CHAPTER I1

HISTORICAL ANALYSIS OF PRINCIPLES OF PROGRESSION

ON SALARIED INDIVIDUALS: POLICY PERSPECTIVE A

PARADIGM SHIFT

CHAPTER I1

HISTORICAL ANALYSIS OF PRINCIPLES OF PROGRESSION

ON SALARIED INDIVIDUALS:

POLICY PERSPECTIVE A PARADIGM SHIFT

The primary function of any tax system is to raise revenue in an efficient and

equitable manner.' Taxes finance for substantive functions of government and also

serve as an engine of social and economic betterment.2 One view asserts that

reducing inequalities of income is to be done through taxation by redistribution of

purchasing power from rich to the poor." Upgrading the poor through affirmative

state action and reducing the fabulous earnings of the rich by imposing ceilings and

restricting excess earnings through taxes are favoured by this view."he tax policy

should aim at the objective of material equity and maximum welfare even if both

may not be optimally achieved simultaneously5. In India, the administration has used

taxation to achieve various socio-economic objective^.^ Fiscal policy like any other

policy derives its meaning and direction from the aspirations and goals of the society

within which it operates and the people whom it serves7. Growth and social justice

have been the key note of the goals of planning in India and the achievement of the

same through redistribution of purchasing power and the use of progressive taxation

1 Anil Kumar, Direct Tmation in India-Some Aspects ( 2002 Jaipur) ,p.9.

2 The New Encyclopedia Britannica Macropaedia (15th edn. 1997 Chicago) Vol 8, p. 726,

3 S. Sankaran, Economic Analysis (1990, Madras), p.629.

4 Ibid

5 Ian Hinckfuss, "Progressive Taxation On Personal Expenditure," http//w.ug.edu.au/ philosophy/morsodhinck html visited on 7.10.2003.

6 Ibid.

7 Wa1ter.W. Heller, "Fiscal Policies for Underdeveloped Countries," in Richard M. Bird and Oliver Oldman), Reading on Tmation in Developing Countries (1967 Baltimore), p.5.

as an instrument have figured prominently among the objectives set in the Five

Year Plans.'

The importance of principles of progression and review of various theories of

progression are discussed in this chapter. Introduction of the said principle to income

tax and its development right from pre-colonial era till date has also been analyzed.

The policy of the administration towards salaried class during this period and the

impact of globalization have also been probed. The reports of the various

committees appointed by the Government are also reviewed. Present rate structure

and its impact on salaried are analyzed and solutions suggested. Erosion of

progression due to disallowance for dependant members and its impact on single

earners are probed from a human right perceptive. The inadequacy of social security

measures is also discussed in this chapter.

According to David A. Heartman, 'progressive taxation was designed to

reduce income disparity by disproportionately taxing upper income and

redistributing the proceeds through welfare state'? A schedule of progressive tax

rates is one in which the rate of taxation increases with the tax base." Under a

progressive tax regime taxpayer with ten times the total income of another should

pay more than ten times as much tax." If rate rises as income rises or if tax takes a

greater percentage of a person's income, the tax is progressive. Progression has an

in-built aspect of equality, as those who can well afford should pay more. Thus it

accords with good canons of taxation.

A progressive income tax has been central to redistribution for generations." In

the Communist Mani$esto Marx and Engels put it in the second place behind only to

8 Ameresh Bagchi and Nicholas Stem, Tax Policy and Planning in Developing Countries (Delhi. 1994). p.37.

9 David A. Heartman, Does Progressive Taxation Redistribute Income? (2002, Institute for Public Innovation), p. 162.

lo Blun Wa1ter.J. and Kalven Harry.J, The Uneosy Case For Progressive Taxation (1954 Chicago), p.3.

" Philip E. Tayor, Economics ofPublic Finance (Third ed. 1968), P.293.

Arthur Okun, Equality and Eflciency: The Big Trade Off (1978 Oxford.), p.101.

abolition of private and land ownership." Karl Mark and Engel expressed their

opinion thus:

If the democrats propose proportional taxes the worker must demand progressive taxes; If the democrats themselves put forward a moderately progressive tax the workers must insist on a tax with rates that rise so steeply that big capital will be ruined by it.. .They also proposed that progresssive taxation be used "to wrest, by degrees all capital from the bourgeois to centralize all instruments of production in the hands of state. "

While progression is said to be a twentieth century phenomenon, it is

interesting to note that the Indian sage Manu recognized the principle of

progression." The ancient fiscal maxims tried to reconcile needs of the state with

ability of the subjects to pay taxes.16 In Mahabharatha Bhishma says that the King

should not by his thirst, destroy his own foundations as well as those of others and

that a person desirous of milk never obtains any by cutting off the udders of a cow "

It is further stated in the Shanthi Parva also that King should add to taxes on his

subjects like a person gradually increasing the burdens of a.young bul lo~k.~~ixni lar

observation is found in Manusmrithi also. As the water insect (leech), the calf and

the bee eat their food little by little, so little by little should the King draw from his

kingdom the annual taxes.I9 Just as these derive full nourishment by taking in only a

little food, similarly the King should not uproot his people by overtaxing them.20

The Bhashya further interprets that only a small tax shall be levied upon the person

whose agricultural holding is not prosperous.21 The implication is that, the rate of tax

shall be lesser for the less prosperous and higher for the prosperous or in a

progressive manner. Where the profit made by trader has been large, the King

l 3 Ibid. " Karl Marx ,Engels Frederick, Selected Works (1955 Moscow), Vol.1, p.116. l5 Encyclopedia Britanica, op.cit, p. 726 16 Kunwar Deo Prasad, Taration in Ancient Indin (Delhi, 1987), p. 26. 17 Supra n. 2 at 1 .

l8 Ibid at 89 l9 Medhatithi , Manubhasya (Tr. Ganganath Jha, Seconded. 1999), Vol.11, p. 361.

20 [bid

2 1 Ibid

should charge heavier taxes even exceeding the proportion fixed.22 Analysis shows

that factors of ability and source had some bearing on tax.

The ideal tax system has been the concern of philosophers at least since

Hobbes, and presupposes certain objectives to be a~hieved.~) The prevailing wisdom

has been that progressive taxation of wealth is a necessary condition of social equity

and required that the wealthy be taxed at increasing rates for increasing levels of

income and assets. A progressive rate structure has been advocated in most countries

for reducing inequalities of income and ~ e a l t h . ~ Principle of progression was thus

inducted into the tax system to ensure the egalitarian ideals of equality.23 It is

claimed that progressive structure also serves the purpose of revenue elasticity.""

Since progressivity is intended to aim equity in tax burden distribution, attempts

have been made to design taxes to achieve both horizontal and vertical equity."

The overall progression of tax is dependent on all three elements, viz. base,

unit and rates." The proper application of tax rates is as important as a selection of

proper tax base.29 A progressive rate schedule offers many slop patterns, all of which

represent progression so long as any increase in the base is accompanied by an

increase in the rate.)' Progression is justified on grounds of revenue productivity,

optimum individual allocation of tax burden, promotion of stability and growth and

optimum social allocation of resources." The difficulty of identifying proper rate

pattern from a great variety of patterns all of which are progressive was given its

most famous expression over a hundred years ago by Mc Culloch thus:

'' Ibid

Supra n at 8 .

' b r . G . Thimmaiah, Perspectives On Tar Design And Reform (1984). p. 12. 25 Hancock Dora, Tmation Policy And Practice (199516 1,ondon ), p.9.

26 lbid.

2' lbid '' Yoshihiro Masui and Minoru Nakazato, "Persoaal Income Taxation" (1999),

hnp://www.watchtower.org.cgi. bin/imagemap/section. (visited on 21.9.2003) '' Philip E.Taylor , op.cit. at 293.

'O Ibid at 294.

" lbidat 296.

The moment you abandon . . . the cardinal principle of exacting from all individuals the same proportion of their income or their property, yore are at sea without rudder or compass, and there is no point amount of injustice or folly you may commit.32

Every counm should aspire a tax system which is equitable, i.e. that each

taxpayer should contribute his fair share to the cost of government.13 But the

difficulty is that there are two general economic theories dealing with distribution of

tax burden. The first rests on the benefit principle and has a long pedigree, dating

back to Adam Smith. The other school favours ability to pay principle, which is

widely accepted by modem states.

According to benefit principle theory, an equitable tax system is one under

which each taxpayer contributes in line with the benefit he receives from public

service^.'^ Historically benefit principle derives support from the contract theory of

the state as understood by political theorists of the seventeenth century, such as

Locke and hob be^.'^ Subsequently it was woven into the greatest-happiness

principle of utilitarians and appeared early in classical economics as Adam Smith's

first canon of taxation.j6 Adam Smith in Wealth of Nations set forth the equity

principle thus:

The subjects of every state ought to contribute towards the support of the government. as nearly as possible, in proportion to their respective abilities; that is, in proportion to the revenue which they respectively enjoy under the protection of the state.37

The benefit principle is difficult to follow with precision because of difficulty in

measuring individual benefits from public service, and because people who most

3Z McCulloch, Taxation and the Funding System (1 845), p. 142. 33 ~ichard A. Musgrave and Peggy 8. Musgrave, Public Finance in Theory and Practice (1980),

p.237. '* Seligman, Progressive Taxation in Theory andpractice (1908), Part 11, p. 160.

" Ibid. 36 Richard A. Musgrave, The Theory of Public Finance (1959), p.65. 37 Adam Smith, The Wealth ofNations (1904), Vol. II, p.310.

need services are often those least able to pay." Dalton was therefore in favor of the

principle that marginal utility of the community from all forms of public expenditure

should be equal.39

The theory of 'ability-to-pay' calls people with equal capacity to pay the

same, while people with greater ability should pay more. The former is referred to

as horizontal equity and latter as vertical equity. Income is the most accepted

measure of ability to pay. But there are others who hold that consumption would be

a superior choice." There are different types of ability- to- pay approaches. One type

addresses itself to the distribution of tax payments only, and another considers

distribution of tax as a matter of welfare economics rather than justice?'

Though different in spirit, the welfare approach to tax distribution grew out

of the equity view. Adam Smith recognized equity as a basic requirement for tax

structure design. He suggested that a good tax ought to be equitable, convenient and

economical. The link was provided by an overlap of ideas in John Stuart Mill's

formulation of the equity rule. Mill had argued that equity should be defined as the

requirement that each taxpayer should suffer equal sa~rifice.4~ Equal sacrifice would

require tax liabilities to be the same for all similar incomes." Thus vertical equity

has been viewed in terms of equal-sacrifice prescription. Taxpayers may be equal if

their payments involve equal sacrifice or loss of welfare.#

In the development of ability-to-pay theories of progressive taxation,

'sacrifice' doctrine played a major role. Taxation necessarily involves sacrifice on

the part of taxpayer. The aim of taxation in a welfare state should be to tax in such a

way that the burden imposed on the community is the minimum. The aggregate

sacrifice of the community is minimum when the marginal sacrifice of individual

38 Blum and Walter, J. op.cit. at 47. 39 Hugh Dalton, Principles of Public Finance (1954). p. 14. 40 Richard A.Musgrave and Reggy B. Musgrave, op.cit, at.243.

