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CHAPTER V INFLATION ADJUSTMENT IN INCOME TAX STRUCTURE

In this chapter, the need of inflation adjustment in Indian income-tax structure, has been

discussed.

The first part

of the chapter examines the effect of inflation on the tax liabilities

of

The

part

second

individuals examines

adjustment schemes.

at the

different various

inflation

possible

rates.

inflation

The third part examines the experience

of other countries on this aspect and last part suggests the measures

to

income-tax

neutralise system.

the

The

impact

study

is

of

inflation

made

on

the

from

the

basis

of

personal income tax rates for the assessment year 1992-93 i.e., the Finance Act. 1991. The effect of inflation on the tax burdens of individuals particularly the fixed income group has heightened interest in these days.

It

is said that the

inflation

not only

reduces the value of income but also raises the tax burdens of many people1.

Here an attempt has been made to examine

the impact of inflation on the tax burdens of individuals. Although the inflation affects all the direct and indirect taxes but the scope of this chapter is limited to personal income tax only. To

assess

the

effect

of

inflation,

before

inflation

and

after inflation tax liabilities are calculated on selected income levels at different inflation rates. 126

Table 5.1 shows

the

effect

of

three

per

cent

inflation

on

the

tax

liabilities of an individual at selected income levels.

The

table reveals that on the income level of Rs.

the

25,000,

tax before inflation is Rs.600, the effective rate of tax is 2.4

per

cent.

After

three

per

cent

inflation,

the

tax

liability increased to Rs.750 with an effective tax rate of 2.91

per

cent.

increased

The

monetary

income

of

the

assessee

just three per cent while his tax

increased by 25 per cent.

is

liability

The effective tax rate is also

increased by 0.51 percentage point. On the

income

levels

Rs.30,000,

increased by 16.87 per cent.

the

tax

liability

is

There are two reasons behind

this increase in tax liability.

First, the monetary income

of the assessee is increased by Rs.900, however there is no change in his real income.

Second, previously only one tax

rate of 20 per cent was applicable on him.

But now, as his

monetary income is increased, the second rate of 30 percent is also applicable on him.

So the assessee is pushed into

high tax tax rate bracket and the tax becomes progressive. The percentage increase in the tax liability on the income levels of Rs.75,000, is 17.73 per cent. in

liability

is,

This high increase

because previously the assessee was not

liable to pay surcharge which is applicable on the income level of above Rs.75,000.

But after

monetary

Rs.75,000

income

crossed

the

inflation as his level,

he

is

also

liable to pay surcharge @ 12 per cent and consequently the tax liability is substantially increased. 127

The inflation has the greatest effect on the tax liability *

at the lowest end of the income scale as transpired from column 6 of table 5.1.

However, the effect of inflation on

effective rates as shown in the column 7 of the table,

is

much more uniform by income classes. Table 5.2 gives the effect of 5 per cent inflation on the tax liabilities of

individuals at selected income

levels.

The table shows that the tax liability at income level of Rs.25,000 is increased by 41.6 per cent when there is only 5 per cent increase in monetary income at that level.

The

increase in tax liability is 28.13 per cent on income level of

Rs. 30,000

Rs.40,000.

and On

13.04

the

per

income

cent

level

on of

income

level

Rs.75,000,

of

the tax

liability is increased by 21.55 per cent and the percentage point increase is 3.69, due to the changes in tax bracket. The effect of inflation on tax burden is decreased to 9.06 per cent on

income

level

of

Rs. 1,00,000

decline on higher income levels.

and

again

shows

The percentage point

increase in effective tax rates is highest at income level of Rs.75,000.

It is because at Rs.75,000 of income, there

is no surcharge,

but

increase in nominal

during

(monetary)

attract 12 per cent surcharge. slab the

inflation

effective tax

rates

period due

income,

to the

the income will

After the Rs.75,000 income show

declining

trend.

The

table reveals that the effect of inflation on tax burdens is not

similar

on

all

income

128

groups.

The major

effect

of

inflation is on the low income groups and less effect on the high income groups. Table 5.3 shows the effect of 7 per cent inflation on the tax burdens at selected income levels. of

Rs .25,000,

inflation,

the

increase

in

On the income level

tax

liability,

due

to

is 58.33 per cent in comparison to 7 per cent

increase in monetary income.

The effect is decreasing up to

the income level of Rs.60,000 and increases at income level of

Rs.75,000.

The

effect,

which

is

25.36

per

cent

at

Rs.75,000 level, decreases to 8.23 per cent at income level of Rs.3,00,000.

The major conclusion that emerges from the

table, is that the effect increases when there is any change in tax brackets due to inflation and if the same rate is applicable even after the

inflation,

the

effect shows

decline. The

effect

on

effective

tax

rate

is

much

uniform

on

different income groups in comparison to the effect on the tax liabilities. Table 5.4 gives the effect of 10 per cent inflation. shows that on the lower income group,

It

say Rs.25,000, there

is an increase of 83.33 per cent in the tax liability while there was only 10 per cent increase in the monetary income and the real income remains constant.

The effect on higher

income group is also significant at this rate of inflation. The effect is 31.09 per cent at income level of Rs.75,000 which

is

reduced

to

11.76

129

per

cent

at

income

level

of

Rs.3,00,000.

The percentage point increase in effective tax

rate varies from 0.76 to 4.5 among different income classes which is very significant. Table

5.5

shows

different

income

the

effect

levels.

of

It

12

can

per be

cent

inflation

visualised

at

from the

table that the tax burden on Rs.25,000 level of income has doubled due to inflation and the effective tax rate also records 1.89 percentage point increase.

