Is a Middle Class Tax Bonanza Coming? - The 5 Minute WrapUp by Equitymaster
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Is a Middle Class Tax Bonanza Coming?

Dec 29, 2016

In this issue:
» The Strange Dichotomy Between Cars Sold and Tax Paying Individuals
» Is this the New Hotbed of Corruption?
» Why Favor the Politicians?
» ...and more!
Rahul Shah, Co-Head of Research

Modi wants to increase taxes on stock market investors. At least, this was the most common interpretation doing the rounds after his recent speech. Markets tanked on Monday at the prospect.

There's no doubt the government needs more tax money. But they better not fall into the trap of linear thinking...or what we might call 'The Cobra Effect'.

Word has it that when the British were ruling India, they offered a bounty to anyone who brought them dead cobras. The idea was to control the growing cobra population. But the move backfired. Instead of going down, the cobra population went up. Turns out, people started breeding cobras to get the reward. And when the government saw this and cancelled the scheme, all the cobras were released in the wild.

Linear thinking assumes that increasing tax revenue is a simple function of increasing the tax rate. The Cobra Effect, on the other hand, alerts us to the reality of non-linear consequences. What if, instead of leading to increased revenues, the higher tax rates actually lowering revenues?

Arthur Laffer, an American economist and former member of Ronald Reagan's Economic Policy Advisory Board, had an intuitive understanding of the cobra effect in the realm of taxes.

Once, during a war of words about the president's tax plan, he couldn't take it any longer. He ordered for a napkin and drew an elegant chart. No one has been able to present the relationship between government revenue and taxes better than Arthur Laffer did on that cocktail napkin.

The chart was a simple 'inverted U', a hallmark of non-linear thinking. An 'inverted U' has a peak point right at the center and tends to go to zero at both its ends.

The idea is that there exists a certain tax rate at which the government will earn the maximum revenues. And it is the government's job to find this sweet spot. Anything lower than this optimum tax rate and tax revenues would drop. Anything higher and the revenues would still drop as people would start to evade taxes or even stop working altogether.

Whether you implement a 0% tax rate or 100% tax rate doesn't matter: Revenues would be zero. And it intuitively makes sense, doesn't it? Why would someone want to work if the government is going to take away all the income?

Personal income taxes in India were as high as 85% in the 70s. And still, there were people who felt Indian tax rates were too far on the left side of the 'inverted U' curve. That is, they thought tax rates could be hiked even more to reach peak tax collection. But since then, taxes have come down to 30%. And many now feel that tax rates are still too high and should be lowered to reach peak collection.

Either way, there's no denying the relationship between taxation and revenue is non-linear. There is an optimum tax rate. There is a level at which revenues will peak.

As far as taxes on capital gains are concerned, market participants believe they are already on the right side of the curve. Any more tinkering and it may not go down well with investors.

What about personal income tax rates? The slabs have remained constant since 1997-98. Still, they could well be on the right side of the curve; lowering income tax rates could actually end up increasing government tax revenues.

Will Jaitley oblige come February 2017? If he does and the government revenues do go up, it would be a double treat for the stock markets. Both the economy and the government finances would get a boost.

We see a minor, if not a big, relief coming for the middle-class tax payer. If for no other reason than to ease some of the pain from demonetisation. What do you think? Tell us.

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03:10 Chart of the day

Here's an obvious sign that many Indians may not be paying up their taxes very dutifully. As today's chart shows, the number of cars sold in India is actually higher than the number of people declaring annual income of over Rs 1 million.

Reports suggest that while annual car sales on an average in last three years has been about 2.6 million per year, the number of people in the country who declared an annual income of over Rs 1 million stood at just 2.4 million.

Further, while luxury brands like BMW, Jaguar, Audi, Mercedes, Porsche and Maserati sell almost 35,000 cars a year, an Economic Times report highlights that only about 48,000 persons reported income of over Rs 10 million in a year.

Yet another data point that indicates that many Indians are shying away from paying up their taxes; and thus personal income tax rates indeed being on the right hand side of the above mentioned 'inverted U' shaped curve.

India Low on Taxpayers, High on Car Buyers


Move aside government bureaucrats. The government's 8 November move towards demonetisation and its botched up implementation has seemingly led to a new hub of corruption: the good old commercial banker.

