In the initial phases of forming a government, crucial decisions often come to the fore. One such pressing issue is the rationalization of direct tax structures, where a new administration can prioritize long-term gains over populist concerns.
During FY23, the government garnered nearly Rs 7.1 lakh crore from individual income taxes, with an expected increase to Rs 10 lakh crore by FY25 — notably positive figures for India. However, implementing tough measures such as broadening the tax base, eliminating deductions and exemptions for certain professional categories, and reducing tax burdens for top income earners could potentially enhance the tax-GDP ratio.
Impact of Taxes on Human Behavior
A fundamental aspect of human behavior is the tendency to avoid actions perceived as detrimental to personal interests. This principle significantly influences tax payment behavior, particularly for individuals not bound by salary-based TDS deductions.
Such individuals often invest considerable time and effort in minimizing their tax liabilities through various means, such as strategic transaction categorization, offsetting income with expenses, opting for self-employment over traditional employment, and at times, resorting to cash transactions to evade taxes altogether.
While these tactics may result in reduced individual tax burdens, they deviate from the fundamental purpose of the tax system — maximizing revenue for public welfare while minimizing individual tax burdens.
Established economic literature emphasizes a key proposition: higher tax rates lead to amplified distortions in human behavior. Elevated tax rates can reduce consumption, work hours, and prompt significant efforts to evade taxes, resulting in an “excess burden” or “deadweight loss” — an additional cost to both taxpayers and society due to tax-induced distortions in economic decisions.
Consequently, while higher tax rates may boost revenue, they also escalate the “excess burden,” potentially offsetting the revenue gains.
The optimal tax structure entails a broad tax base where everyone contributes, coupled with minimal tax slabs, exemptions, and concessions. This approach enables tax rate reduction, curbing evasion, and reducing the time and effort spent on tax management.
Ensuring tax compliance is not simply reliant on enforcement measures but also hinges on providing incentives for adherence to tax laws. While stringent enforcement plays a vital role, it is most effective when coupled with incentivized compliance.