The Middle Class in India and the Burden of the Union Budget

The Middle Class in India and the Burden of the Union Budget
Arun Kumar
CESP, SSS, JNU, N. Delhi 110067.

The middle class in India is not the middle of the population distribution. In a population of about 118 crore it is not the 40 crore who fall in the middle of the nation’s income ladder. In fact, most of this middle is poor if not extremely poor (below poverty line). So, who constitute the Indian middle class?
They are the families with purchasing power to buy conveniences of life. In the Indian context such people are the well off, say, the top 10% in the income ladder. They are not the well off by international standards but those of a very poor country with a per capita income of around Rs.45,000, one of the lowest in the world. Hence our middle class is also one of the poorest by world standards.
According to the NSS data for 2004-05, 96% of Indians spent less than Rs.48 per person per day or for a family of five they spent less than Rs.7,200 per month. Only 1 % of the families spent more than Rs.12,500 per month that year. Add to these numbers the black incomes of the rich families which are not declared to the authorities. Further, assume that due to inflation, these figures have doubled since 2004-05. Accounting for all this, the middle class would be not more than 10% of the population.
The middle class is largely out of the income tax net. There are about 35 million individuals (3% of the population) who file income tax returns but only about 10 million (1% of population) pay effective taxes while the remaining 25 million declare very little income and pay negligible income taxes. Thus, income tax is relevant for 25 million middle class individuals (2% of the population) and mostly affects the rich (1% of the population).
There are several reasons for this low tax base. First, there is a large black economy so businessmen and professionals only declare a small part of their actual income. Secondly, taxation begins at about 500% of the per capita income. Thirdly, there are a large number of deductions and concessions which take incomes out of the income tax net. Finally, agricultural incomes are exempt from income taxation. However, even if agricultural incomes were formally taxed, little would have been collected from it since these incomes are mostly below the tax exemption limit and the share of this sector in GDP is declining.
The direct tax net has been narrow since most of the property/wealth taxation has been reduced over the decades. For instance, more wealth tax was collected in 1976 than now even though property and share prices have shot through the roof – the reason is that they have been mostly exempted from taxation. Capital gains, gift taxes and estate duties have been largely diluted or eliminated. These taxes help in collection of income tax so their reduction has weakened the base of income tax.
Consequently, our income tax structure is regressive even though formally it is progressive. The richer one is more is the share of property income and since most of that is exempt, they pay on an average a lower tax rate than the middle class does. The rich shoot from the shoulders of the middle class when they demand lowering of the income tax rates – they are its real beneficiaries and not the middle classes. No wonder India has one of the most moderate income tax rates in the world.
The middle class pays more tax through indirect taxes on their consumption (customs and excise duties and sales tax) than the income taxes. Indirect tax raises prices of goods and services and lightens the pockets of the consumers. The entire consumption is taxed through the indirect taxes. Thus a middle class family that may be paying 5% of its income as income tax may end up paying 15% through indirect taxes because it consumes most of its income. A rich family in contrast consumes a tiny fraction of its declared income, say, 5%. Thus, even if it consumes luxury goods where the indirect tax rate maybe 50%, it only pays 2.5% of its income as indirect tax.
Thus, the rich families pay little direct taxes because of the black incomes and the low income tax rates and they pay little indirect taxes since they consume little of their incomes. The middle class gets fooled into demanding reduction in direct taxes because it sees direct tax being deducted from income but does not think of inflation due to indirect taxes as a tax on its income.
The rich get a large part of their incomes from the ownership of the corporate sector which is concentrated in the hands of 0.1% of the population. They are getting more than 20% of the national income whereas the 55% working in agriculture are getting only 15%. This is partly because the corporate sector gets Rs.5 lakh crores of tax expenditures (indirect subsidies) which boost its incomes. In effect, massive income disparities are being generated in the economy both because of the black and the white incomes. No wonder India has one of the largest number of billionaires in spite of massive poverty and has one of the lowest Direct Tax/GDP ratio in the world, even compared to the developing countries.
In brief, the combined effect of direct and indirect taxes falls on the middle and the poor classes rather than on the rich who are increasingly cornering the nation’s income. If the black economy, about 50% of GDP, could be brought into the tax net, the nation could collect an additional Rs.14 lakh crores of taxes. Then, indirect taxes could be mostly eliminated, benefiting the poor and the middle classes. But, that is like asking for the moon since the black economy is controlled by the elite in society – the businessmen, the politicians, the professionals and the executive – who have little interest in checking its growth.
arunkumar1000@hotmail.com