How to design a better tax system
I see a lot of my peers bickering about whether it’s worthwhile to save 4000 rupees a year by switching to the new tax regime or should they ask their creative CA to come up with a scheme that saves them exactly 5231 rupees. I find these kinds of discussions to be pretty banal and borderline obnoxious. Young people should think about ideas, not taxes. Since the budget is up I think this is the correct time to email you something that I have been pondering for a while. Here is my attempt to answer the One question that keeps all economists awake; How to design a better tax system?
Before I try to come up with a solution, I think it’s helpful to remind the reader what exactly the utility of a tax system is. In my opinion, the tax system should do exactly two things:
- Raise enough money from the citizens to provide for public goods.
- Make it feel less coercive to the taxpayers.
While there has been a lot of intellectual energy being spent on what exactly should the deficit for the next financial year should be and how great GST numbers are climbing quarter on quarter, I find very little discussion on how to make the Design of Taxes such that more wage earner would be willing to donate their hard earned money to the treasury out of their own volition and how to enable young people to have more disposable income. The problem is psychological and not enough folks are talking about it.
Here I propose the Inverted Pyramid Taxation that addresses the coercive issues associated with a tax system.
There are two assumptions behind the tax design that I am proposing.
- Young people should earn more (and spend) than their older counterparts.
- A paltry savings of 2000 rupees a year in income tax for a VP at Big Phrama Co. does not make a significant dent in the financial health of the individual.
So here’s the idea; make income tax free up to the first Rs.X lifetime income and reverse the tax slab. Say there is a benevolent government who wants young people to have fun. What they should do first is make income tax free up to the first 30 lakh rupees that the individual might earn during their entire career. Whether it’s a BTech graduate slogging for 10 years at TCS or a 19 year old lucky crypto trader who took a huge option bet and made 1300x their investment, they would pay no tax for their first 30 lakhs. After the ceiling is crossed, they would pay tax to the treasury inversely proportional to their annual income. The more you earn, the less as a percentage of the annual wage you have to forgo for the sake of availing basic public goods. As a consequence, young people at the start of their career would have more disposable income as a percentage of the total income than their older peers. This enables the young to possess the Holy Trinity; the trifecta of Time, Energy and Money at the beginning of their wage-life. A saving of 10,000 rupees at the end of the individual’s career does not move the needle while for a young person it’s material.
This type of wonky tax design would incentivise wage earners to commit to themselves and earn more so that they may reduce their tax burden. If I, as an MBA grad, had already made 40 lakh in lifetime income by the age of 28, I would be more motivated to increase my income two fold so that the taxman knocks at my door with a reduced bill. As a young crypto trader who made a fortune, I should spend more on vacations, starting a business, and buying the latest iPhone than spending my days concerned about the government taking away 30% of my income.
The young have it pretty difficult to make a living in a country with per capita GDP hovering at $2,500. They have little credit history and banks don’t service loans to them unless they graduate from a Big-I (IIT/IIMs and their less fortunate cousins). That 25000 rupees savings at the end of the year might push an entrepreneurial individual to register a pvt ltd. and deposit the initial working capital. An older individual with two kids and a home loan would most probably forget about it or at best put it into a Fixed Deposit account. While both types of spending might look the same to an accountant referencing through a line item on a spreadsheet, in aggregate, that would make a material difference to the overall GDP of the country even if a tiny number of these bets taken by a few young people pay off.
On the flipside, older people earning more will pay a lower amount as a percentage of their total income, and the incentive for tax evasion lessens. The young will have more money and don’t have to worry about the taxman for a considerable time.
There are concerns too. This type of tax design expects total mapping of an individual's earnings. The taxman will have complete legibility over the individual’s financial footprint. In the absence of legal guardrails, techno-solutionism and KYC-hell would give birth to a weird surveillance state making people happier and anxious at the same time. There will be super-normal salary inflation at the edges of tax brackets and bad actors would under report their income. It might lead to a runaway inflation condition.