It is a tax levied on both earned income (wages, salaries, commission) and unearned income (dividends, interest, rents).
Why should income tax be abolished?
No income tax means more spending, more demand, more production and more jobs. In short, in a faster growing economy income tax leads to tax evasion as people don't declare their true income. If there is no income tax there will be no need to evade tax!
No income tax will mean a greater incentive to work, after all, a large chunk of our salary or business profits goes towards payment of taxes plus the utilization of our taxes is largely shrouded in mystery.
Certain habits can be curbed through elective use of the indirect tax weapon, such as very high taxes on fuel guzzling imported cars. Don't we all crave a greener world?
The cost of collecting income tax is higher (more than 0.65% of the revenue collected), than the cost of indirect tax collection.
Income tax is progressive, Indirect tax is regressive
The rich pay more and in turn this money is used to benefit the society, including the weaker sections of society.
If income tax is abolished (both individuals and corporates), the indirect tax machinery will need to work overtime and the tax rates would need to be higher.
The biggest criticism in relation to an indirect tax regime is that it is regressive in nature. You buy, you pay!(i.e. it is same for both rich and poor). On the other hand, sin products like tobacco and imported wines has heavy indirect tax levies. On abolition of income tax, hiking rates on essentials to meet the collections would badly hit the Aam aadmi.
Yet the above measures are not easy to introduce or to implement. Further, even if implemented, it would take time for the new mechanism to fill in the entire gap which total abolition of direct taxes would result in. For example, what extent can tax rates be hiked for luxury items and niche luxury items?
However, steep rates on niche luxury items would further shrink the population which consumes these products, resulting in the tax collection estimate from this mechanism not being met. To bridge the ever widening tax collection gap, there would be a trickle-down, with the tax rates on even essentials rising.
In India, if there is an immediate and complete abolition of income tax, we are likely to see rising prices and a huge dent in consumer and investor confidence. It is true that the ills of black money would be abolished if income tax were abolished, but one cannot throw the baby out with the bathwater.
Perhaps, the regressive nature of indirect taxes can be diluted by
Identifying and imposing a higher tax on luxury items and an even higher tax on niche luxury items.
Introducing a supplementary tax on some goods, such as an imported car or an indigenously manufactured luxury car, taxing a proportion of spends on big fat weddings etc.,
Bringing in real estate within the ambit of indirect tax in a more meaningful manner, such as progressive mechanism of stamp duties (say purchase of large mansions, second homes etc., being subject to a higher percentage of duties).
Introducing estate duties - Countries such as Belgium, Germany and Switzerland have steep estate duties. In Belgium's capital Brussels the rate can be as high as 80% if the inheritance is not from direct/indirect ascendants or descendants.
Can India afford to do away with income tax? Is there any alternative?
It might sound surprising, but there are countries where you do not need to pay income tax (UAE, Qatar, Oman, Kuwait, Cayman Islands, Bahrain, Bermuda, The Bahamas, Saudi Arabia, Brunei Darussalam).
Some of these countries are well known tax havens, while most others have managed to use natural resources to fund government expenses. Can India afford to do away with income taxes?
Clearly, there are legal and constitutional issues involved, as sales and excise taxes on some products are in the domain of state governments. And administration of the new regime would require a huge overall change in the existing system, most importantly the banking system.
Alternate for income tax Expenditure Tax.
The direct taxation from personal expenditures for consumption is one of the oldest yet least tried ideas in the history of taxation.
It has both merits and demerits and deserves a serious thinking, what with the given state of the economy, stubborn inflation and savings rates having fallen significantly in recent years in India.
Expenditure tax
The consumption tax, sometimes referred to as 'spending tax' or 'expenditure tax, is quite like the income tax, with one key difference being that the tax base is expenditure, not income.
The best way to arrive at a person's spending power vis--vis his needs is to look at his day-to-day living expenses. Income tax is an inferior measure of taxable capacity because it does not encompass spending power in other forms and takes no account of differences among individuals as to the need to save.
One major argument put forward against the expenditure tax is that by taking away savings from the tax base, one tends to favour the rich, as they are in a better position to save larger portions of their incomes. This would render the proposition 'inequitable'. It may also lead to greater concentration of wealth in the hands of few. So the rates of an expenditure tax can be made steeply progressive in order to tax the rich heavily.
Another criticism of the consumption base is that it would favour the miser (hoarder) over the spendthrift (spender).
It is argued that only by spending, and not by earning and saving, the individual impose a burden on the rest of the community. In other words, personal consumption drains the resources available to the community for investment and public uses while work and saving add to these resources.
One generally accepted merit of this tax is that it would be highly effective as an anti- inflationary tool. On the other hand, the tax lacks the automatic stabilizing effect of the income tax in periods of recession.
Current facts on income tax in India
In contemporary India, income tax is largely a tax on the middle class salary earner. The poor hardly pays any income tax. The rich have dividends and capital gains as large part of their source of income rather than salaries.
99 per cent of India's tax paying people are being coerced into filing their tax-returns, while they pay miniscule amounts as tax on some pretext or other. The guys who pay up are mostly the salaried class, because they can't evade it, as it gets deducted as TDS.
Case for replacing Income tax by a 'consumption tax' like BTT (Banking Transaction Tax)
Why should only a particular class be forced to pay taxes? It would render great political mileage to the political parties supporting/proposing such a change. People would be enchanted by a proposal that reduces their net tax liabilities from existing 10-20 per cent to a mere 2 per cent!
But then how would the government make up for the loss in tax revenue? If it were to scrap income taxes.
As per 2013-14 Union Budget, personal income tax has been budgeted at Rs.2,47,639 Crore for the current fiscal year.
The total gross tax revenue of the govt. (including the state's share) stands at about Rs.12.4 lakh Crore (budgeted) in the current fiscal. A two per cent Banking Transaction Tax on current banking transaction can potentially generate about Rs.15 lakh Crore - more than compensating for the loss.
The rich and business men have to show their total income, as everything is coming under bank account as there will not be any currency notes (papers). So they will pay more tax than today.
This will encourage the people to do more bank transactions and will gradually finish the black money.