' Ibidat 90.

John Stuart Mill, Principles of Political Economy (1921), p.804. 43 Paul A. Samuelson, Foundations of Economic Analysis (1947), P.227.

Ibid at 804.

taxpayer is equal or as nearly equal as possible, and Dalton refers to this as 'the

principle of minimum ~acrifice'."~ Noted economist A.C. Pigou made a significant

contribution by introducing the principle of 'least aggregate sacrifice that the burden

of taxes should be distributed in such a manner that the total sum of the subjective

sacrifice of all individuals shows a declining trend'.& Minimum sacrifice thus calls

for progressive taxes, which bear heavily on the less important units of satisfaction

at the margin of small incomes?' The states started considering it as a duty to

interfere with the rights of private property in order to bring about a more equitable

distribution of wealth in furtherance of socio-political policy through progressive

ta~ation.~' The least sacrifice theory thus gained popularity and warranted

progressive rates.

According to Raja Chelliah 'the reduction in inequalities stands high in the

scheme of social values in countries of southern Asia.d9 Policies that do not take any

note of the objective are unlikely to be acceptable to the broad masses of the people

in these co~ntries.'~ It has been recognized that progressive structure also serves the

purpose of revenue elasticity." The progressive tax rate structure is one component

of the progressive tax mechanism, and it was intended mainly to aim at equity in tax

burden distribution to ensure horizontal and vertical equity."

During the colonial era, raising of revenue was the main purpose of taxation.

There were hardly any concession, exemption for savings, investments, industrial

growth or other desirable socio-economic objectives." The socialistic doctrine was

45 Hugh Dalton, op.cit. at. 59 " A.C. Pigou, A Study in Public Finance (1951), p.64. " Richard A.Musgrave & Peggy B. Musgrave, op.cit. at.726.

48 Seligman, op-cit. at 67. 49 Raja Chelliah, Fiscalpolicy in Underdeveloped Countries (1969), p.52.

' O lbid. " Hugh Dalton, op.cir. at. 52.

S2 Ibid. 53 "India: Basics of Income Tax" (1999), Tax Research series, Indian Tax Institute, Delhi, p 4.

expressly refi~ted." In the proceedings of the Legislative Council of India in 1860,

Mr. James Wilson, the first Finance Minister of the Government of India, observed

thus:

The lot of men is fixed by thousands of inscrutable causes, and if a Government were to attempt to produce equality by distributing the incidence of taxation, it would undertake a task, the end of which must be confusion and disappointment to all

In 1916 that income tax was levied on gradated scale and this made it

necessary to abandon the system of assessing tax separately on different sources of

income falling under the four parts of the second schedule to Act 1 lof 188656. A

fresh look was made on the subject in 1918, resulting in the reconstitution and

remedying certain inequalities, which existed in the earlier legislation. Under the

previous system assessees deriving income from more than one source might have to

pay only less than assessee of equal taxable capacity, but whose income was from

one source.57 The Act provided for aggregating income from all sources to determine

rate, and assessment was on that basis." The Act fixed rates varying from four pies

in the rupee on the lower income ranges to twelve pies in the rupee in the higher

income ranges.

The Income Tax Act, 1922 made a departwe from the previous enactments

by abandoning the system of specifiing the rate of taxation in its own schedule and

introduced the scheme of fixing rates through annual finance Acts.59 The schedule to

the Act fixed the rates of income tax and super tax with reference to assessees' total

income. Income tax was levied on step- wise gradation. The Act made it obligatory

on employer to deduct tax at source from salary. 'Earned income' was defined as

" Banerjee .P. History of Indian Taxation (1930),p.3. '' See S.M Jha, Taxation and The Indian Economy (,1990), p. 163.

56 Ibid.

I' Ibid 58 Section 4 of Indian Income Tax Act ,1918. 59 Schedule to the Finance Act, 1922.

income derived from actual work or service performed and included wages, salaries

and income from profession."

The sources of income covered by the income tax are one of the important

elements that affect its progressivity." Classification of different classes of income

for the purpose of taxation is a matter of state policy. Generally, law distinguished

between earned and unearned income and taxes latter receipts heavily.62 Salary being

earned income was given soft treatment in various countries. J.E.Meade Committee

appointed in the United Kingdom for reform of direct taxes recommended soft

treatment of earned income on the reason that earned income involved sacrifice of

leisure, which is absent in the case of non-earned income. Another reasoning of the

committee was that earned income was the creation of a taxpayer's own skill, ability

and effort, while unearned income might accrue through luck, prestige, security, and

independence and influence and generally associated with the ownership of wealth."'

The demand for special treatment for earned income was rising in the light of

international practice. The Indian Taxation Enquiry Committee examined the

desirability of differentiation between earned and unearned incomes. The committee

rejected it on the ground that it was 'premature in the Indian condi t i~ns ' .~

In 1935-36 the starting rate was 0.7%. Rates of tax rose gradually through

ten slabs for income tax and twelve slabs for super tax."' The rates during 1938-39

were based on step system, (Table 1) although super tax rates were on slab basis.

60 Section 2(6-AA) of Indian Income Tax Act, 1922. ' Marina Kesner Slcreb et al "Progressivity of Income Tax in Croatia During 1995 to 1999 Peroid"

p.2. http://www. tXhr/eng /istrasivanja~progresivnost2000. htm. Visited on 19.1 1.2004. 61 Hockely Graham, Public Finance: An Introduction (1979 London), p.189. " Report of the Structure and Reform of Direct Taxation (1 978 London), p. 132. td Report of Indian Taxation Enquiry Committee 1924-25 (Government of India), p.189.

" Finance Act, 1935.

Table - 2

Rates of income tax in 1938-1939 (The last year under step system of taxation)

Rates of income tax in 1939-1940 (The first year under slab system of taxation)

Grade of income

2000 - 4999 5000 - 9999 10000 - 14999 15000 - 19999 20000 - 29999 30000 - 39999 40000 - 99999 100000 and above

On the First Rs. 15001- I nil

On the next Rs35001- 9

Source: Prepared by referring to Finance Act, 1938.

Rate of tax

Grade of income

On the next Rs.50001- 15

On the next Rs.5000/- 24

Pies per Rupee of income 6 9 12 16 19 23 25 26

Rate of tax Pies per Rupee of income I Percentage

Percentage 3.125 4.688 6.250 8.333 9.896 1 1.980 13.021 13.542

The personal income tax slab pattem was changed to slab system in 1939 on

On the balance

the basis of recommendation of the Income Tax Inquiry Committee, (1936). It

introduced a tax free slice of Rs.1,500/- for all assessees in recognition of the fact

Source: Prepared by referring to Finance Act 1938 30

that earlier units of income were more valuable even to rich persons. Under the slab

15.625

system the rate increase progressively with a rise in each slab of income and

therefore was considered to be more equitable. The structure and rate of tax for

1939-40 are given in Table 2

In India, differentiation of earned income and unearned income was first

introduced in 1945. It was affected in two ways. Firstly, the assessee was allowed

exemption of a fixed proportion sub.ject to a maximum limit and secondly, for super

tax purposes. The method adopted was to levy tax on earned income at lower rates

than on unearned income. The tax policy varied for salary and other earned income.

A deduction of one-tenth of earned income included in the total income, exclusive of

any income chargeable under the head 'salaries' was permitted for salaried class."

The permissible deduction was subject to maximum of Rs.2,000/-. In 1947 the

differential treatment was dispensed with and all earned income assessees were

permitted to deduct one-fifth of the earned income from total income. The benefit of

deduction was limited to Rs.4,000/-. Since earned income allowance was given as a

deduction from the total income, the relief in terms of tax was at the marginal rate of

tax applicable to the highest slab. During 1946-47 to 1949-50 special relief to earned

income was extended to super tax also by stipulating different rates in the schedule

(Table 3).

Table - 3

Concessions in the form of lesser super tax rates for earned income

nil 1 nil ( ~ i r s t Rs. 25,0001-1 nil I nil

No. Slab First Rs.

12.500 I l8.750 1 Next Rs. 5,0001- / 12.500 18.750

1

2

3 18.750 1 25.000 1 Next Rs. 5,0001- 1 15.625 1 21.875

25,0001- Next Rs. 10,0001- Next Rs. 10,0001-

25.000 I 3 1.250 Next Rs. 10,0001- 18.750 I Next Rs.

4 15,0001- Next Rs.

5 20,0001- ext Rs.

6 30,0001- ext Rs.

Next Rs. 8 50,0001-

ext Rs. 9 50,0001-

10 1,00,0001- Next Rs.

11 1,50,000/- 12 On the balance

Source: Prepared b:

31Z50 I 37.500 Next Rs. 10,0001- 25.000 I / 31.250

37s00 I 43.750 Next Rs. 10,0001- 31.250 I 37.500

43.750 50.000 Next Rs. 10,0001- 37.500 43.750

50.000 56.250 Next Rs.15,0001- 43.750 50.000

56.250 59.375 Next Rs.15,000/- 50.000 56.250

62.500 65.625 Next Rs.30,0001- 62.500 65.625 65.625 65.625 On the balance 65.625 65.625

.eferring to Finance Acts of relevant years.

66 Finance Act, 1945

The analysis goes to show that taxation was never accepted as an important

tool for furthering social objectives during earlier colonial era. Latter, tax policy was

moulded according to recommendations of tax enquiry committees. Progression was

first introduced on step-wise gradation and was subsequently replaced by 'slab

system'. The tax policy towards salaried group was rather soft during the close of

colonial period.

It is the belief that a constitution reflects the economic beliefs and interests of

dominant sections of the society at that time67. Egalitarian ideals of economic justice

are reflected and enshrined in the preamble, directive principles and the fundamental

rights of the Constitution. The tax system was expected to play an important part as

an instrument of social transformation. Two pronged attempts were made to

rejuvenate the economy. First was by raising the progressiveness. The second was

to achieve certain devised goals through redistribution. Controlling the effects of

inequalities of income through taxation and public expenditure was the accepted

fiscal policy in all countries of the world in 1950.68

After the independence there was no remarkable change in the tax policy

towards salaried group. The relief in favour of earned income for super tax was

withdrawn in 1950 and a common schedule was ~t ipulated.~~ The income tax

schedule from 1950-5 1 to 1954-55 is shown in (Table 4)."

Table - 4

Rates of income tax for 1950-51 to 1954-1955 No I~otal Income l ~ a t e / Percent* 1 (On the first Rs.1500 of total income (Nil 1 2 Ion the next Rs.3500 oftotal income l ~ i n e Pies in the Rupee 1 4.69 1 3 4

Source: prepared by referring to the first schedule of Finance Acts of 1950, 51, 52, 53, 54 and 55. 'Percentage calculated.

