Posted by: Vikram | May 1, 2016

Who pays income tax in India ?

In 2014, 5 crore Indians (50 million) paid income tax. Many media outlets simply divide this number by India’s total population to make claims like only 4% of Indians pay income tax and so on. Then this number is compared to the same statistic for industrialized countries to show how non tax-compliant India is.

But a little more probing reveals that non tax-compliance of salaried professionals is a myth, at least as far as the matter of filing taxes is concerned. To really compute a meaningful number from the data about the total number of tax filers, we have to divide it by the possible pool of tax payers, not the population of the entire country.

So who can pay tax in India ?

There are three simple steps to arrive at this number. First, to be able to pay tax, you should be able to work, i.e. be in the potential labour force. The potential labour force is defined as the proportion of the total population which is above the age of 15 and below the age of 64. This is because one doesnt usually expect children below the age of 16 to be working, and people above 64 are usually retired or depend on their children. So what is the number of people in the 15-64 band for India, the world bank says its 65% of the total population, which amounts to:

0.65 * 123.6 = 80.34.

So 80 crore (803 million).

But of course, not all of these 80 crore are working. Many are students, some stay at home as housewives and so forth. So we have to further sharpen things to the number of actual participants in the workforce from these 80 crore. Again, the World Bank’s data tells us that only 56.5% of India’s possible workforce actually engages in economic activity, which gives us,

0.565*80.34 = 45.40.

i.e. 45 crore (450 million).

So is 5/45 the number we are looking for ? Not quite, there is one more step. In India, agricultural income is not taxed. Therefore, we need to subtract agricultural workers from the actual workforce. 50% of Indian workers are either farmers or farm labourers, so the pool to be subtracted from the 45 crore number is,

0.5*45.4 = 22.70.

So we are left with 45.4 – 22.7 = 22.7 crore possible tax payers.

The actual rate of tax payers then is, 5/22.7 = 22 %. So 22% of our possible pool of tax payers actually pays tax. A large component of the non-tax compliant population might be petty shop keepers, and low skilled workers like drivers and domestic workers.

But the point of this calculation is to drive home the message that the real problem is not tax-compliance, as much as it is employment. India’s private sector is incredibly small. Most of our workforce either sits at home or is trapped in low skilled farm work.

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