The effect on tax

liability at Rs.30,000 level of income is decreased to 67.50 per cent but the effective tax rate is increased to 2.65 percentage point.

The highest effect is on the income level

of Rs.75,000 where the effective tax rate has increased to 4.8 percentage point. and at the liability increase

After that the effect shows declines

income level is

in

14.11

of Rs. 3,00,000 the effect on tax

per

effective

cent

tax

rate

and is

the

percentage

0.89.

The

point

effect

of

inflation at 12 per cent rate is higher in comparison to that at the lower rates. In table 5.6, the effect of 15 per cent inflation has been analysed.

Columns 6 and 7 of the table reveal

that the

effect on this rate of inflation is more than that was in the previous table.

On the income

level

of Rs.

25,000,

the effect on tax liability has increased to 125 per cent which was 100 per cent at 12 per cent inflation rate.. The increase of 125 per cent in tax liability in consequent upon merely 15 per cent very serious.

increase

in monetary

income

is really

The effect on the income level of Rs. 75,000 130

is 40.64 per cent with an increase in the effective tax rate by 5.23 percentage point.

The effect on Rs. 3,00,000 income

level is 17.63 per cent, although it is

less

than

that in

the lower income group but still it is very significant and is followed by 1.09 percentage point increase in effective tax rate. Table 5.7 demonstrates the effect of 17 per cent inflation on the tax burden of an income

levels.

It

shows

level,

say Rs.

25000,

is

that

individual

the

effect

on

at selected low

income

141.67 per cent increase in tax

liability due to 2.56 percentage point increase in effective tax rate. 60,000 75.000,

The effect is decreasing upto income level of Rs.

and

again

increases

at

income

level

of, Rs.

due to the change in tax bracket resulted by the

surcharge. 3.00.

than

000,

Even

on

the

higher

the tax liability is

income

group,

say Rs.

increased by about 20 per

cent followed by 1.21 percentage point increase in effective tax rate. Combined results of the above seven tables are : 1.

The inflation causes significant increases in the

tax burdens of individuals. is

The increase in tax burden

several times more than the

income.

increase

in monetary

It causes a person to pay a different amount

of tax than he would pay on the same real income in a non-inflationary period. 2.

Inflation

causes

significant

increase

in

the

effective rate of the individual income tax. 3.

The

inflation alters 131

the

structure of

income tax

rates, the real width of tax brackets and real value of all exemptions,

deductions and allowances fixed in

nominal terms. 4.

The effect of inflation on the tax liabilities of

individual incomes.

is The

not

uniform on different

levels

of

low income group is affected more and

comparatively less effects

are recorded on high income

group. 5. When the rates of inflation are relatively low, say upto

5

per

cent,

its

effects

on

individual

tax

liabilities is limited, but when the rate of inflation goes up in two digits, it starts to hunt the taxpayers. 6.

Inflation generates

fictitious

increase

in

income

and pushes the taxpayers into higher tax-rate slab and the

tax

becomes

more

progressive.

Therefore,

a

taxpayer will find himself climbing the tax ladder at the progressive rates,

even when his real

income has

not changed. 7.

The

inflation

reduces

the

real

value

of

all

exemptions, deductions and allowances fixed in nominal (monetary)

terms.

When

a

person's

money

income

increases by the amount just enough or not enough even to offset decreases.

inflation, But

as

his his

real

income

is constant or

money

income

increases,

the

person is thrown into higher tax brackets and the fixed

132

rupee

deductions,

fraction

of

income

exemptions and

hence

eliminate subject

to

a

lesser

tax.

The

result is that the tax liabilities increase faster than inflation and take away an increasing percentage of the real income of the taxpayers. 8.

The salaried persons

are

inflation because of a fixed

affected more

by the

'standard deduction'

for

them in lieu of allowing expenditure in computing the taxable income and the inflation reduces the real value of

'standard

deduction'

which

is

fixed

in

monetary ‘

terms.2 In India personal incomes above certain exempted level are taxed with progressive rates.

These rates apply to income

brackets specified in monetary terms in the taxation law. Many exemptions and deductions are also fixed values. money

In inflationary period income

falling.

is

rising,

real

in current

it may happen that while income may

actually be

Some persons, who because of their low income in

relation to 'minimum taxable limit' and due to deductions to which they are entitled, have previously been exempted from paying tax, may now be liable to pay tax.

Others who were

already taxed may become subject to higher average rate of tax even when their real income has not been changed. If the income-tax were proportional i.e.,

if there were no

progressive rate and no exemption or if the exemptions were a fixed proportion of income,

133

the average tax rates would

not be affected by inflation3 and therefore, there would be no increase in the tax burdens. In

the light of foregoing discussion, it seems that it has

become necessary to protect the income-tax system from-the effects of inflation. In

this

respect

introduce

we

have

periodic

two

basic

adjustment

or

alternatives; introduce

we

can

permanent

automatic adjustment schemes without leaving the taxpayers on the mercy of the Finance Minister. To permanently overcome this problem, we need an 'inflation proof tax system'.

An inflation free tax system is one that

imposes the same real tax burden on a particular amount of real

'before

inflation.

tax

income'

regardless

of

the

rate

of

For given 'before tax income' the real tax base

and the rate structure must be unaffected by inflation.,

If

the tax system were truly inflation-proof, neither the tax burden

nor

the

distribution

taxpayers would be affected by

of

that

burden

inflation.

among

the

Although,

the

existence of such a system is very difficult, however, much can be done to neutralize the impact of inflation from the tax system particularly the income-tax.