5 Ion the balance of total income Ion the balance of total income

67 K.C.Wheare, Modern Constitutions (First edn Oxford), p. 80.

Dilip.K.Basu et al, Social and EconomicDevelopment in India (1986), p. 228. 69 Section 2(2) of Finance Act, 1950.

Finance Acts of 1951,1952. 1953* 1954,1955.

On the next Rs.5.0001- of total income

On the next Rs.5.0001- of total income

25

One Anna and nine pies in the

Three Annas in the rupee 10.94 18.75

The gradated scales of income tax provided by the Finance Act, 1951 was

challenged by reason of contravention of Article 14 of the Constitution before the

Calcutta High Court in Seth Sukhlall Chandamul v A. C Jain. " The court was of the

view that the object of removal of inequalities as contemplated in Article 39(b) and

(c) of the Constitution was in the mind of the legislature while enacting the Finance

It also held that the differences in income on which the classification was

based and gradated scale, rising with the rise of income, had an obvious rational

connection with the object of the ena~tment.~' Hence the gradated scale of income

was held not to be in contravention of the laws of equal protection.

The Taxation Enquiry Commission (1953) made several recommendations

and was in favour of limiting earned income allowance to income group below

R~.24000/ .~~ The Government accepted in principle the recommendation and took

steps to reduce relief to higher earned income group.75 In 1955-56, salaried class was

given a concession of one- fifth of the salary subject to a maximum of Rs.4000/.

Concession to the same extent was given to other earned income not exceeding

R~.2500/- .~~ In respect of earned income, eligible deduction was confined to an

amount arrived at after deducting from four thousand rupees, an amount equal to one

fifth of the earned income in excess of R~.25000/.'~ Under this method, between

7' A.I.R.1959 (Cal) 444.

'' Ibid at 446.

" Ibid 74 Report of the Taxation Enquiry Commisssion 1953-54 p.39. The Commission had probed into

the issue of justification of earned income relief and recommended thus: "it is necessary to provide for some kind of 'depreciation allowance' for human machinery; that cognizance has to be taken of the relatively precarious nature of earned income ; that it is necessary to stimulate the incentives to work in order to encourage productive effort, and that taxable capacity of those who receive unearned income is greater since they have also fund of capital in addition to the income which arise from it ... we consider that it is right to tax income arising without any direct effort on the part of the recipient more heavily than income arising from work ( associated with special skill or knowledge or enterprise). The importance of the consideration in favour of differentiation, however, diminishes as one goes higher up in the income scale, it appears therefore, desirable to impose a limit in terms of income beyond which the allowance should not be available".

75 Budget Speech 1955-56, para 64, Budget Speeches of the Union Ministers 1947-48 To 1990-91, (2nd ed. 1990), p. 1 17.

'' Section 2(2)(i) & (ii) of Finance Act, 1955.

77 Section 2(2)(ii)(a)(b), Ibid

Rs.250001- and Rs.45000/- the relief of Rs.40001- would be reduced by Rs.2001- for

each Rs.10001- of earned income, the concession ceasing when the level of

Rs.4000/- was reached. The same pattern was followed in the next two succeeding

years also78. The Finance Act 1957 extended the benefit to surcharges on income tax

and super tax.79 Finance Act, 1958 withdrew the concession of deduction from

income tax. The Act limited it to surcharge on income tax and super tax and on

gradation basis. Earned income was subject to a lower surcharge than that on

unearned income. The surcharge was fixed at 5%of the tax on earned income up to

rupees one lakh and ten per cent on incomes in excess of that sum while unearned

income was subject to a uniform rate of 20%?0

The Income Tax Act, 1961 replaced the 1922 Act but the concession to

earned income continued.'' The Finance Act, 1962 further reduced the rate of

surcharge on salaried class to two and a half per cent on the amount of income tax

and five per cent for earned income below one lakh and ten per cent for income

above that level and twenty percent in other cases of unearned income. In the

Finance Act of 1963 the salaried class of person has been excluded from the

application of the provisions for the levy of surcharge. The provision was challenged

as discriminatory in Ved Vyas Chawla v The Income Tax Oflcer 'C' Ward

Allahabad and another.s2 The court opined that the impugned Finance Act dealt all

the persons within the salaried equally and the classification was reasonable as it

was based on a real and substantial distinction between salaried employees and

otherss3. The Court observed as follows:

"This is for the every good reason that a salaried employee has to

balance his budget, his income from that source being precise,

predetermined and limited; it is but fair that he should know what his

78 Section 2(2)(a) &(b) of Finance Act, 1956 79 The Finance (No.2) Act, 1957.

The Finance Act, 1958. " The Finance Acts of 1959,'60,'61.

P2 AIR 1965 (All) 37

83 Ibidat 38

liability is likely to be for the particular year before hand, so that he

can cut his coat accordingly to his

Hence the court held that 'the classification was neither arbitrary nor capricious and

classification of salaried and others was perfectly understandable. intelligible and

~easonable."~

Gradation was made steeper in 1964 for surcharge on income tax and super

tax. The unearned income was subject to 12.5% (Rs.lOOOO - Rs 25000), 15%

(Rs.25000 - Rs.75000) and 17.5% for income above Rs.75000/- whereas earned

income was subject to a lesser rate of

The concession to salaried class continued till 1968. The Committee for

Rationalization and Simplification of Direct Tax Laws considered the necessity of

differential tax treatment of earned and unearned incomes. The committee opined

that there was hardly any economic justification for differential treatment,

particularly when income arises from investment made out of one's own savings." It

was of the view that 'any attempt to distinguish between income from investments

obtained by inheritance or gift would lead to administrative complications, which

are hardly worth~hile'.'~ The committee recommended abolition of the distinction

between earned and unearned income* The recommendation was accepted and the

budget 1968-69 stated that different treatments resulted in complication in

calculati~ns.~ For next two decades there was very little discrimination among

incomes from different sources.

'"bid at 3 8

'' lbid 86 The Finance Act, 1964. '" First Inferim Report of Rationalization and Simplification of Direcf Tax Laws (1967). p.33

Ibid.

" Ibid 90 Budget Speeches ofthe Union Ministers 1947-48 To 1990-91, (2nd ed.1990). p.303.

Moraraji R. Desai then Finance Minister while withdrawing the concession for earned income, in his budget speech of 1968-69 stated thus: "Under our integrated scheme of direct taxation which comprises, besides income tax, an annual tax on wealth and taxes on gifts and inheritance

The Government also limited the dependent tax benefit to 40 % for

individual assesses whose total income exceeded Rs. 10000/-. Though Finance Act,

1964 and Finance Act, 1969 enhanced the top rates to 65% and 75% respectively but

rates at the bottom slabs continued to be 5%. Hike at the top slabs did not affect

majority of the salaried group since most of them belonged to the first two slabs?'

The Finance Act, 1971 enhanced the initial slab rate from 5 % to 10 %. Slabs were

also increased to twelve9' (Table 5).

Table - 5

- . . Source: The Finance Act, 1971.

.I do not see any need or justification for differentiating between unearned income and earned income.. . ."

9 ' P.R.Panhamukhi. Tm Rate and Tm Revenue-A Quantitative study (1996 New Delhi). p.156. 92 Para A of Part 1 of First Schedule of The Finance Act, 1971.

for 1971 - 72 Rate

10 per cent of the amount by which the total income exceeds Rs.5,0001- Rs.5001- plus 17 per cent. Ofthe amount by which the total income exceeds Rs.10,000/-

Rs.1,350/- plus 23 per cent. Of the amount by which the total income exceeds Rs.15,000/-

Rs.2,500/- plus 30 per cent. of the amount by which the total income exceeds Rs.20,000/

Rs.4,000/- plus 40 per cent. Of the amount by which the total income exceeds Rs.25,OOOl-

Rs.6,0001- plus 50 per cent of the amount by which the total income exceeds Rs.30,000/.

Rs. l1,000/- plus 60 per cent of the amount by which the total income exceeds Rs.40,0001-

Rs.60,OOOl-Rs.23,000/- plus 70 per cent. Of the amount b: which the total income exceeds Rs.60,000/-

Rs.37,0001- plus 75 per cent of the amount by which the total income exceeds Rs.80,000/-

Rs.52.0001- plus 80 per cent. Of the amount b: which the total income exceeds Rs.1,00,0001-

Rs.1,32,000/- plus 85 per cent of the amount bv which the total income exceeds Rs.2.00.001

Slab 1

2

3

4

5

6

7

8

9

10

11

12

- Income Tax Structure Income range

Where the total income does not exceedNil Rs.50001-

Where the total income exceeds Rs.50001- but does not exceed Rs. 10,0001- Where the total income exceeds s. 10,000/- but does not exceed Rs. 15,0001-

Where the total income exceeds Rs.15,000/- but does not exceed Rs.20,OOOI-

Where the total income exceeds Rs.20,0001- but does not exceed Rs.25,000/-

Where the total income exceeds Rs.25.0001- but does not exceed Rs.30,000/-

Where the total income exceeds Rs.30,0001- but does not exceed Rs.40,000/-

Where the total income exceeds Rs.40,000/- but does not exceed Rs.60,000/-

Where the total income exceeds but does not exceed Rs.80,OOOl-

Where the total income exceeds Rs.80,000/- but does not exceed Rs. 1,00,000/-

Where the total income exceeds Rs. 1,00,000/- but does not exceed Rs.2,00,000/-

Where the total income exceeds Rs.2,00,000/-

Table - 6

The top slab provided for a rate of 85% and 10% surcharge. High rates have

lnconle

On fint Rs.5000 On next Rs.1000 On next Rs.1000 On next Rs.2000 On next Rs.5000 On next Rs.3000 On next Rs,2000 On next Rs.2000 On next Rs,3000 On next Rs.5000 On next 10000 Onnext RS.lOM)O On next Rs,loooo On next Rs. 10000 On next Rs.10000 On next Rs,5000 On next Rs,15000

On next Rs. 100000

On the balance Source: prepared

often proved to be counter- productive. In 1970 a committee headed by Justice

Wanchoo examined this issue and recommended measures to unearth black money.

Rates of income-tax for individuals, from assessment years 1971-72 to 1991-92

The committee was of the view that high rates were responsible for large-scale tax

lg7l- 7210 1974.

75

Nil

10%

10%

10%

17%

23%

23%

30%

30%

40%

50%

60%

60%

70%

70%

75%

75%

80%

85%

by

evasion because they made tax evasion profitable and attractive, and recommended

for reduction of rates9' The committee suggested a rate structure with ten slabs, top

93 Final report ofDirect Taxes Enquiry Committee (1971). p.7

1975- 76

Nil

Nil

12%

12%

15%

20%

20??

