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Context: The Centre has distanced itself from a report containing proposals to raise taxes for tackling the economic fallout of the covid-19 pandemic.

Proposals in the report

  • A road map with specific suggestions on the revenue and expenditure side. 
    • An increase in the peak tax rate to 40%, introduction of a 4?ss on those with incomes above ₹10 lakh.
    • The introduction of wealth and inheritance taxes
  • The report opined that the government needs to mobilize resources to support the vulnerable sections of the economy.
    • Raising taxes would help bridge the fiscal deficit as the government's tax revenue is suffering due to closure of economic activity.

Implications of taxing Rich

  • India already has a system of taxing the rich significantly in the name of progressive taxation.
    • A narrow tax base has led to an increase in tax burden on taxpayers, resulting in higher levels of taxes, especially on the wealthy
      • Even among the 2.5% Indians who pay income tax, there is huge inequality. Less than 4% of taxpayers pay 60% of the tax income.
    • It needs to be put in perspective that public services provided in the country from public resources are often not even comparable with those in similar developing countries.
    • Tax revenue, tax rate and economic growth have a complex relationship
      • The Laffer Curve shows how increasing tax rates beyond a point results in lower revenue. 
      • This happens as higher tax rates impact both growth and tax compliance. 
  • The best lesson for the consequences of a hike in taxes during a slowdown is from the US in the 1930s.
    • The highest income tax rate was raised from 25% in 1930 to 79% in 1936
      • Similar policies were adopted in Britain and Germany around that time. 
    • These had an impact on delaying recovery from the Great Depression and led to the Keynesian idea, which argued for increased government expenditure or a tax cut during a slowdown.

Global patterns of raising taxes during a lockdown

  • There are very few examples of countries increasing tax rates during a slowdown. 
    • Most of the developed countries cut taxes during a slowdown to boost demand and increase the disposable income of their population. 
    • The alternative is to leave taxes as they are, while the government raises its expenditure, even if this leads to an increase in the deficit.
  • The experience of the Great Depression makes it evident that resource mobilization should not be a concern during a slowdown.

Laffer Curve

About 

  • The Laffer curve, popularised in 1974 by economist Arthur Laffer is often used to bolster the argument that high or increasing tax rates will not yield additional tax revenue.
    • It is based on the reasoning that because in such circumstances  members of the workforce will opt to work less substituting earned income with leisure. 
    • The curve supports the notion in supply-side economics that tax and regulatory burdens can impede growth.
    • Typically, it has an inverted-U shape.

Source: Investopedia