DIFFERENT INFLATION ADJUSTMENT SCHEMES There are two conceptually distinct forms of adjustment

of

income

tax

system.4

The

first

inflation type

of

adjustment, which is quite complicated, is the adjustment of 134

the measurement of income from business and capital.

If the

measurement of income is not protected from the effects of inflation,

taxable

overstated.

income

will

be

either

understated

or

Inflation adjustment is thus needed in order to

provide both equity and neutrality.

Second and the easier

alternative is the adjustment of inflation in the income tax structure.

This adjustment is needed in order to prevent

bracket creep, the tendency for inflation to cause taxpayers with a given real income to pay at increasing effective tax rates. In the second system

of

'inflation adjustment',

three

different schemes have been proposed by the experts to neutralize inflationary effect. Under the first scheme,

all statutory tax rates would be

lowered proportionately to eliminate the increase in the tax burden due to inflation.

This scheme can prevent the growth

in the effective tax rates,

but it would not prevent the

unintended redistribution of tax burdens For example,

a person who was not subject to income tax

because of his inflation, statutory

low income but

would rates

remain were

By this

is

subject

liable

to pay

reduced

and

administrative burden would authority.

among taxpayers.

scheme,

remain the

on

high

to

tax

tax even

the the

135

if

the

uhdesired tax

income

collection group would

benefit from progressively lower marginal tax rates. scheme is not free from defects. 5

due to

So the

The second scheme would exempt that income of an individual which is attributed by inflation.

For example,

cost -of-

living adjustments in salaries(D.A.) would automatically be exempt from tax and other assessees can be allowed an 'inflation deduction' inflation.

that would depend on the rate of

This inflation deduction would be calculated by

multiplying the gross income of the assessees by the rate of inflation. income

This scheme is unsatisfactory because taxable

would remain

constant

decline in real terms,

in

nominal

terms

but

would

consequently real tax payments and

the average effective tax rate would also fall.6 Table

5.8

shows

the

effect

of

12

per

cent

inflation

adjustment under this scheme and reveals that the effective tax rate has been decreased by 1.87 percentage point. This scheme stops the growth of revenue and not advisable because the revenue from income tax should also be increased atleast equal to the rate of inflation.

This scheme was adopted by

Israel but abolished in July 1975 and replaced by another scheme discussed below. The Third scheme indexes the whole Income Tax structure with the prices level,

so that tax rates apply to real incomes

rather than to nominal income resulted by inflation. the brackets,

exemptions,

provisions expressed in increased inflation.7

annually

at

All

deductions and all the other

fixed monetary values would be a

rate

equal

to

the

rate, of

This scheme has been introduced in a number of

136

countries 8 As

already

advisable.

discussed,

first

two

schemes

are

not

So the third scheme is examined in 12 per

inflation period. salaried

the

The

results

of

cent

indexing applied

to a

person with an annual income of Rs.70,000 at 1991

level, assuming his income increases at the rate just enough to offset the effect of inflation, are shown in table 5.10. Before inflation the assessee would pay a tax of Rs.

10,800

on annual income of Rs. 70,000 forming an effective tax rate of 15.43 per cent.

Inflation of 12 per cent increases the

assessee's

to Rs.

income

inflation adjustment, Rs.

14,160.

78,400.

Unless

there

is

an

tax would increase by 31 percent to

If the Income tax structure is

would increase only by 12 per cent to Rs.

indexed,

tax

12,096 and thus

there would be no increase in the effective tax rate. Table

5.11

shows the

bracket schedule. taxable The

limit'

second

12

By 12

would be

rate

slab

per

cent

inflation

per cent increased

would

be

adjusted tax

inflation the from

'minimum

22.000 to 24,640.

increased

from

30,000

to

33,600 and the third slab would be increased from 50,000 to 56.000. the

The maximum marginal rate will now be applicable on

income

1.00.

above Rs.

1,12,000

which was

on

above Rs.

000 previously and the 12 per cent surcharge would be

on the income above Rs. previously.

84,000

instead of Rs.

75,000,

The 'standard deduction' ceiling would increase

from 12,000 to 13,440.

137

Table 5.12 gives the effect of a 12 per cent inflation on the tax liability of a salaried person at selected levels of income.

Inflation has the highest effect on tax liability

at the lower levels of the income as column viii of table 5.12.

is transpired

from

However, the effect of inflation

on effective rates of tax and on income after tax, as shown in columns ix and x of table 5.12, different income levels.

is almost uniform at

If the indexation is not done at

the inflation rate, the burden of tax will be comparatively higher at lower income levels.

As the income increases, the

percentage increase in tax goes on reducing as is evident from column ix of table 5.12. The table also reveals

(column vii)

that if indexation is

done at all levels of income at the inflation rate the tax revenue will be increase but the effective tax rate will remain

the

same

and

it

will

be

beneficial

both

to

the

assessees and the exchequer. It is wrongly believed that the adoption of

•'automatic

inflation adjustment scheme" can stop the annual increase in the income tax revenue.

Tables 5.10 and 5.12 clearly shows

that even after inflation adjustment, there

is an increase

in tax revenue,equal to the rate of inflation. The operational question now is, India

should

enact

whether the government of

legislation

that

will

permit

the

automatic adjustment of inflation in income-tax law ? If so, which scheme is suitable in Indian circumstances

138

?

Before answering this question,

we

should

examine

the

experience of the countries that have ' inflation adjustment scheme' in their income tax laws.