Earlier, corruption in banking was mostly centered around loan sanctioning to undeserving borrowers - that too mostly in public sector banks. But post demonetisation, bankers seem to be finding it hard to resist the temptation of a fast buck in many more an activity.

As per reports in a business daily, visits by income tax officers to Axis Bank branches across the country started early in December. The bank had alerted them about suspicious transactions in about 50 accounts. And the officers promptly arrived to inspect books, speak to executives and probe possible attempts to launder money.

While Axis Bank's name has perhaps done the rounds the most, many other banks too are being investigated for alleged complicity of their officials in helping many turn their black money into white.

For a business based on trust, Indian banks cannot afford to play with fire. They better clean up their act, fast.


It's no secret that political parties are a kind of black hole to black money. Much of these donations to political parties, being below the limit of Rs 20,000, happen in cash and remain unaccountable (one must note that political parties are currently not required to publicly disclose contributions of up to Rs 20,000). So while you and I need to show an identity proof while depositing our old Rs 500 and Rs 1,000 notes into a bank account, political parties can continue to receive donations of up to Rs 20,000 in cash. And they need not declare who gave those donations.

There is a scope that we as citizens of India can put an end to this discrimination. My colleague Vivek Kaul is on a mission to get us EQUAL RIGHTS. Vivek has initiated a petition to the President of India to request him to set things right. Thousands have already signed the petition. He needs 25,000 signatures before 6th of January to kick this off. Already, over 5,000 people have signed.

In case you haven't, it's time to do your bit now. Sign the petition, and become an agent of change.


We've written to you multiple times about how there was no scope for note printing by the RBI to match up with the required quantum of demand for things to go smoothly. And indeed, things are going anything but smoothly.

As per reports, workers at the RBI's currency note printing press at Salboni in West Bengal have now flatly refused to work overtime. For over a month, instead of nine, workers at the unit were working twelve hours a day. But reports suggest that many are unable to cope with the work load and have fallen ill. This new development will likely further contract the supply of badly needed new notes.


The Indian stock markets were trading flat today on the back of sedate buying activity across most index heavyweights. At the time of writing, the BSE-Sensex was trading up by just about 20 points. Gains were largely seen in IT and FMCG stocks.


"If anything, taxes for the lower and middle class and maybe even the upper middle class should even probably be cut further. But I think that people at the high end - people like myself - should be paying a lot more in taxes. We have it better than we've ever had it." - Warren Buffett

This edition of The 5 Minute WrapUp is authored by Rahul Shah (Research Analyst).

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6 Responses to "Is a Middle Class Tax Bonanza Coming?"

Pravin B. Rathod

Jan 2, 2017

In order to bring the large part of the Economy into mainstream post demonetisation and ensure atleast a three fold increase in number of assessees , the base income level should be increased to Rs 3 lacs and upto Rs 10 lacs -10% , Rs 10-20 lacs at 15% and above that at 20%. In few years the total tax collection will more than double. Post 1991 tax rates reduction , see the quantum jump in comparison.



Dec 30, 2016

There may be some relief for the middle-class tax payer. But those trading in stock markets may see a hike in Securities Transaction Taxes instead of increase in Capital Gain Taxes.



Dec 30, 2016

Regarding the issue of No.of car sold Vs.No. of I.Tax payers,probably KYC documents submitted to Banks by the individuals will provide a better picture,since while filling KYC details one tend to be more open.


V S Venkataraman

Dec 30, 2016

A very good attempt to convey the optimum tax level concept.


Muralidharan natarajan

Dec 29, 2016

Pain of demonetisation is mostly felt by the poor who donot pay taxes. tax relief is for the 3 crore or odd tax payers out of the 125 crores. Since these form the vocal group govt can convey a message of easing the pain easily while we need more measures to ease the pain of the majority.

Like (2)

Mukesh Malhotra

Dec 29, 2016

No one seems to factor the fact that a lot of cars are purchased by corporate bodies, firms, government departments etc who provide these cars to their senior and middle management. So merely arithmetically comparing number of individuals declaring income above 1 million and number of cars sold does not show the whole picture in the correct perspective. We should also count the number of business entities having income above a threshold and the number of cars purchased by government or quasi government bodies.

Like (3)
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