30%

30%

40%

50%

50%

60%

60%

70%

70%

70%

70%

70%

me by

1977- 7810 1981-

82

Nil

Nil

Nil

15%

15%

18%

18%

25%

25%

30%

40%

40%

50%

50%

55%

55%

55%

60%

60%

to various

1976 77

Nil

Nil

Nil

17%

17%

20%

20%

3

30%

40%

50%

50%

60%

60%

70%

70%

70%

70%

70%

referring

1982- 83

Nil

Nil

Nil

Nil

Nil

30%

30%

30%

30%

34%

40%

40%

50%

50%

55%

55%

55%

60%

60%

Finance

Assessment

1983- 84

Nil

Nil

Nil

Nil

Nil

30%

30%

30%

30%

34%

40%

40%

50%

:2 55%

55%

57'5 oO/.

60%

60%

Acts

years

1984- 85

Nil

Nil

Nil

Nil

Nil

25%

25%

30%

30%

35%

40%

40%

50%

5tT 55%

55%

57.50 Ye

60%

60%

from 197

1985- 86

Nil

Nil

Nil

Nil

Nil

20%

20%

25%

25%

30%

35%

40%

45%

45%

50%

50%

50%

55%

55%

1-72 to

1986- 8710 198% 90

Nil

Nil

Nil

Nil

Nil

Nil

25%

25%

25%

30%

30%

30%

4

40%

40%

40%

40%

50%

50%

1991

1990. 91

Nil

Nil

Nil

Nil

Nil

Nil

20%

20%

20%

30%

30%

30%

40%

40%

40%

40%

40%

50%

50%

-92

199182

Nil

Nil

Nil

Nil

Nil

Nil

Nil

Nil

20%

20%

30%

30%

40%

40%

40%

40%

40%

50%

50%

slab being 65 %.94 The Government later reduced top rate from 85 % to 70 %." The

Direct Tax Laws Committee (1977) was more concerned with top rate. It

recommended lowering it to 60% and for the abolition of surcharge.% Though the

top rate was reduced, bottom rate was raised to 12% initially and this was further

raised to 17%:' The hike at the bottom level adversely affected the employees since

they constituted the largest number at that level. (See Table 6).

The Finance Act, 1982 made a drastic deviation from the old pattern of

starting with moderate rates. The initial slab rate was hiked from 15% to 30% and

the top slab continued to be levied at the rate of 60%.98 The surcharge was continued

at the rate of The top slab continued to be levied at the rate of 60%.IW The

Finance Act, 1984 reduced the initial rate to 25%, the succeeding Finance Act

further reduced the initial rates to 20%. The top rate was brought down to 55% from

60%.'01 The Finance Act, 1986 enhanced the nontaxable limit to 18,0001-. The initial

slab rate was again increased to 25%. During the period of 1986 to 1990 the bottom

rate of 25% continued and the top rate was 50%. In 1990-91 the initial rate was

brought down to 20%.

Comparing the rate structure for different years it is evident that the rate of

30% was applied in 1949-50 to income above 2.25 lakhs (in terms of 1991 rupees).

In 1991-92 this rate was applied to income above Rupee 0.3 lakh (Table 7). The

same trend could be noticed in the case of 50% and 70% rates. The sudden dose of

heavy rates to lower levels of income occurred during this period. This was

detrimental to the salaried class since most of them belonged to the lower income

category.

94 Ibid. 9J Sub-para I of para A of First Schedule of Finance Act, 1975. 96 Report of the Direct Tax Laws Committee (1977), p.9: para 2. 97 Sub Para 1 of Para A of Part 1 of the Fint Schedule of The Finance Act,1976

Sub-Para 1of Para A of Part I of First Schedule of The Finance Act,1982.

'' Ibid. I W Sub-Para 1 of Para A of Part 1 of First Schedule of The Finance Act, 1982. 'O' Sub-Para 1 of Para A of Part 1 of First Schedule of The Finance Acts of 1984 and 1985.

Table -- 7 Shifting of high rates to lower levels

7

Assessment year

10.20

8.20

7.35

4.38

4.00

2.24

nil

nil

nil

nil

Tax Rates & Income Range (Rs. Lakhs in 1991)

Source: Prepared by referring to Finance Acts of relevant period

30%

The analysis of tax policy for the period 1950 to 1991 goes to show that in

early post-constitutional period the approach towards salaried class was very soft. In

mid fifties concession for earned income was first introduced and later eroded

completely. Early seventies witnessed high rates for top slabs and moderate rates for

lower slabs. Ascending trend at of lowest slabs affecting the salaried group is

observed during mid seventies. The policy further hardened during eighties.

50% I 70%

Pristine theories and principles of taxation have to be revalued in the light of

changed international economic condition and technical developments due to

gl~balization.'~~ The accelerating economic globalization, deregulations of monetary

systems and financial flow in combination with the fast development of electronic

communication and trade have made national boarders less important.103 Since

capital moved freely, states were anxious to woo capital and thus lost control over

many aspects of economic policy. As capital and skilled labour migrate freely from

Sven-Olof Lodin, "lntemational Tax Issues in a Rapidly Changing World," 55 Bulletin for lnternational Fiscal Documentation 1 (2001). 73,74.

lo' Ibid. at 78.

high tax to low tax countries, the power of the state to set tax rates is constrained. I M

Tax free zones and regional tax deductions became common feature to attract

foreign investment. States were forced to cut down public expenditure and curtail

welfare p~licies.'~'These factors resulted in erosion of the principle of progression to

a considerable extent.

Table - 8

The Indian tax structure adjusted during nineties to liberalize and globalize

economy. Tax reforms were part of the package to open up economy. In August

1991, Government of India constituted a Tax Reform Committee to recommend

comprehensive reform of both direct and indirect tax laws. The committee observed

Rates of income-tax for individuals for assessment years 1991-92 to 2001 to 2002

that "a structure of taxes which appeared highly progressive in the statute remained

Income Range

On tint RnU000

On next Rs.3000

OnnextRs.3000

On next Rs.2000

On next Rs.5M)O

On next Rs.5000

On next Rs. 10000

On next Rs.10000

On next Rs.40000

On next Rs.20000

On next Rs.30000

On balance

progressive only on paper and turned out to be highly iniquitous and

dist~rtionary."'~~ It recommended rate schedule with simple and moderate rates for

I M Yash Ghai, Economic Development and Human Rights in in Joanne.R.Bauer and Daniel A. Bell, The East Asian Challenge For Human Right (1999 Cambridge) p.25 1.

lo' Ibid.

Source: Prepared by refemng to the Finance Acts of relevant period

ASSESSMENT YEARS

106 Final Reporf Tar Reform Committee Part- 1 (August. 1992), p. 1 1 I: para 6.14.

1991-92

Nil

20%

20%

20%

30%

30%

30%

40%

40%

50%

50%

50%

1992-93

Nil

Nil

Nil

20%

20%

20%

20%

30%

30%

40%

40%

40%

1993.94

Nil

Nil

Nil

Nil

20%

20%

20%

30%

30%

40%

40%

40%

1994-95

Nil

Nil

Nil

Nil

Nil

20%

20%

20%

30%

30%

40%

40??

1995-96

Nil

Nil

Nil

Nil

Nil

20%

20%

20%

30%

30%

40%

40%

1996-97

Nil

Nil

Nil

Nil

Nil

Nil

15%

IS%

30%

30%

40%

40%

1997-98

Nil

Nil

Nil

Nil

Nil

Nil

10%

10%

20%

20%

30%

30%

199899

Nil

Nil

Nil

Nil

Nil

Nil

Nil

10%

20%

20%

30%

30%

1999-00

Nil

Nil

Nil

Nil

Nil

Nil

Nil

10%

20%

20%

20%

30%

2 W 1

Nil

Nil

Nil

Nil

Nil

Nil

Nil

LOO?

20%

20%

20%

30%

2CQl42

Nil

Nil

Nil

Nil

Nil

Nil

Nil

10%

20%

20%

20%

30%

20024:

Nil

Nil

Nil

Nil

Nil

Nil

Nil

10%

20%

20%

20%

30%

better enf~rcement.'~' The committee recommended for a three-rate schedule of

20%, 27.5% and 40%. The recommendations were implemented with modifications.

The maximum rate was made applicable to slabs above Rs.1,20,000/- as against the

recommendation of the committee that income exceeding two lakh need be

subjected to maximum rate. The same rates continued until 1995 (Table 8). The

Finance Act 1996 reduced the initial slab rate to 15%. The Finance Act, 1997

reduced the maximum and minimum rates to 30% and 10% respectively. The three-

rate gradation of lo%, 20% and 30% continued ever since 1997.Io8

Table -- 9

In a progressive rate schedule, slab structure is equally important as rates.

The Finance Act, 1998 applied the initial rate of 10% to a narrow slab of Rs. 10000/-

i.e. between Rs. 50000-60000 (See Table 9). The income above Rs. 600001- was

subject to 20% and very often accompanied by a surcharge in one form or another

since Kargil war - Kargil surcharge, Gujarat surcharge, drought surcharge etc. Since

the gradation was very steep at the lower level and flat for income above

Rs.150000/-, was beneficial to top earners. The salaried never constituted a

significant percentage of this class and hence the reduction of rate at the top was of

Rates of Income tax (1997- 98 to2004-05)

lo' Ibid. at 1 14. It read thus: "'The marginal rates of tax should be: (i) 20 per cent for total income in the range of Rs.28000 to Rs, 50,000. (ii) 27.5 per cent for total income in the range of Rs 50000 to Rs 2.00.000 and iii) 40 per cent for total income exceeding 2,00.000!'

108 Sub-para 1 of Para A, Part 1 of First Schedule of Finance Act, 1997.

(1) Where the total income does not exceed

Rs. 50,0001-

(2) Where the total income exceeds Rs.

50,0001- but does not exceed Rs. 60,000/-

(3) Where the total income exceeds Rs.

60,0001- but does not exceed Rs. 1,50,000/-

(4) Where the total income exceeds

Rs.1,50,0001-

Nil

10 %of the amount by which the total income

exceeds Rs. 50,0001-

Rs. 1,0001- plus 20% of the amount by which the

total income exceeds Rs. 60,0001-

Rs.19,0001- plus 30 %of the amount by which the

total amount exceeds Rs.1,50,000/-

Source: Prepared by referring to Finance Acts of 1997 to 2004.

little importance to them. Perusal of data in AN India Income Tux statistics of

relevant years reveals that majority of the salaried (approximately 90%) belonged to

the income slab below Rs. 200000/-.'W Hence marginal impact due to the sharp

gradation was more on the honest low-income group, and steep gradation at lower

levels hurt them badly. During the last seven years tax rates increased steeply from

the low through the middle-income range and then flattened out for high incomes.

