 lakh as IT payers in Middle class. Current bucket is 20% for Income b/w 5-10 lakh post 80 c investments. So govt approximately would be getting ~8000 cr as 5% tax from this Middle class IT payers. I am assuming that here people would be using the full 1.5 lakh exemption limit plus some additional benefits like 80D, 80DD, 80E or 80G. Based on these I am assuming average 50000 as tax which will yield ~33000 cr as Income tax.

If we introduce a new slab of 10% for 5-7 lakh than average tax will be reduced to 35000 which means a loss of another 10000 cr to Finance minister.

Increasing 50000 limit of new Infrastructure bond will nullify the effect of removing Medical bill & Transport allowance (34200).

For Higher Middle class & higher class:

This is the class which actually drives the personal IT collection of India. Also these are the people who drive the consumption in India in luxury space. Currently my estimation is that Govt collects 1.4-1.5 lakh cr from this category of people. If we implement all the recommendations than govt has to forego close to 12000 Cr due to new 10% IT rate. Removing exemptions will almost negate the new tax free infra bonds introduction.

So if Narendra Modi accepts these points and introduce them then the Finance department will lose ~30000 CR (7500+10000+12000). This forego revenue will surely effect the fiscal consolidation path taken by Modi govt but current need is to create demand in the economy.

Best way of communicating & achieving is not to wait till Jan 2018 PM should come back on National TV on 20 September (Just before the Festive season of Navratri starts) and announce new IT rates of next year. This will create the immediate spending spree with Middle & Higher class which can take back our growth to 8% in Q3.



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