THE FOREIGN EXPERIENCE India is one of the few countries of the world which, have not adjusted the

taxation

system

for

inflation.

Others

include Canada,9 the United Kingdom,9 France,9 West Germany and many others who have taken measures to adjust for the effects of price increase on income-tax system.10 countries Israel,

including

Japan,

Latin

American

countries,

Several

Indonesia,

Korea and some countries of Eastern Europe

have recognised the effects of inflation on business income also.10

The inflation adjustment scheme does not resemble

all over the world.

Some countries have rules that allow

for full adjustment for inflation on an annual others

make

annual

adjustment

only

for

basis and

part

of

the

inflationary change. The Canadian scheme indexes the whole nominal structure of the personal income tax annually.11

The adjustment is based

on the increase in the consumer price index of the previous year.

Argentina has also an 'automatic indexation scheme'

for exemptions,

deductions and the tax

brackets.

The

indexation for exemptions was intended to keep off the tax rolls of those taxpayers who,

because of their low income,

should have not been subjected to any income taxation.12

139

The Uruguayan scheme was almost one.

identical to the Canadian

The income tax structure was adjusted fully, annually

and automatically for the change in cost of living. 1974,

But in

the government abolished the individual income tax.13

Obviously, without a tax, there can be no indexing.

On the

recommendation of the Mathews Committee on personal income tax,

Australia also

introduced an automatic indexation in

the personal income tax structure on the basis of changes in the consumer price index.14 rates,

income

brackets

The indexation applies to tax and

most

of

the

exemptions,

deductions and allowances, only at the time of increase in prices but not for decline in prices. Upto 1975,

Israel had a scheme that provided the cost-of-

living adjustment component of salary exempted from personal taxation.

It was not an automatic indexation.

There was

also a provision for adjusting the profits for inflation. In 1975, this scheme was replaced by another scheme similar to the Canadian scheme.15

Peru

has a partial adjustment

scheme

this

scheme,

since

1973.

In

exemptions

and

deductions are adjusted by an index related to the consumer price index. brackets.

There is no automatic adjustments for the tax

1 fi

The indexation in Sweden was adopted in 1977, discussions

in

parliament.

Indexation

coefficients fixed by the national

after heated is

tax board.

based But

on in

Sweden, there is only a partial indexation as only brackets

140

are indexed and not the exemptions and the deductions which are

fixed

in

monetary

terms.

Therefore,

the

effect

of

inflation on personal income tax structure is not completely removed.17

The United Kingdom chose to index the exemptions

and deductions

but

not

the

brackets,

since

indexation scheme is based on retail price

1977.

index

The

for the

previous year. ° In France,

partial system of

indexing

is used.19

adjustments may occur only when the rate of exceeds a particular limit.

The

inflation

No adjustment is required if

inflation remains below five per cent.

The authorities may

adjust

The

various

brackets

differently.

based on consumer price index. deal with creeping inflation. system of indexing.

indexation

is

The France approach fails to Luxembourg also has a partial

The scheme provides a revision of the

nominal tax structure in proportion to the variation in the consumer price index. Netherland also has an inflation adjustment system in the income tax law.21 percent

of

the

But the adjustment is limited to eight

rise

in

the

relevant

index

and

only

for

taxable incomes subject to marginal income tax rates of 49 per cent and lower.

The Danish scheme of indexing has gone

beyond inflation adjustment ,22 The personal deduction and brackets are now related to changes in the index for the hourly

earnings

of

an

industrial

worker.

This

index

reflects changes not only in prices but also in real wages. The scheme was motivated by the belief that 141

indexing

for

**

price changes alone does not prevent sharp increases in tax burden

on

the

middle

income

groups

brought

about

by

interaction between economic growth and a very progressive structure. Chile

has

developed

the

most

comprehensive

correction of income tax for inflation.23 Chilean government adjusts the brackets.

The

income-tax

system

Since 1954,

exemptions

and

of the

the tax

is adjusted on the basis of a

basic tax unit that is calculated by the tax authorities on the basis of the rate of inflation.

The Brazilian income-

tax law provides the inflation adjustment if the inflation exceeds 10 per cent in a given year or 15 per cent in three years.24

Actually,

in

Brazil,

indexing has

been used to

achieve an objective of redistribution of tax burden and not for the neutralization of inflation effect.25

Iceland has had a provision in its income tax law for the indexation of nominal structure of the income tax.25

The

scheme adjusts

and

all

the

brackets,

personal

allowances

certain other deductions on the basis of an index that would reflect

increases

Colombia

has

in prices

taken

as

important

inflation-proof tax system.27

well

as

steps

in to

real

incomes.

establish

an

The system provides for

annual adjustment of personal exemptions, bracket limit and other

magnitudes

fixed

in

nominal

amounts.

Complete

inflation adjustment is also available for capital gains and only

real

capital

gains

142

are

legally

taxable.

The

inflationary component of interest income is excluded from the tax base of

individuals.

Inflation adjustment of

business income is also m practice. °

Colombia has one of

the best income tax structure from the inflation point of view. The review of various countries shows that Canada, Uruguay, Israel, Denmark, Chile and Colombia and fully, annually and automatic

indexation scheme.

are Argentina,

Peru,

Sweden,

Other note-worthy countries U.K.,

France,

Luxembourg and

the Netherland which have the partial systems of indexing. In

some

other

countries

the

indexing

mechanisms

are

not

directly related to inflation but to other indexes which are based on earnings of industrial workers, per capita income.

minimum wages or

But in most of the countries, either the

consumer price index or the wholesale price index is used. Three major conclusions can be drawn from the experience of various countries.