The Planning Commission constituted an advisory group in July 2000, to

study issues relating to tax policy and tax administration and to make appropriate

recommendations with a view to generate adequate resources for the Tenth Five

Year Plan (2002-03 to 2006-07). According to the group the design of the existing

rate schedule was not economically efficient or equitable or amenable to voluntary

c~mpliance."~ It stressed the need to redesign the rate schedule to make it more

equitable."' According to it maximum marginal rate of tax should be moderate so

that distortion in economic behaviow of taxpayer and incentive to evade tax

payment are minimized."' It also recommended against imposition of surcharge

since that resulted in increase of the marginal rates and adversely affected

compliance.'^' The model recommended by it is given in Table 10.

Table - 10

l~etween Rs.5000 1 - 100000 Il~%of the income in excess of 50000 I

Income tax structure proposed by advisory group

l~etween Rs. 100001-200000 IRs 50000 plus 20Ymf the income in excess of 100000

Income range

( ~ b o v e 200000 (RS 250000 plus 30% of the income in excess of 200000 (

Tax rates

L Source: ~e~orf-bj-ihhr Advisory Group bn -Tm ~ o l i c z d T u Adminrsrral,onjor the Tenth Plan (;00i), p.78, 'Lhblc 4.2. hrrp~~www.planningcammissron.nrc. t~L/uhou~us~camm~trrelwrkgrp~tp~arprpdf

All India Income Tax Statistics of the relevant years. 110 Report of the Advisory Group on Tax Policy and Tax Administration for the Tenth Plan

(Chairperson Partha Sarhi Shome) (2001), p.77.

Below Rs. 50000

" I lbid at 74.

Ibid.

""bidat 77.

Nil

Ministry of finance and company affairs with the objective to rationalize and

simplify the direct tax laws set up a task force on direct taxes. The task force agreed

in principle with the proposals of the advisory group. The task force recommended

for replacement by two slabs schedule as indicated in Table 1 1.

Table .. 1 1

I

Below Rs 100000 i l

Personal income tax structure proposed by the task force

]~s100000-400000 (20%of the income in excess of Rs100000/- 1

Income level Tax Rates

Incomes above Rs.4,00,000/- alone were to be subjected to tax at the

Above-Rs400000

marginal rate of 30 per cent and the uniform application of the 20% rate for a wider

slab between one lakh and four lakh. "'It wanted to ensure the benefits of tax cut to

be extended to all class of taxpayers rather than be restricted to taxpayers at the top

slab."'. Therefore it recommended elimination of surcharge of 5 per cent on

taxpayers with incomes above R~.60,000/-."~ While the Union Budget of 2001-02

abolished surcharge temporarily, the other recommendation regarding wide slabs

Rs 600001- plus 30Yoof salary in excess of 4,00,000/-

was not carried out and the brackets remained stagnant for eight years from 1997 to

2005.

The Finance Act, 2005 redesigned the slabs and widened it to certain extent

(Table 12) though there was slight improvement in the slab width, the maximum rate

of 30% was made applicable to income above Rs.2,50,000/-. This was contrary to

the recommendations of the task force and Shome committee. The rate structure still

suffers from the infirmity of being steeply graded at bottom level. The developed as

well as developing countries have incorporated smooth gradation into the rate

schedule at all income levels. The international practice was to subject only very top

Source: Report of the Tnsk Force, 2002.Table 4.1 .p 71

114 Report of the Tusk Force (20M), at 112: para 4.1 10. "' Ibid at 71 para 4.24.

'I6 Ibid at para 4.26.

income to maximum rates."' The denial of standard deduction nullified the benefit

of widening of the tax slabs introduced by the Finance Act, 2005 to the salaried

class.

Table - 12

Rate of Income tax for Individuals- 2005-06

I Slabs I Income Range Rate of Tax 1 1

2

1 4 1 Where the total Income Exceeds Rs.Rs.25,OOOI- + 30 % of the amount by which the 2.50.0001-. I total income exceeds Rs.2,50,000/- I

Where the total lncome Exceeds 1,50,000/- but does not exceedstotal Rs.2,50,0001-.

Source: Finance Act. 2005

Where the total lncome does not Exceednil Rs. One Lakh Where the total lncome Exceeds Rs. One Lakh but does not exceeds Rs.1,50,000/-.

Rs'Rs.5,000/- + 20 % of the amount by which the income exceeds ~s.1,50,000/-

The current progressive income tax is flat at the higher level. There is little

10% of the amount by which Total lncome Exceeds Rs. 1,00,0001-

doubt that low-income group pays larger portion of their income needed for bare

necessitie~."~ The tax structure during the aforesaid period has disproportionately

shifted the burden to low and middle income groups. The principle of equity

requires that a person with a higher income should pay relatively higher proportion

of his income as tax. Gradated tax is designed to lessen economic inequalities, the

progression presumably meant to affect not only high and middle incomes relative to

low incomes, but also high incomes relative to middle and low income^"^. In terms

of economic inequalities the position of those near but above the subsistence level

have position more akin to that of those below them who are exempt from tax.I2'

Appropriating half the income of a poor man through taxation is harsh than taking

half income of a milli~naire.'~' Pigou suggested that 'the amount of revenue to be

' I 7 For details, see Chapter 7. ' I 8 Randau, "Proportional VS Progressive Taxation" June 1998. hlfp://www.proaris.com/-randau2/

tmes/proport.html. p. 2. Visited on 23-7-2003. ' I 9 Walter J., Blun and Hany Kalven Jr. op cil at. 98.

I2O Ibid. at 99. 12' F,W.Taussig, Principles ofEconomics (1920 New York), Vol 11, p.480.

raised is such that the sacrifice imposed on the wealthy man is more than the total

satisfaction available to the less wealthy man before tax'.'2'

Hence the tax structure has to be redesigned. The experience garnered for

during these years calls for different tax schedule for salaried and non salaried

groups. Fixing a high nontaxable limit to low income assesses may provide a good

shelter to tax evading non-salaried assesses. On the other hand starting with a low

nontaxable income would unnecessarily harass salaried at the lower 1eve1.I~~ At

higher slabs also impact of bracket creep is more felt by salaried group. Hence

higher slabs also should be wide enough to provide for smooth progression.

Alternate proposals for an ideal tax structure were discussed during the

interview with prominent legal luminaries. Justice Bhaskar Rao proposed for a

uniform rate of 15% tax for salary above Rs.150000/- as in Russia (13%).Iz4 Flat rate

structure suggested by him was rather flat and easy for administration but not

satisfies the sacrifice test. Justice K.T. Thomas was of the view that there should be

gradation even at the top le~el'~'. After studying tax structures of different countries

the ideal one seems to be that of China which provides for a high exemption limit

and smooth progression.'26 Considering all aspects a model rate structure is

formulated which is given in Table 16.

Table - 16 Alternate proposal of Tax structure for salaried class

Income level I Tax Rates Below Rs 150000 1 Nil I

'*' Pigou, A shldy in Public Finance (3rd rev. ed. 195 I), p. 849.

~~ -.... ~~

Rs150000-250000 Rs250000-400000 Above Rs 400000

I23 For details see chapter 111.

lO%of the salary in excess of Rsl50000 Rs 10000 plus 20%of salary in excess of Rs 2,50.000 Rs 40000plus 30% of the salay in excess of Rs 400000

'" Justice Y.Bhaskar Rao expressed his opinion during an interview on 1.5.2003 at Chennai. Justice Bhaskar Rao was Chief Justice of Karnataka High Court and presently sewing as member of the National Human Rights Commission.

125 Justice K.T.Thomas (Former Supreme Court Judge) during his interview on 10.12.2003 at Kozhikode.

See chapter VI1.

As per the proposed tax structure, non-taxable limit is fixed at Rs.1,50,000/-

to avoid unnecessary burden to taxpayer and the department. The middle slab of

20% has been proposed for slabs between Rs.1,50000/- to Rs.2,50000, to avoid

bracket creep. The thirty percent rate is to be applicable to salary above

Rs.4,50,000/-. The gradation over four lakh fifty thousand has been flattened

because very few among the salaried have income above that level.

For making a progressive income tax operate in an equitable manner bracket

adjustment for inflation is necessary.I2' Annual indexing of income within the tax

brackets is intended to keep a taxpayer in the same bracket, as long as his or her

income increases no faster than the consumer price index.'28 Maintenance of

inflation at low level is considered a necessary part of an effective anti-poverty

strategy."' It distorts the functioning of the price mechani~m.'~~ The variations in the

price level are measured in India in terms of wholesale price index, or the consumer

price index meant to reflect the cost of living conditions."' Consumer price index is

computed on the basis of changes in the level of retail prices of selected goods and

services on which a homogeneous group of consumers spend major part of their

income. Inflation reduces the economic value of money and creates problems in

income taxation'32. Wholesale price index is recommended as most suitable for

income tax studies.')'

12' Final Report Tax Reform Committee Part-l (1992), p.30.

'" "California: Revenue and Taxation", (2005), http://ww.~sembly.co.gov/acdcommittee p.7. Visited on 9-7-2005.

12' Vineet Virmani, "Modeling Inflation in India- An Error Correction Approach" http://www.fineprint, corn.

"O Sunil Ashra, "lnflation and Openness: A Study of Selected Developing Economy" (2002),

http://www. india onstop.com/economy.linkhtm. p.2. Visited on 4-9-2003. "' Dr.Y.V.Reddy, "Inflation in India : Status and Issues" (1999),

http://www. india omtop. com/economy. link htm

(Paper presented by Y.V Reddy Deputy Governor. Reserve Bank of India at Centre for Economic and Social Studies, Hyderabad on August 17, 1999).

Younkins Edward.W, "Taxation And Justice," 30 September, 2000 http://www..quebecoisIibrr.org/. Dr.Younkins is the Professor of Accountancy and Business Administration at Wheeling Jesuit University in West Virginia. Visited on 5-4-2003. p.3.

Supra n.130.

A taxpayer who gets a cost-of-living wage increase exactly equal to inflation

will have more income but will have only the same buying power as in the previous

year."' In the absence of indexing, the taxpayer's increased income might bump him

into a higher marginal tax bracket, causing additional burden. Indexing keeps the

taxpayer's tax rate at the same level as the prior year, since the taxpayer's buying

power remains the same."5

Table - 17

Comparison of variation of non-taxable limit and WPI during years 1970 to 2005 I I I WPI 1 I I WPI I WPI I

Financial Exemption Financial Exemption I Year / Limit 1 '96'- 1 Year 1 Limit 1 19''- 1 I 62=100 82=100 94=100

- . . . . of Insustrial policy & promotion, Govt of lndia), http://delhiplanning.nic.in. EconomicSurvey/Chapter-6htm.#top, Office of Economic Advisor, Central Statistical Organisation (CSO), Ministry of Statistics and Programme implementation, Govt of lndia Web: http://eaindustry. nic.in/ visited on 12- 1-2006.

