The missing taxpayer in India’s middle class

There is much middle-class angst at the heavy burden it bears on income taxes paid. Other than the dysfunctional nature of government services and a deeply corrupt interface with government agencies, what weighs heavily on the middle-class heart is the fact that so many people remain stubbornly outside the tax net. These people are seen with their wads of untaxed cash even as the taxpayer uses his tax-paid money via a card or UPI. But it is worth examining the question: How much is it that India is missing in unpaid direct taxes on the middle-class individual? I could not find a recent number in an academic study that nails this down, so I have tried some back-of-the-envelope calculations. I find that the amount of tax exempted (agricultural income) and evaded is almost ₹8 lakh crore for 2020-21 by the middle class. This is an annual loss. Just for perspective, the total budget for 2020-21 (tinyurl.com/mparfdr9) was almost ₹27 lakh crore.

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But what is the definition of this middle class? Those households with income between ₹5 lakh and ₹30 lakh at 2020-21 prices comprise the middle class, based on a report titled The Rise of India’s Middle Class by the People Research on India’s Consumer Economy (PRICE). You can see the executive summary of the report at tinyurl.com/2u4a9b7v. The study finds that there are 432 million people in this income band in India.

But this is household income data that that says there are 432 million people with a household income of between ₹5 lakh and ₹30 lakh a year. Therefore, we need to estimate how many taxpayers there might be in each household. Given that the average size of the household is 4.4 (tinyurl.com/3ynbc2p2) and further assuming that each household has just one taxpayer, there are 98 million people who might be eligible to pay tax. There can be households with no taxpayers, or households with more than two. For a rough estimate, I am taking one taxpayer per household.

Next, I take the tax data from the release from the Income Tax Department for financial year 2020-21 (tinyurl.com/mvmu3h86) to see how many of those defined as middle class file returns and pay taxes. I look at the number of returns filed, which is according to the tax slabs for individuals. This includes income from salary, capital gains, house property, business and profession and other income. The number of returns between the ₹25 lakh and ₹50 lakh slab is bunched together, therefore, I make a further assumption that 20% of the taxpayers will be in the ₹25 lakh to ₹30 lakh tax band. As per these assumptions. the total number of returns filed in the individual income band of ₹5-30 lakh is 15 million. Remember, these are, at best, back-of-the-envelope numbers.

Now comparing the two sets of data — the number of middle-class people in India and the number that file returns, around 83 million middle-class individuals are out of the tax net. Remember that the final number will be larger if we include the rich (incomes above ₹30 lakh a year) in this calculation.

Then comes the question: How much is the tax not collected due to those escaping the tax gaze? The individual taxpayers between income slabs of ₹5 lakh and ₹30 lakh paid ₹1.41 lakh crore in financial year 2020-21. Using the same ratios, if those who did not, had actually paid, India would have another ₹7.8 lakh crore in its coffers. To put this number in context, this is almost 30% of the 2020-21 budget. A substantial part of this can be attributed to agriculture, as that is a big exemption given to income. If I include the rich in this calculation, the amount of tax evaded and exempted is much higher. But this discussion is about just the middle class.

For decades, various governments have tried to bring those outside the tax net into it and have failed. But today, the government has big data. It has the means to go after people who are outside the tax net. Why is that not being used to increase the direct tax amount exponentially? Unfortunately, the easy solution has been to harass and scratch away at the already compliant taxpayer through such regressive ideas as tax collected at source for overseas spends. Why does a country that can put the UPI system in place, run a massive vaccination programme during Covid, and facilitate cash transfers at scale, fail to get more people to pay their fair share of taxes? The wait for formalisation has been a long one and the tax-paying middle India is losing patience.

The mood on the ground is a feeling that it has played the wrong game; that being compliant is a mistake. Charlie Munger, the legendary investor and vice chairman of Berkshire Hathaway, famously said: “Show me the incentive, and I will show you the outcome”. The incentives to go dark look appealing. And it is a bad place for a country to be if those that are legit begin to want to go dark.

Monika Halan is the best-selling author of the Let’s Talk series of books on money. The views expressed are personal

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