First, indexing the rate structure does

not present serious administrative

problems.

The tax

authorities can easily produce new tables and the taxpayers can easily compute their tax tables.

Second,

liabilities with the hew

indexing comes

in many

forms;

increases in the nominal structure are most popular. the search for an index,

simple Third

responsive to the actual rather

than to past rates of inflation,

continues in most of the

countries.29

Now, the question is, like many other nations, should India

143

adopt the 'automatic inflation adjustment scheme' or should it be left to ad hoc remedy by periodic revisions? In

yesteryears,

inflation. a

India

has

experienced

high

rate

of

The increase in prices has come on the top with

16 per cent rise during the

1991.30

very

This means,

12

months ending October,

statistically, that there has been an

increase of over 25 per cent m the WPI

m two years. A

When the rate of inflation was relatively low, its effect on income taxpayers was

less.

But

now when the

inflation has gone up in two digits, the income taxpayers.32

rate

of

It has started hunting

the inflation causes a person to

pay much more amount of tax than he would pay on the same real income in a non-inflationary period.

So the inflation

adjustment system

to

is urgently

required

objective of redistribution of

achieve

tax burden and

the

for the

neutralization of inflation effect. Besides the exemptions, deductions and the rate structure, there are many other provisions in our income-tax law, which are fixed in nominal terms.33 the

provisions

superfluous

The inflation has either made or

inconsistent

objectives for which they were designed.

with

the

In various tax

seminars, tax journals and meetings organised by the chamber of commerce,

the demand that is most vociferously made

relates to the revision of these provisions which are fixed in monetary values.34 But the revision in monetary ceiling will

be

an

ad

hoc

solution

'inflation proof tax system' 144

of

the

problem.

is adopted,

Unless

an

the problem will

arise again and again. India has an unstable income-tax system.

The frequent

changes in the tax law is a sign of immature tax system.

It

generates inevitable strains on the planning machinery and also causes heavy expenditure for the government.

The

taxpayers find themselves in uncertainty while planning their tax affairs.

So, a stable tax system is the need of

the hour and the automatic adjustment of inflation can play a great role to meet the goal. Today the problem of evasion of income tax is on its peak. It is argued that taxpayers resentment against being pushed by inflation into higher marginal tax rates and increase in average effective tax rates, even when their real income has not changed, has led to lower degrees of tax compliance.35 The reduction in the real value of exemption limit due to inflation,

led to a significant increase in the number of

salaried taxpayers36 and this has placed inevitable strains on the tax administration.

The result is an increase in tax

evasion. Ever since,

the Rao Government came into power,

India has

taken a bold and determined move towards globalisation of Indian economy.37 existing

tax

Instead of mere tinkering with the

system,

the

Finance

Minister

took

up

the

historic task of a adopting bold and innovative structural reforms in the economy as a whole. and

fundamental

restructuring 145

of

It included widespread the

direct

and

indirect

taxes

O o

as well. °

The

government

has

also

ensured

to

introduce major changes in tax structure to put it on the line with those countries

have

in other countries.39

introduced

their tax system,

inflation

As the

adjustment

several

scheme

in

steps should also be taken by India to

meet the demand of globalisation of the tax structure. Concluding the chapter, it is suggested that the 'automatic inflation adjustment scheme' India.40

should also be introduced

The whole Income tax Structure should be indexed

in line with that of in Canada. the

income

in

earning

year

indexing.

146

may

The consumer price index of be

adopted

as

the

base

of

NOTES AND REFERENCES

1.

Indian Institute of Management Ahmedabad: Inflation and Tax Reforms in Industrial Taxation, A discussion paper available with the Ministry of Finance Library, Govt, of India at No.336-292 G. 95 I.

2.

Chapter 3 Table 3.2

3.

Vito Tanzi: Inflation and the personal Income Tax, IMF, Cambridge University Press, Cambridge.

4.

Boskin (Michael J) and Charles (E Me Lure): World Tax Reform, International Centre for Economic Grpwth, ICS press San Francisco, California, 1990. Executive Summary P.8.

5.

Chahal S.S. and Raj Singh " Inflation adjustment in Income Tax Structure: International Experience; Case for India, paper presented at 46th All India Commerce conference. Dec. 1992.

6.

Ibid.

7.

Raj Singh: Inflation adjustment in Income Financial Express. June 24, 1991. p.7.

8.

Ibid.

9.

IMF, Taxation, Inflation and Interest Rates, Washington DC. p.12-13.

10.

Aaron, H.J. Inflation D.C. 1976.

11.

IMF Taxation, Inflation Washington D.C. p.12-13.

12.

Vito Tanzi, Ibid p.26. and Financial Times (London) Nov. 1974 p.12.

13.

Vito Tanzi. Ibid p.27.

14.

Milton Friedman: "Monetary Corrections, American Enterprises Institute, Washington D.C. AEI 1974 and Bulletin for International Fiscal Documentation, An Official Journal of the International Fiscal Association, 1992 volume no.7.

15.

Vito Tanzi, Ibid p.33.

16.

Ibid p.30.

147

Tax

Law,

1984.

and the Income Tax, Washington and

Interest

rates

1984

17.

IMF, Taxation, Inflation and Taxation rates, Washington D.C. p.13. and Vinto Tanzi Ibid p.29.

18.

IMF Ibid p.13 and Vinto Tanzi Ibid P.29.

19. 20.

Vito Tanzi Ibid p.30. Ibid p.31

21.