2004-05

Hence exemption should be linked to a minimum subsistence standard of

living. History of revision of exemption limit in India reveals inadequacy of

adjustments to account for inflation over the same period (Table 17). Since this is

supra n.128 at 33.

Ibid.

Source: Preoared bv referrine to the Finance Acts of various vears. Economic Advisor (Deoartment 50000 187.3

not often done or nor done promptly or adequately, taxpayers are pushed into higher

tax brackets with a rise in their nominal incomes.

Another important effect of inflation is that it tends to shrink the real width

of tax brackets. Any benefit of low rates is set off by 'bracket creep' due to

shrinking of tax brackets. Existing fiscal policy protects higher income groups only

against the evils effect of inflation, because they remain in the same tax bracket

since the tax rates are flat for higher i n ~ 0 m e s . I ~ ~ Inflation and progression of rates

affect assessees to an extent depending on rate of progression at that income'". Thus

inflation- induced tax increases are highest not on incomes where marginal tax rates

are highest, but on incomes where marginal tax rates increase most sharply'38. In

India rate structure being sharply graded at the lower level, inflationary tax increases

fall most heavily on low-income group with income just below or above the

exemption level where width of income bracket is small, but marginal tax rates

increase rapidly. Moreover, changes in the real tax rates, induced by inflation, are of

a permanent nature. After a while, further price rise may stop but the shift

introduced by inflation in tax rates will stay on for subsequent periods.'39

The Finance Act, 1992 introduced inflation indexation for computing long-

term capital gains.'40 Traders and industrialists get higher margin of profit as result

of inflationary rise in prices after the deduction of connected expenses in terms of

current prices. Hence these sources are sufficiently cushioned to absorb the

inflationary pressure as against the salaried group. After studying the harmful effect

of distortions by inflation the tax reform committee recommended that the

Supra n120 at 33.

13' lbid.

'I8 Ibid.

'39 lbid.

Section 48 of I.T. Act, 1961. Cost of acquisition should be increased by cost of inflation index equal to 75% of the consumer index for urban non-manual employees. A flat rate of 20% is applicable to long term capital gains arising to individuals and Hindu undivided family.

exemption level and the bracket limits have to be suitably adjusted upward.14' The

committee observed thus:

The top marginal rate of income now applies to incomes above Rs. one lakh which is equivalent to about to Rs.185001- in 1967-68.This is the result of inadequate indexation which has raised the effective tax rates at the lower end of the income tax scale. There would thus seems to be a case for raising the income level at which top marginal tax rate should apply and for adequate indexation.I4'

The committee recommended broad basing the various bracketslslabs'. The

Government ignored the proposal. The adviso~y group pointed out the defect of

non-indexation of tax slab to counter inflation.'" The Task Force recommended for

broad basing the tax slabs and revising it in accordance with their proposal. I M

An analysis of statistics of percentage of returns of salaried and non-salaried

groups for assessment years 1993-94 and 1994-95 (Table 18) and 1998-99 and

2000-2001 (Table 19) at different income levels is made to study the impact of

bracket creep due to inflation. The variation in price level was measured in terms of

the wholesale price index, which is considered to be more proper for such studies

than the consumer price index.'" The wholesale price indices for1993-94 and 1995-

95 were 258.3 and 285.2 re~pectively."~ The data in this respect go to show that

salaried group was pushed to the third slab from second owing to inflationary

pressure during the period. The data regarding the non-salaried indicated a reverse

phenomenon.

Table - 18

141 Fino1 Report Tax Reform Committee Part-l(1992), p.158: para 6.89.

'" Ibid. 14' Report of the Advisory Group on -Tax Policy and Tax Administration for the Tenth Plan (2001),

p.77 reads thus: "The tax rates of 10 percent and 20 percent were applicable for incomes up to Rs.10,0001- and Rs.20,000/- respectively, in 1973-74. The inflation adjusted corresponding income levels are Rs.1,00,0001- and Rs.2,00,000/- in 2001-2002.Contrast this with the existing corresponding income levels of Rs.60,0001- and Rs.1,50,000/- and these are substantially lower than the inflation-indexed levels thereby resulting in an increase in the real tax liability."

I44 Report of the Task Force on Direct Taxes (December 2002), p. 71: para 4.24.

I" Supron 130 at 33..

IMFs World Economic Outlook (April 2003), http/hvww India onestop. com/econorny-linkhtm.

Comparison of 'bracket creep' of salaried and non-salaried (individuals) for1993-94 & 1994-95

Range of

Salaried

J-r

Percentage of No. of returns

returned income

0-35

35-50

50-100

100-200

200-300

300-400

400-500

500-1000

1000+

Total

Returned income

salaried

1 1993-94: 1 1994:95

Source;Prepared by referring to All India lncome Tax Statistics

Directorate of lncome Tax.

Salaried

8.96

75.88

9.25

2.46

0.43

1.71

0,19

0.08

0.04

100

Table - 19 Comparison of 'bracket creep' of salaried and non-salaried (individuals)

for 1998-99 and 2001-02

salaried

5.52 2.01 38.53 45.05 5.05 1.62 0.73 1.2

0.25

Range of

salaried t?jis-

1993-94 Non-

Salaried

11.02

20.93

60.95

5.85

0.58

0.24

0.13

0.25

0.06

100

Percentage of returns

non-salaried 26

1994-95: Non-

salaried

1.89

36.38

54.08

4.9

1.36

0.77

0.46

0.1

0.09

100

and data of A.Y-2001-02 ( ~ L t o r a t e of lncome Tax)

1 Total 100

There was reduction in their numbers in third slab with a corresponding

increase in second slab. Similar analysis was made for assessment years 1998-99

Source; Prepared by referring to All India Income Tax Statistics AY-1996-97, 100 100 100

and 2000-2001. The wholesale price indices were 145 and 161 respectively.ld7 The

tax rates and structure remained stagnant during the period in spite of the hike in

wholesale price index. The salaried in the second slab in 1998-99 were pushed to the

next slab of one lakh and above in 2000-2001. The majority of non-salaried persons

remained below one lakh slab in spite of inflationary pressure during the aforesaid

period. It may be inferred from the analysis that impact of 'bracket creep' due to

non-indexation of inflation of slabs was more on the salaried than on the non-

salaried.

Dearness allowance is a compensatory payment to employees for erosion in

real value of their salaries, resulting from price increase.'" Dearness allowance is

admissible twice a year as on 1st January and 1st July and is payable with the salary

for March and September respectively in the same year. Each installment is

calculated with reference to percentage increase in the twelve monthly average of

consumer price index over the average index of 608, which is the base for existing

scales of pay.'" The increase in dearness allowance very often results in 'bracket

creep' of the salaried to the higher slab resulting in higher tax burden. Thus the

amount given to counter the adverse effect of inflation is set off by penal tax policy.

The Fifth Pay Commission has studied the issue and recommended thus:

The logic of giving allowances net of tax is irrefutable. Government decides a particular basic salary. Other allowances are added only to ensure that the real value of the basic salary is not eroded due to cost of living or to provide partial reimbursement of expenses incurred on certain items of expenditure like house rent, children's education, entertainment and the like. If such allowances are taxed, then either the basic salary gets eroded in its real value from year to year or the partial reimbursement of expenditure incurred on certain items becomes less

14' "Reserve Bank of India" (April 2003), http//www India onestop.com/ecanomy-1ink.htm.Visited on 4-12- 2003.

"India in Debt Trap-Remedies: Economic Survey: Dearness Allowance" (2004), http://wwwvinnyakinfosys.com p.2. Visited on 7-8-2005.

Id9 The formula for calculating DA is: [(I2 Monthly Average - 608) of AlCPl x 1001608) = The percentage increase in prices.

and less with passage of time. In both the cases, the objective giving allowances is partially nullified.'50

Tax experts, academicians and judges were consulted in this aspect. The

outcome of such discussion was that majority of them agreed that dearness

allowance should be excluded in the absence of sufficient indexation of tax brackets.

Large number of non-governmental employees receives remuneration as

consolidated amount. Wage increases are soon eroded by rapidly rising prices and

the need for an adjustment mechanism appears to be justified in equity terms. To

mitigate unintended tax burden induced by inflation and the resultant anomalies in

distribution of tax burden, the following measures may be adopted. To correct any

inflationary distortion, transformation of the original data to differentiate real from

nominal earnings was necessary."' Inflation tends to distort economic data that has a

price component and economist constructed a new variable known as inflation-

adjusted va~iable."~ The nominal (actual) wage data are corrected to arrive at the

inflation-adjusted figure by applying the formula: R = NIP1 * 100. (R = real value, N

= nominal value PI = price index).I5'

Taxable unit is another important component of the progressive tax

mechanism.'* India follows the imposition of tax on individual ba~is."~In a

homogeneous environment progressive taxation has long been known to cut income

differentials but the situation is far different in the heterogeneous case where

ho~seholds"~ differ in family size and composition.

I50 Report of the Fijfh Central Pay Commission (1997 Government of India), Vol 111, p. 2036 para.167.7.

151 "Inflation -Aadjusted Earnings" (2003), http://www uri.edu/artsci/newecdhtml. p.4.Visited on 2-6-05.

Is2 Ibid. 153 Ibid. ""upra n 28 at I 1

15' Ibid. 156 Sathya R. Chakravarthy,and Patric Moyes, "Individual Welfare, Social Deprivation and Income

Taxation" (200 I ), mvw. isical. ac. id-eru/discwsionpapers. html p. l .Visited on 23-4-2003.

Under individual basis system, a couple with income received by one partner

pays more tax than a couple with equal joint incomes, half received by each

partner.'" It ignores the fact that households and families are basic units in which

society is organized and needs and characteristics of a household differ

fundamentally from those of a single person.IJ8 There are several ways of allowing

for differences in family units. One is to give an exemption for each dependent,

either on a flat per-capita basis or in accordance with a schedule. In order to give

equal tax allowances for dependents to families of same size at different income

levels, each exemption is to be multiplied by the standard or basic rate of tax and

converted into a uniform tax credit.Is9 In this regard, our income-tax system is almost

alone among the income tax systems of the major countries in the world in not

having any degree of differentiation of tax liability according to the differences in

family obligations and circumstances of the taxpayer.I6'

The review of the tax literature regarding the disadvantages of an individual

basis revealed that the various Tax Committees appointed by the Government from

time to time considered this issue. The Tax tnvestigation Commission constituted in

1947 had expressed its view on the propriety of tax on individual basis.I6' Though

the Varadachariar Committee agreed in principle to the desirability of having

dependent tax allowance system, it desisted from recommending an alternate model

owing to practical difficulties at implementation stage.162 The matter again came up

for consideration before Tax Enquiry Committee appointed in 1953. The committee

Is' Final Report of the T m Reform CommiNee (1992). p. 120: para.6.27. I s Ibid. For detailed discussion Chapter VII.

