Why So Few Indians Pay Income Tax

Very few Indians pay income taxes. So, millions of them evade taxes and hide their incomes is the popular notion.

But this is a big myth. India has very few taxpayers not because millions of them are hiding their incomes and evading taxes. It is because India's income tax structure is designed in a way that allows only for a small percentage of people to pay income tax.

Let us first understand who should pay income tax in India. According to the latest income tax rules laid out by the Finance Minister in her Union budget, only people earning more than Rs 5 lakh will effectively pay an income tax.

Now, how many Indians earn more than Rs 5 lakh to qualify to pay income tax?

According to the government's Economic Survey of 2020, India's per capita income is Rs 1.4 lakh. That is, the average Indian earns Rs 1.4 lakh a year. We know the income tax threshold is Rs 5 lakh. Which then means the average Indian is not required to pay an income tax.

To give some context, let us look at other countries. The average American, that is a person who earns the same as America's per capita income, has to pay a 22% income tax. Similarly, the average Chinese pays 10%, the average Mexican pays 15%, the average German pays 14%.

Based on calculations of India's inequality, we estimate that only 3% of working Indians earn three times the average per capita income. That is, only 3% of Indians earn more than Rs 5 lakh.

This is comparable to other countries. Only 5% of Americans earn 3 times their average income, 4% of British and roughly 3% of Chinese. This proves that only 3% of Indians are even qualified to pay income tax. Hence India has a very low income tax base. It is not because of millions of people are hiding their incomes in a secret corner. It is because for a poor country such as India, the income tax limit is very high and so automatically most Indians fall out of the tax bracket.

You may ask: This entire argument is based on India's average per capita income. Is it possible that because millions of people hide their incomes, India's average income is also artificially low?

No. The per capita income is calculated using India's GDP data. Let's assume millions of Indians have hidden their income under their pillows as the proponents of demonetisation thought. At some point, these millions of people will use their income over the many years to buy goods, gold, real estate, and other things. This is then captured in GDP data and reflected in the per capita income. It is not possible that millions of people have hidden cash for many years without ever using them. Even if they did, it will get reflected in RBI's money supply data.

So, if we believe India's GDP, economic, and income data, then we have to accept that under India's income tax structure, only 3% of Indians qualify to pay tax. Most elite Indians are unable to come to terms with how poor India really is. They see people around them in fancy cars, bungalows, and avoiding income tax. So they think the entire country is like that. Yes, surely there are tax evaders and black money hoarders in India. But not millions of them as it is made out to be.

This myth that India has a low income tax base because millions of Indians hide their income has led to some catastrophic decisions and created a climate of distrust and suspicion of citizens by the income tax department.

Praveen Chakravarty is a Political Economist, and Chairperson - Data Analytics in the Indian National Congress.

The views expressed here are those of the author and do not necessarily represent the views of BloombergQuint or its editorial team.