When Indira Gandhi brought 97.5% income tax rate

Cometh elections in India, cometh big promises of eradicating poverty through swift measures. While most poll promises do not see the desired implementation, their pitch and emphasis by political parties suggest the country's economic drift.

The Indian economy thrived after the 1991 LPG (Liberalisation, Privatisation and Globalisation) reforms, but the country's economy was in a shambles till the 1980s due to the socialist tendencies of the government.

In 1970, the Indira Gandhi-led government increased the direct tax rate to as high as 93.5%, which went on to become 97.5% in 1973-74. The government's move, mirroring the global trends which villainised wealth creation.

Indira Gandhi saw taxation as a "major instrument to achieve greater equality of incomes and wealth".

Her policy to tax a small pool of people heavily, instead of widening the tax net, didn't work. Large-scale tax evasion forced the policy to be withdrawn within years.

PERSONAL TAX RATES IN INDIA

In 1949-50, then Finance Minister John Mathai tinkered with the tax rates for the first time. He reduced tax on incomes up to Rs 10,000 by a quarter of an anna, from one anna to nine pies in the first slab, and from two annas to "one nine pies" in the second slab.

An anna was a currency unit formerly used in India, which was equal to 1/16 of a rupee. It was divided into 4 paisa or 12 pies, thus there were 64 paise in a rupee and 192 pies.

After this, India adopted a progressive tax regime, and personal income tax rates were extraordinarily high during the decades of 1950-80. While the maximum income tax rate (including the surcharge) in the 1950s was 25 per cent, it shot up exponentially to 88 per cent in the 1960s.

THE BUDGET OF 1970-71

On February 28, 1970, then Prime Minister Indira Gandhi, who also held the finance portfolio, read her Budget speech in Parliament. The theme of social welfare was central to the Budget and a number of provisions were made for the agriculture sector, which was in the thick of Indira Gandhi's policies following the Green Revolution.

To fund these social welfare programmes, the government required major funding from the exchequer. With Indira Gandhi being a strong opponent of foreign direct investment (FDI), the taxpayer had to bear the brunt of her socialist ambitions.

"Taxation is also a major instrument in all-modern societies to achieve greater equality of incomes and wealth. It is, therefore, proposed to make our direct tax system serve this purpose by increasing income taxation at the higher levels as well as by substantially enhancing the present rates of taxation on wealth and gifts," said the Prime Minister in her speech.

In her speech, Indira Gandhi announced an income tax rate of 10% on income between Rs 5,000- Rs 10,000, which progressively went up to 85% for income above Rs 2,00,000.

With the addition of the surcharge at 10%, an astonishing 93.5% tax rate was applicable on those with income above Rs 2,00,000.

In simpler terms, this meant that for every Rs 100 earned by a person above Rs 200,000, he/she could get just Rs 6.50.

Moreover, the personal income tax had 11 tax brackets in 1970-71.

In their paper 'Trends and Issues in Tax Policy and Reform in India', M Govinda Rao and R Kavita Rao note that "the increase in income tax rates to confiscatory levels was completed immediately after the split in the Congress party in 1969 and appeared to be a part of the effort to give the party a pro-Left image".

THE 97.5% TAX RATE AND TAX EVASION

The progressive taxation did not stop there. Even as India emerged victorious in the war of 1971 with Pakistan, the war strained the economy further.

"Fiscal instruments must be deployed to discourage payment of high salaries and remunerations which go ill with the norms of an egalitarian society," said former Finance Minister YB Chavan in his 1971 Union Budget speech.

In the Budget of 1973-74, YB Chavan proposed an increase in the surcharge to 15%, taking the highest tax rate applicable to an individual to an astronomical 97.50%.

A report by the Direct Taxes Enquiry Committee in 1971 attributed large-scale tax evasion, among other reasons, as a result of the exorbitant tax rates.

"Prevalence of high tax rates is the first and foremost reason for tax evasion because this is what makes the evasion so profitable and attractive in spite of the attendant risk," the committee report stated, recommending a reduction in the marginal tax rate to 75%.

This change was implemented in 1974-75, when the marginal rate was brought down to 77%, including a 10% surcharge. In 1976-77, the marginal rate was further reduced to 66%.

A major simplification and rationalisation initiative came in 1985-86, when the number of tax brackets were reduced from eight to four and the highest marginal rate was brought down to 50%.

The last wave of reform in personal income taxation was initiated based on the recommendation of the Tax Reform Committee, 1991. The tax rates were considerably simplified to have only three tax brackets of 20, 30 and 40% in 1992-93. Further reductions came in 1997-98, when the three rates were brought down to 10, 20 and 30%.

Prior to the ongoing Lok Sabha elections, the Congress has made promises to make people lakhpati without offering a real road map for funding such policies. Unlike the 1970s, India may not be allergic to FDIs, but the discussion around reintroducing inheritance tax and wealth tax and the idea of wealth redistribution surely reminds of the socialist times.

These are the times of widening the tax net, not overtaxing the small percentage of people who diligently pay their taxes. Otherwise, the policy will backfire, as it did during the time of Indira Gandhi.