Is9 The New Encyclopedia Britannica Macropaedia (15th edition), p. 407. For details, see Chapter v11.

'" Report of the Enquiry Commission, (1954) Vol. 11, p.136: para 1 I '" Report of the Income T m Investigation Commission (1949) Part-I, p.6: para.16. It reads thus:

"There is no denying of the fact that the exemption does not properly give effect to the principle of 'relating tax to the tax payers' .The exemption under the Indian law has no relation to the needs and circumstance of each individual assessee .A bachelor and a married man with large family and a man with no family are alike granted the exemption. A logical application of the principle 'ability to pay' will certainly require something like the allowance system of the English law related to domestic responsibilities of each tax payer". Ibid.

162 Ibid.

mdied the various aspect of the issue in the background of international practices

and observed thus:

For a completely satisfactory system of graduation related to family obligations, dependents should be taken into account. But a system, which does include benefits to dependents, may be inquisitorial and diff~cult to administer in Indian conditions; and on the other hand, a system, which does not include dependants, may, nevertheless, make an advance towards greater equity. We consider that recognition of a certain differentiation in the position of different income tax payers according to the size of the immediate family in its very restricted sense of the earner, wife and children will be a move in the direction of greater equity of the direct tax system.Ig

The Finance Act, 1956 fixed non- taxable limit of income tax and surcharge

on the basis of marital status of the assessee.lM Unmarried individuals were eligible

for nontaxable limit of Rs.1,000/- only, whereas married individuals were eligible

for a sum of Rs.2,000/-.1a

Table - 20

Income tax rates based on marital status-assessment year -1957

Ability to pay is limited by obligations in respect of maintenance of children

Slab No.

I

2 3 4 5 6

1 7 Ion the next 5000 ,, 15000 15000 ,,

also (Table 20). The Finance Act, 1957 introduced certain changes in fixing higher

18%1

nontaxable limit for married individuals with child dependents. To promote

Where the individual has no child wholly or mainly

dependent on him On the first 3000 of total income On the next 2000 ,, On the next2500 ,, On the next 2500 ,, On the next 2500 ,, On the next 2500 ,,

Source: Finance Act 1957.

Ie3 Report of the Tar Enquiry Commission (1954), p. 137. para 13, I M Part 1 A(i) of the first schedule to the Finance Act, 1956. 16' Part 1 A(i) of first schedule of the Finance Act.1956.

Where the individual has one child wholly or mainly

dependent on him 3300 of total income

1700 2500 2500 2500 2500

Where the individual has more than one child wholly or

mainly dependent on him 3600 of total income

1400 ,, 2500 ,, 2500 ,, 2500 ,, 2500 ,,

%

nil

3% 6% 9% 11% 14%

progressiveness of income tax system, the Act restricted the advantage only to

individuals having a total income not exceeding Rs.20,000/-. It fixed the nontaxable

limit at Rs.3,000/-, Rs.3,300/- and Rs.3,600/- for married individuals, individuals

with one dependent child and individuals with more than one dependent child

re~pective1y.l~ (See Table 21).

Table -21

Income tax rates based on marital status-assessment year -1957 I Slab I Where the individual has no I Where the individual has one I Where the individual has I I No. I child whollv or mainly I child wholly or mainly I more than one child wholly I % I ! dependent on him

Unmarried individuals and individuals having total income of more than Rs.20,000/-

were eligible for a lesser nontaxable income of Rs. 1,0001- only, so that high income groups

were to bear more tax burdeni6'. The exemption limit for dependents continued until

1965.'68 In the case of every individual who is not married and whose total income exceeds

Rs.20,000/- the rates are given in Table 21.

Table - 2 1

dependent on him - 1 or mainly dependent on him I

2 3 4 5 6 7

Rates lor unmarried individual - 1957-58 Slab No. I Range

I Ln the first 3000 of total 13300 of total income 13600 of total income [nil

On the first 1000 of the total income

Source: Finance Act, 1957

Source: Prepared from Finance Act 1957.

income On the next 2000 ,, On the next2500 ,, On the next 2500 ,, On the next2500 ,, On the next 2500 ,, On the next 5000 ,,

- Rate

Nil 3% 6% 9% 11% 14% 18% 25% -

1700 2500 2500 ,. 2500 2500 2500 11% 2500 ,, 2500 14% 5000 ,. 5000 ,, 18%

166 Para A, Part I of first schedule, Finance Act, 1957.

16' Ibid.

Finance Acts of 1958 to 1964.

The Finance Act, 1965 dispensed with separate nontaxable limits and rates

for married individuals1" and replaced it with tax concession for dependents. The

relief was in the form of reduction of a fixed amount from the tax. The eligible

amount for relief was fixed at Rs.1001-, Rs.1751-, Rs.1951-, and Rs.2151-

respectively for unmarried individual, married individual. married individual having

one child and married individual having more than one child.17' The Finance Act,

1966 enhanced these amounts to Rs.1251-, Rs.2001-, Rs.2201- and Rs.2401-

respectively.I7' The individual was given tax concession as against other taxable

legal entities.

The Finance Act, 1968 extended the scope of dependent benefits to

individual assessees who incuned expenditure in the previous year for maintenance

of parents and grand parents.172 The deductible amount was limited to 40% of the

amount by which total income of the assessee exceeded Rs.10,0001-.173 The pattern

continued in the next succeeding year also. The Finance Act, 1970 dispended with

relief for family obligations. Smt. Indira Gandhi during budgetary speech of 1970-

71 briefly spelt out the reasons thus:

... there is considerable force in the argument that tax administration would improve if income tax authorities did not have to devote so much time to smaller cases .Faced with this dilemma, I have decided to appeal to the higher court of family planning and I propose to do away with the present system where exemption is related to the number of dependents. In future, a uniform exemption limit of Rs.5,000/- will apply in the case of all non-corporate assesses irrespective of whether they are married or have children . The relief will be naturally greater for those who continue to seek relief from matrimony or parenthood as well. The change in respect of the exemption limit would involve some loss of revenue. But I have taken no debit for it as it should be more

169 Para A of Part I of first schedule to Finance Act, 1965. '" Proviso (ii) Para A of Part 1 of first schedule to Finance Act, 1965 171 Proviso (ii) Para A of Part I of first schedule to Finance Act, 1966. I n Proviso (ii) of Part 1 of first schedule to Finance Act, 1968. 173 Proviso (iv) (A) (2) of Part 1 of first schedule to Finance Act, 1968.

than offset by the improvement in tax administration resulting from greater concentration on cases involving the bigger assessees.'"

Administrative convenience thus got an upper hand of family obligations.

Unfortunately efficiency of the tax department did not improve in respect of 'bigger

assessees' by reduction of workload. Thus equity was forsaken in the name of

convenience and instead of saving the baby it was given to the waters, which

ultimately resulted in greater injustice to honest tax complying group like salaried

class. In fact during the seventies when rates reached sky rocketing heights, the

salaried income constituted more than half of the total income tax revenue.''* The

nonsalaried escaped tax liability through suppression and concealment.

Survey samples consisting of one hundred single breadwinner employee

families with two children and income range between Rs.1,50,000/- and

Rs.2,00,000/- were selected for the study. The data revealed that the assesses had to

spent 50% to 65% of their income for child development The status of the wives of

the assesses was as follows: Sixty of them were graduates, twenty postgraduates,

and the rest undergraduates. Majority of them wanted to contribute to enhance the

family income by taking up jobs but remained unemployed owing to lack of

employment opportunities. According to them the choice was not between job and

leisure but between unemployment and ill-paid jobs. Since needs of each family

differed with one another depending upon the lifestyles, expenditure behavior,

consumption, health, medical expenses etc, it was not possible to come to any

conclusion regarding the desirable amount for dignified life.

The impact of tax policy on family was studied by comparing the tax liability

of single earner employee as against double income group. In 2004-05 a single

earner employee with wife and children having an total income of rupees three lakh

was to pay tax of Rs.65,280/- (income tax + 2% education cess), which constituted

21.76% of the total income of the family. If the husband and wife earned the same

174 Budget Speeches of Union Finance Ministers1947 to 1990-91 (Government of India), p. 323. para 33. The speech o f Smt. lndira Gandhi, then Prime Minister and Finance Minister while introducing the budget for the year 1970-71.

175 AN lndia Income TaxStatistics A.Y. 1974 to 1984.

income equally, they had to pay Rs.33,0001- which forms only 11% of the total

income of the family. For the assessment year 2005-06 the tax liability of the same

couples would be Rs.400001- (13.33% of the total income) and Rs. 65001- (2.16 %

of the total income) respectively. The policy of granting rebate to women having

independent income is a good incentive.'76 The economically dependent women are

more prone to marginalization and this demands that tax policy should be more

lenient towards them. Women contribute to development not only through

remunerated work but also through a great deal of unremunerated work'". Women

perform great majority of unremunerated domestic and community work, such as

caring for children and aged persons, preparing food for family, protecting the

environment and providing voluntary assistance to vulnerable and disadvantaged

This work is often not measured in quantitative terms and is not valued in

national accounts.'79 Women's contribution to development is seriously

underestimated in India. More attention has to be devoted to areas of economic and

social structure, taxation and social security systems.

In the present economic condition of our country, parents' income and

wealth are a crucial determinant of human capital investments. Abres Erosa and

Tatyana koreshkova through their research work developed the quantum theory of

economic inequality due to parental investment in human and physical capital and

its impact on intergenerational transmission of earnings, income and ~ e a l t h . ' ~ Their

findings showed that when the taxes were proportional rather than progressive the

'" Old section 88 C of Income Tax Act. Women were entitled to a rebate of Rs. 50001- until 2005, as an incentive to take up jobs. In 2005-06, this concession is given in the form of higher exemption limit of Rs.135,0001- for women. Thus there is a decrease in the benefit to the extent of Rs.15001- for women in the higher tax brackets.

17' Dr. Rebecca Wallace, International Human Rights Text and Materials (1997), p.727.