Mongia, J.N., Tax Pattern around Enterprise, New Delhi 1984 p.320.

22.

Aaron A. Henry, Inflation and Income Tax, D.C. Brooking Institute, 1976 p.66.

23.

Boskin (Michael) and Mclure (Charles) Ibid p.205.

24.

M. Eshaq Nadiri "Indexation, the Brazilian Experience" National Bureau of Economic Research, Occasional Papers vol.4. No.1 (winter 1977)

25.

Ana Lucia Goncalves Soares: "Brazil Tax Reform", Inti. Fiscal Bulletin Nov. 1992. p.556.

26.

Vito Tanzi, Ibid p.39-40.

27.

Baskin (Michael) and Mclure (Charles) Ibid p.205-225.

28.

Ibid.

29.

Edward F. Denison "Price Series for Indexing the Income Tax System" in Aaron ed. "Inflation and the income tax" p.248.

30.

Hindustan Times, Dec.1, 1992.

31.

Ibid.

32.

Raj Singh: "Inflation Adjustment in Financial Express, Jun.24, 1991 p.7.

33.

For example; Maintenance of Account (Sec. 44AA (2) (i) and (ii), Auditing of Accounts (Sec. 44 AB), Valuations of perquisites in respect of car, domestic servants etc.

34.

Quoted by T.N. Pandey "Income Tax revision for entertainment expenditure" Fin. Exp. June 3, 1991, p.7.

35.

Chahal, S.S. & Raj Singh, Inflation adjustment in Income Tax structure: International Experience: Case for India, paper presented at 46th All India Commerce Conference, Dec.1992.

36.

Based

on

the

the

globe.

1984.

Neera

Washington

Editorial" The Inflection puzzle,

Data 148

given

in

All

Income

India

Tax Law,

Income

Tax

Statistics. 37.

Vena, S.K. Reorientation of Direct Taxes Administration to meet the demand of Globalisation, paper presented at International Tax Conference Nov. 67, 1992, New Delhi.

38.

Dr. Manmohan Singh, A major tax reform within a year "in the Economic Times, Sept. 17, 1992.

39.

R.N. Lakhotia, Point of view, on July 4, 1991 supporting the article "Inflation adjustment in Income Tax Law" by Raj Singh on Jun. 24, 1991 in Financial Express.

149

TABLE : 5.1

Effect of 3 per cent inflation on the tax liabilities.of an Individual at selected income level (Fin. Act. 1991).

Income before inflation

Tax before inflation

(Amt in Rs)

Amt.

Tax after 3 per inflation

Effective

Rate

Amt.

per cent

per cent (1)

SOURCE

Effective

(5)

Rate

Effect

of

Percentage increase in tax liability (6)

inflation

Percentage increase in eff.tax rate (7)

(2)

(3)

25,000

600

2.40

750

2.91

25.00

0.51

30,000

1600

5.33

1870

6.10

16.87

0.77

40,000

4600

11.50

4960

12.04

7.83

0.54

50,000

7600

15.20

8200

15.92

7.89

0.72

60,000

11600

19.33

12320

19.94

7.20

0.61

75,000

17600

23.47

20720

26.82

17.73

3.35

1,00,000

30912

30.91

32592

31.64

5.43

0.73

1,50,000

58912

39.27

61432

39.76

4.28

0.49

2,00,000

86912

43.46

90272

43.82

2.72

0.36

2,50,000

114912

45.96

119112

46.26

3.65

0.30

3,00,000

142912

47.64

147952

47.88

3.53

0.24

:

Developed

by Researcher

(4)

cent

from the Finance Act 1991.

150

Table -5.2

Effect of 5 per cent inflation on the tax liabilities of an individual at selected Income leve (Fin. Act. 1991)

Income before inflation

Tax before inflation

(Amt

Amt.

in Rs)

Tax after 3 per cent inflation

Effective

Rate

Amt.

per cent (1)

(2)

(3)

25,000

600

2.40

30,000

1600

40,000

Effective per cent

(4)

Rate

Effect

of

Percentage increase in tax liability

inflation

Percentage increase in eff.tax rate (7)

(5)

(6)

850

3.24

41.67

0.8

5.33

2050

6.51

28.13

1.18

4600

11.50

5200

12.38

13.04

0.88

50,000

7600

15.20

8600

16.38

13.16

1.18

60,000

11600

19.33

12800

20.32

10.34

0.99

75,000

17600

23.47

21392

27.16

21.55

3.69

1,00,000

30912

30.91

33712

32.11

9.06

1.20

1,50,000

58912

39.27

63112

40.07

7.13

0.80

2,00,000

86912

43.46

92512

44.05

6.44

0.59

2,50,000

114912

45.96

121912

46.44

6.09

0.48

3,00,000

142912

47.64

151312

48.04

5.88

0.40

SOURCE

:

Developed

by Researcher

from the Finance

151

Act 1991.

Table -5.3

Effect of 7 per cent inflation on the tax liabilities of an individual at selected Income level (Fin. Act. 1991)

Income before inflation

Tax before inflation

(Amt in Rs)

Amt.