Ibid. ' 7 9 Report of UN Fourth Conference On Women, 1995 Para 155. 180 Andr'es Erosa, Tatyana Koreshkova, "Progressive Taxation in a Dynastic Model of Human

Capital". November I, 2001 .p.3. http://www, economics. utoronto.ca/dirgor/paperdprogress rev.pdfVisited on 7-12-2003.

after tax returns to investment in education were higher and that reduction of wage

due to tax affected the benefits of human capital acc~mula t ion .~~~

The analysis of the treatment of single earner family and double income

family reveals that tax policy towards dependent wife and children does not conform

to human rights norms or 'ability to pay principle'. Household size is widely

accepted as a justification for differential treatment on the ground that larger

households have greater needs.lU2 One method that could be recommended for

rectifying the anomalies in this area is the application of quotient familial rule as

employed in France and Luxernbo~rg.'~' This mechanism requires a tax schedule t to

be set for single personal households and a suitable quotient y to be assigned to each

household's size.'" Taxes are then calculated for all households by deflating income

by the corresponding value of y, applying the tax schedule t , and multiplying the

resultant figure by the quotient factor *y'.'u5 The quotient values remained

unchanged over time; an income tax reform requires only a change in the single

personal tax schedule which then translates in a manner to the tax schedule of the

household^."^

Taxation can reduce the income of the rich but cannot raise that of the lower

level without making government expenditure a redistribute tool."' In the process of

liberalization, opening up and competitiveness, the incidence of dis-employment has

increased in India owing to closure of industries in major cities by way of

downsizing and voluntary retirement scheme.'88 An increasing number of people are

Patric Moyes and Anthony. F .Shorrocks, "Progressive Income Taxation and Household Size: In Praise of the 'Quotient Familial", June 1998, htpp://www/wwwvcharie.univ-mrs.fi/idep/Englis~page 4publi2dten.htm. p.1. Visited on 7-10-2003.This work forms part of the research work programme of the HCU net work "The Distribution and Redistribution of Income".

/bid

I" Ibid.

'" Ibid

Iu6 Ibid Is' G.S Chandawat, Distribution of Tax Burden and Expenditure BenefiLF (1999, New Delhi), p.7. 188 D.J.Mahajan, "Impact of Liberalization on Employment in India," Southern Economist

(June. 1,2002) p.9.

being forced to undertake casual employment with no guarantee for job security or

service conditions in the private as well as public sector'89. While in employment

they had to part with substantial amount of their pay by way of tax. There is no

social security measure to support the unemployed or dis-employed during the

period of unemployment. In developed countries the social security system is so

strong that during the unemployed period state will look after the employee and his

fa mil^.'^ While emphasizing the importance of social security arrangements, the

renounced Nobel Laurate, Dr. Amarthya Sen, opined:

The reason why there are no famines in the rich countries is not because people are generally rich on the average. Rich they certainly are when they have jobs and earn a proper wage; but for large numbers of people this condition fails to hold for large periods of time, and the exchange entitlements of their endowments in the absence of social security arrangements could provide very meager commodity bundles indeed. With the proportion of unemployment as high as it is, say in Britain or America today, but for the social security arrangements there would be widespread starvation and possibly a famine. What prevents that is not the high average income or wealth of the British or the general opulence of the Americans, but the guaranteed minimum values of exchange entitlements owing to the security system.I9'

In the absence of social security measures the government is not justified in

hardening the tax policy towards salaried class.

An analysis of major tax legislation since 2000 was attempted to understand

the legislative trend towards salaried class. Finance Act, 2001 denied the scope of

standard deduction of salaried to employees drawing salary above Rupees five lakh.

Entertainment allowance available to employees in general was restricted to

governmental employees by the Finance Act, 2002. Mr. Yeshwant Sinha while

presenting the budget for 2003-04 stated that 'salaried class suffers a more exacting

Subodh Varma, "The Indian Economy-1998-99: An Alternative Survey", Southern Economist (June.1,2002) 157,158.

IW For details see Chapter VI1. 191 The Amartya Sen and Jean Dreze Omnibus, Poverly and Famines Hunger and Public Action

India: Economic Development and Social Opporhrnity (Oxford University Press), p. 6 .

regime, therefore, as already announced standard deduction would be raised'.lPz The

sympathy expressed by the Finance Minister did not last long, as evident from the

subsequent legislation. The Finance Act, 2004 dispensed with deduction of

entertainment allowance. The Act amended section 71 and deleted the benefit of 'set

off against salary.19) Finance Act, 2005 withdrew standard deduction enjoyed by

employees. The simultaneous withdrawal of deductions on interest of securities

under 80L was a regressive step since retired employees usually seek safe

investment to supplement pension. Persons controlling big business houses, eaming

crores of unearned income, like dividends do not pay any tax on huge incomes,

while eamed incomes like salaries and wages are being subjected to tax and denied

even deduction for employment generated expense^.'^"

An analysis of the tax policy revealed that there is a paradigm shift in the

governmental policy. The government has hardened its stand against salaried group

in spite of their best compliance record.

The standard deduction to which the employees were accustomed for

decades was withdrawn by the Parliament without any discussion. This indicates the

inertness of political will in this behalf. The recommendation of the Task Force was

highlighted as reason for withdrawal of standard deduction. Several consecutive

recommendations with respect to non-salaried were not implemented. Taxation

Enquiry Committee 1953-54,'9' Sixth Five Year Plan Report of Planning

Commi~sion, '~~ and Tax Reform Committee Report 1992'97 recommended the

Budget speech of Finance Minister for 2003-04 para 147.Finance lndia (2003). p.47. 19' Finance Act 2004 section 14. 194 T.N. Pandey "Income Tax Issues That Need Consideration During 2006 Budget

Exercises"(2006)200 CTR 124,125. 19' Report of the Taxation Enquiry Commission 1953-54, p.35 I% Sixth Five Year Plan 1980-85, (Planning Commission, Government of lndia), p.77. It read thus:

"Fixation of minimum support and procurement prices for major agricultural crops and provisions of various inputs such as fertilizers, irrigation and electricity at subsidised price or concessional rates have helped to raise agriculture income particularly of large farmers. It is therefore necessary to consider measures for raising additional resources from agricultural sector and introducing a measure of progessivity in agriculture taxation."

19' Final Report of the Tax Reform Committee (1992), p.26. It reads thus: "It is well known fact that exclusion of agriculture income from tax base provides opportunities for tax evasion by

necessity of inclusion of agriculture income for promotion of equity. Similarly, Raja

Chelliah committee had recommended for taxing the allowance of the members of e

legislature^.'^' Shome Committee also took the same view in the matter.'" Wanchoo

committee has recommended for fixing a ceiling limit for allowing business

expenditure on the basis of international practice^.'^ The Finance Act, 1992

introduced inflation indexation of the cost of acquisition of assets and cost of

improvement for computing long-term capital gains."' Thus concessionary treatment

to long-term capital gains is given through inflation indexing, a relatively lower rate

of tax2'' and a set of exemptions2". Tax concessions and reduced rates are available

for dividend also.2M Preferential treatment once enjoyed by the salaried are now

available to long term capital gains, which are purely accidental in nature and bear

no proportion to the effort on the part of the recipient. The present policy violates

the vertical equity between the different sources of income. The implementation of

certain recommendations and non-implementation of others raise questions of

equity.

The analysis indicates that government is selecting only certain items for

implementation through legislation. Researchers have probed the reason for

distorted legislation in developed countries. Research work by Nicholas Marceau

and Michael Smart reveals the effect of lobbying by business corporate in shaping

camouflaging taxable income and black money as agriculture income. The urban elite own agriculture land farms at the outskirts of metropolitan cities for the sole purpose of diverting their high nonagricultural income from the taxable zone to tax haven."

19' Ibid at.149. para.6.74. I" Report of the Advisory Group on -Tax Policy and Tax Administration for the Tenth Plan, (May,

2001), p.130. Appendex 4.1. items 60 and 61. The Shome Committee recommended for the deletion of section 10(17(ii) and (iii) which provides for exemption from tax for constituency allowance and other allowance of members of legislature.

2W Report of the Taration Enquiry Committee, (197 I), p.23: para 2.69.

Section 48 of ITAct,1961. '02 A flat rate of 20% is applicable to long term capital gains arising to individuals and Hindu

Undivided Family *03 Section 112 of IT Act 1961. 2M Tax on dividends were abolished in 1997 and continued until 2002-03 then reversed at the

reduced rate of 10%.

tax policy in the United States.'os The work indicated that tax differences could be

attributed to differences in the intensity of lobbying efforts and had lead to lower

level of welfare of voters?" :In India no such documentation is available. The

existence of pressure groups and their participation and institutionalization are

critical elements in the development of responsive political system world over.z07

The influence of pressure group in the decision making of the government was

referred to by Justice K.P. Sivasubramanyam on his last day in office as follows: 'It

is not as though the Government is not aware of the situation. But, we do not have a

lobby of our own in a parliament or among politician^.'^^

If Government is selecting some sources to give concessional treatment from

taxpayers in similar economic circumstances then they will not be facing similar

liabilities209 The present policy adopted by the Government has far-reaching

consequences on the morale of the salaried group. Some believed that the

government is hard on the best complying group and soft on the manipulator^?^^

The agriculturists' organizations have strong political background.'" There

are number of best-organized associations of the business community. The nexus

between political parties and business groups and the dependence of the former on

the latter for election funds had been pointed out by Wanchoo Committee as one of

the reasons for tax evasion.212

Nicholas Marceau and Michael Bnart, "Business Tax Lobbying" (Jan.2000),

http://ww.sfi.ca~gmmyers/marceau.pdf.#searchincome p.3. Visited on 6-10-2004.

'" lbid. '07 Dr.S.Sen, Unique Quintessence gfAdvancedStudies, (2002), p.189.

'On The Hindu (13-9-2005). p.7. 209 Prof. Brian Andrew, Mark Hughes, Some Implications of D~ffermt Asia-Pat@ Tax Regimes.

Working paper at the School of Accounting, Banking and Finance Division of Technology and Management, University of Canb~:na.

2'" Hargovind Arora, "Budget-Hard On The Middle Class Sol? On The Manipulators". [2003] 128. Taxman 1 1 1.

'" Some such important associations are All lndia Kissan Congress, All lndia Kangar Sammelan, Kisan Janata, Akil Bharatia Kisan Sangh and All lndia Agriculturists Federation etc. The parties to whom they are affiliated are strong at state level.

2 1 2 Report of the Direct Tax Enquiry Committee (1971). p.9. para.2.20.

Employees have their own associations, which have links with political parties.

The trade union activities are mainly confined to issues like wages, job security,

improved working conditions ,and organizing strikes in protest of governmentd

policies affecting them. The unions at state level are powerful but at the all India

level there is no powerful lobby for them to stand for a common cause. The various

employee unions are also fragmented at national level. It was observed that except

for certain futile effort of employee unions of banks and central government, there

was no organized pressure group for the salaried to represent common cause like

tax. The associations of fragmented groups of employees try to protect their

segmental interests only. Even after the abolition of standard deduction the

employees were not able to exert any pressure on the Government during the 2006-

07 pre-budget discussions to restore the same. Whereas the industrialists were able

to highlight the anomalies in the fringe benefit tax through upper chambers at pre

budget consultation and the Finance Minister has agreed to revisit the topic?"

Proposals are made to rectify some of the anomalies in this area in the 2006

budget.214

It is hard to avoid the conclusion that tax policy is guided more by exigencies

of revenue than principles of efliciency, equity and simplicity.

213 The Hindu (12-1-2006), p. I .

Budget Speech of the Finance Minister 2006, The Hindu (1-3-2006), p.1.