(1)

SOURCE

Effective per cent

Rate

Tax after 3 per inflation

cent

Effective per cent

Rate

Amt.

of

Percentage increase in tax liability (6)

inflation

Percentage increase in eff.tax rate (7)

(2)

(3)

25,000

600

2.40

950

3.55

58.33

1.15

30,000

1600

5.33

2230

6.95

39.38

1.62

40,000

4600

11.50

5440

12.71

18.26

1.01

50,000

7600

15.20

9000

16.82

18.42

1.62

60,000

11600

19.33

13280

20.69

14.48

1.36

75,000

17600

23.47

22064

27.49

25.36

4.02

1,00,000

30912

30.91

34832

32.55

12.68

1.64

1,50,000

58912

39.27

64792

40.37

9.98

1.11

2,00,000

86912

43.46

94752

44.28

9.02

0.82

2,50,000

114912

45.96

124712

46.62

8.5

0.66

3,00,000

142912

47.64

154672

48.18

8.23

0.54

:

Developed

by Researcher

(4)

(5)

Effect

from the Finance Act 1991.

152

Table £ 5.4

Effect of 10 per cent inflation on the tax liabilities of an Individual at selected income level (Fin.

Act. 1991).

Income before inflation

Tax before inflation

(Amt

Amt.

in Rs)

Tax after 3 per inflation

Effective

Rate

Amt.

per cent (1)

SOURCE

Effective per cent (5)

Rate

Effect

of

Percentage

inflation

Percentage

increase in increase in tax liability eff.tax rate (6) (7)

(2)

(3)

25,000

600

2.40

1100

4.00

30,000

1600

5.33

2500

7.58

56.25

2.25

40,000

4600

11.50

5800

13.18

26.09

1.68

50,000

7600

15.20

9600

17.45

26.32

2.25

60,000

11600

19.33

14000

21.21

20.69

1.88

75,000

17600

23.47

23072

27.97

31.09

4.5

1,00,000

30912

30.91

36512

33.19

18.12

2.28

1,50,000

58912

39.27

67312

40.80

14.26

1.53

2,00,000

86912

43.46

98112

44.60

12.89

1.14

2,50,000

114912

45.96

128912

46.88

12.18

0.92

3,00,000

142912

47.64

159712

48.40

11.76

0.76

:

Developed

by Researcher

(4)

cent

from the Finance Act 1991.

153

83.33

1.6

Table : 5.5

Effect of 12 per cent inflation on the tax liabilities of an individual at selected Income level (Fin. Act. 1991)

Income before inflation

Tax before inflation

(Amt

Amt.

in Rs)

Effective

Rate

Tax after 3 per inflation

cent

Effective

Rate

Amt.

per cent

per cent

SOURCE

(5)

of

Percentage increase in tax liability

Percentage increase In eff.tax rate (7)

(3)

25,000

600

2.40

1200

4.29

100.00

1.89

30,000

1600

5.33

2680

7.98

67.50

2.65

40,000

4600

11.50

6040

13.48

31.30

1.98

50,000

7600

15.20

10000

17.86

31.58

2.66

60,000

11600

19.33

14480

21.55

24.83

2.22

75,000

17600

23.47

23744

28.27

34.91

4.80

1,00,000

30912

30.91

37632

33.60

21.74

2.69

1,50,000

58912

39.27

68992

41.07

17.11

1.80

2,00,000

86912

43.46

100352

44.80

15.46

1.34

2,50,000

114912

45.96

131712

47.04

14.62

1.08

3,00,000

142912

47.64

163072

48.53

14.11

0.89

:

Developed

by Researcher

from the Finance

154

Act 1991.

(6)

inflation

(2)

(1)

(4)

Effect

Table - 5.6

Effect of 15 per cent inflation on the tax liabilities of an individual at selected income level (Fin. Act. 1991)

Income before inflation

Tax before inflation

(Amt in Rs.)

Amt.

Effective

Rate

Tax after 3 per inflation

cent

Effective per cent

Rate

Amt.

per cent

SOURCE

of

Percentage increase in tax liability (6)

inflation

Percentage increase in eff.tax rate (7)

(2)

(3)

25,000

600

2.40

1350

4.70

125.00

2.3

30,000

1600

5.33

2950

8.55

84.38

3.22

60,000

4600

11.50

6400

13.91

39.13

2.41

50,000

7600

15.20

10600

18.43

39.47

3.23

60,000

11600

19.33

15200

22.03

31.03

2.70

75,000

17600

23.47

24752

28.70

40.64

5.23

1,00,000

30912

30.91

39312

34.18

27.17

3.27

1,50,000

58912

39.27

71512

41.46

21.39

2.19

2,00,000

86912

43.46

103712

45.09

19.33

1.63

2,50,000

114912

45.96

135912

47.27

18.27

1.31

3,00,000

142912

47.64

168112

48.73

17.63

1.09

(1)

:

Developed

by Researcher

(4)

(5)

Effect

from the Finance Act 1991.

155

Table - 5.7

Effect of 17 per cent inflation on the tax liabilities of an individual at selected income level (Fin. Act. 1991)

Income before inflation

(Amt

in Rs.)

Amt.

Tax after 3 per inflation

Effective per cent

Rate

Amt.

Effective per cent

cent

Rate

Effect

of

inflation

Percentage Percentage increase in increase in tax liability eff.tax rate (7) (6)

(2)

(3)

25,000

600

2.40

1450

4.96

141.67

2.56

30,000

1600

5.33

3130

8.92

95.63

3.59

40,000

4600

11.50

6640

14.19

44.35

2.69

50,000

7600

15.20

11000

18.80

44.74

3.60

60,000

11600

19.33

15680

22.34

35.17

3.01

75,000

17600

23.47

25424

28.97

44.45

5.5

1,00,000

30912

30.91

40432

34.56

30.80

3.65

1,50,000

58912

39.27

73192

41.70

24.24

2.43

2,00,000

86912

43.46

105952

45.28

21.91

1.82

2,50,000

114912

45.96

138712

47.42

20.71

1.46

3,00,000

142912

47.64

171472

48.85

19.98

1.21

(1)

SOURCE

Tax before inflation

:

Developed

by Researcher

(4)

from the Finance

156

(5)

Act 1991.

Table -5.8

12 per cent inflation adjustment on the tax liabilities of a person with an Annual Income of Rs 55,000, 1991.

1991 Level

Item

No Adjustment For Inflation Rs.

After Adjustment for Inflation Rs.

55,000

61,600

61,600

22,000

22,000

22,000

33,000

39,600

39,600

Rs.

Income

Less minimum taxable

limit

Less Inflation deduction 12X of Gross Income

Taxable

Income

Tax liability

Effective

SOURCE

:

tax rate

Developed

by Researcher

1991 Level plus 12 % inflation

6,600

-

-

33,000

39,600

33,000

9,600

12,240

9,600

17.45%

19.87%

15.58%

from the Finance Act 1991.

157

Table - 5.9

Countries that Adjusting Income-Tax System for Inflation

Country

Year of Indexing introduced

Argentina Australia Austria Brazil Belgium Bolivia Canada Colombia Chile Denmark France Iceland Indonesia Israel Italy Japan Korea Luxembourg Mexico Netherland Peru Sweden Spain United Kingdom Uruguay

Index Used

Consumer Price Index Consumer Price Index Government Coefficients Minimum Wages or Consumer Price Index Appraisal, within specified limits Depreciation of currency Consumer Price Index Consumer Price Index Consumer Price Index Government Coefficients Consumer Price Index Change in nominal income Indexes of prices Consumer Price Index Government Coefficient Wholesale Price Index Wholesale Price Index Consumer Price Index Appraisal, within specified limit Government Coefficient Consumer Price Index Government Coefficients Government Coefficient Retail Price Index Consumer Price Index

1972 1976 1948 1961 1947 1972 1974 1960 1954 1970 1969 1966 1971 1975 1946 1950 1958 1968 1954 1971 1973 1977 1961 1977 1968

SOURCE : Canadian Tax Foundation (Toronto Annual Publication), OECD, The Adjustment of Personal Income-tax System for inflation Paris 1975, Ministerio Da Fazenda, Anuario Economic-Fiscal (1970) National Economic Instiute of Iceland.

158

Table - 5.10

Effect of 12 per cent inflation on the Tax Income of Rs. 70,000, 1991.

1liabilities of a salaried person with an Annual

1991 Level

Item

1991 Level plus 12 % inflation No Adjustment For inflation Rs. b

After Adjustment for Inflation Rs.

70,000

78,400

78,400

22,000

22,000

24,640

Less Standard deduction

12,000

12,000

13,440

Taxable

36,000

44,400

40,320

Tax liability

10,800

14,160

12,096

Effective

15.43%

18.06%

15.43%

Rs. a

Income Less minimum taxable

SOURCE 1991

Income

tax rate

: Developed tax

limit

law.

C,

by Researcher calculated

a,,b calculated

from

the

adjusted

from provisions rate

schedule

c

of the as

in

table 5.11.

M

159

Table - 5.11

The before inflation rate schedule and inflation-adjusted rate schedule for the relevant brackets for Individual Assessees (Inflation rate 12 per cent).

Before Inflation Rate Schedule

Inflation Adjusted Rate Schedule (b)

(a) Income Slab Amt. Rs.

Rate X

Income Slab Amt. Rs.

Rate X

Below 22,000

Nil

8elow 24,640

Nil

22,000 to 30,000

20

24,640 to 33,640

20

30,000 to 50,000

30

33,640 to 56,000

30

50,000 to 1,00,000

40

56,000 to 1,12,000

40

above 1,00,000

50

above 1,12,000

50

Surcharge above 75,000

12

Surcharge above 84,000

12

SOURCE : a. Finance Act 1991. b. Developed by Researcher.

NOTE : Rate Schedule given in this table is just to illustrate the inflation adjustment scheme and not a Suggested Rate Schedule.

*

160

Table i 5.12

Effect of 12 per cent inflation on the tax liabilities of a salaried person at selected Income levels, 1991

Tax after 12 per cent Inflation

Income before

Tax before Inflation

Inflation

Amt .

Rs.

Rs.

Per cent

Rs.

I

II

III

IV

Effective Rate

No indexing Amt.

With indexina

Effective Amt. Rate per

Rs.

V

VI

Effective Rate per VII

Effect of not indexing Percentage Percentage Percentage Increase point inc* reduction in tax crease in in income Eff. Rate after tax VIII

IX

X

36000

400

1.11

1264

3.13

448

1.11

182.14

2.02

2.05

40000

1200

3.00

2440

5.45

1344

3.00

81.55

2.45

2.52

50000

4000

8.00

5800

10.36

4480

8.00

29.46

2.36

2.56

60000

7000

11.67

9680

14.40

7840

11.67

23.47

2.73

3.10

75000

12800

17.07

18368

21.87

14336

17.07

28.13

4.80

100000

25536

25.54

30912

27.60 28600

25.54

8.08

2.06

2.77

150000

52192

34.79

62272

37.07 58455

34.79

6.53

2.28

3.48

200000

80192

40.10

93632

41.80 89815

40.10

4.25

1.70

2.84

250000

108192

43.28

124992

44.64 121175

43.28

3.15

1.36

2.40

SOURCE : Developed from the provisions of Finance Act 1991 and adjusted rate schedule in table 6.11.

161

-

5.79