A Macroeconomic Model for Income Tax Assessment for the Country

Copyright © IFA C Dynamic Modellin g a nd Control of National Econom ies, Budapest, Hungary 1986

A MACROECONOMIC MODEL FOR INCOME TAX ASSESSMENT FOR THE COUNTRY S. Philipose Natiullal IlI stit utl' fi}/ - Traillillg ill IlIdwtrial ElIgilll'I'ri,lg. Vihar Lail!'. BOlllbay -lOO 081. IlIdia

Abstract. In the taxation policy of the Government income tax is the main source of income by way of direct taxes. Even though the amount collected by income tax is small in volume the income tax policy is very much affected by public opinion as it affects the middle income and high income group people directly. The net revenue which is to be collected by way of income tax is a predetermined amount by the policy makers. Keeping this in view how well an income tax policy can be formulated? This is done by developing a goal programming model. Different aspects of taxation policy of the previous year and the necessary changes required are incorporated in the new budget. The investment opportunities in Life Insurance, National Saving Certificates, Unit Trusts etc. and their tax rebates are accounted in the model. Number of people for different income slabs is projected for the country. Then the model is developed to fit into the different requirements and the constraints. The method adopted till today is purely on hit and trial basis. This goal programming model decides the taxation rates for different income slabs satisfying the goal which is only one in this case. This is explained with the current budget of 1985. Keywords. Taxation policy, goal programming, tax rates, investment opportunities, constraints, tax slabs. INTRODUCTION Taxation at any time was used to raise resources for the running of the administration and performance of other essential duties of the country such as defence, education, law and order, provision of roads and public utilities etc. After the independence taxation became a tool to remove the disparities in income and wealth in Indian Society and thus to realise the dream of equitable distribution of material wealth and mobilising resources for economic development. The structure of taxation as well as the incidence of taxation on corporations and individuals has far reaching effects on the economic life of the people. Even though the amount collected by personal taxation is much less compared to the indirected taxes of the country, the taxation policy of the country attracts countrywide criticism as many people are affected by personal taxation. Out of the 700 millions of India only 4 million persons are coming under personal taxation. It is about less than 10% of the country's budget, which is met by the revenue obtained by personal taxation. In this paper a method to obtain a predetermined amount of income tax to be procured by the Government is explained showing the conditions of 1985-86 financial year.

permitted should be very explicitly and unambiguously stated. Subsequent to the definition of the tax base, the tax rates are to be specified (Chawla, 1981). Taxable Income Income is often defined to provide a measure of the welfare enjoyed by an individual. This definition does not serve any useful purpose for income taxation as welfare is not measurable. The welfare enjoyed by an individual is, therefore, converted into money terms for quantitative measurement and this money counterpart of the individual welfare is regarded as his income. Income can be defined in terms of what has been accrued to an individual as measured by the amount of his consumption plus a net addition to his wealth. Under this definition undistributed profits of companies and unrealised capital gains also become income of the individual alongwith every other income which is received. In view of the difficulties in measuring accrued income, taxation in Indi a is bas:d on the concept of realised income. Accrued income is said to be realised at Jne time or other in the life span of an individual or at the time of his death. In an individual~ life span the total accrued income is equal to the total realised incomes so that the life time tax liability of an individual would remain unaltered (except when tax rates change and/or irregular income co-exist with a high degree of progress).

STRUCTURE OF PERSONAL INCOME TAX Every tax has an explicitly defined base. The definition of the tax base should very clearly state what is to be included in and excluded from the tax base. Also the definitions and exemptions that are 13 1

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taxable income in India. Under Indian income tax total income of an individual is defined as income received or deemed to be received or income accrued or deemed to have accrued within and outside India. The income for income tax purpose is recognised under 6 broad heading~ (a) Salaries (b) Profits or gains of business or profession c~ Capital gain d Income from house property e Interest on securities (f) Income from other source.

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Exclusions. Exemptions and Deductions Exclusions. These consist of such incomes which are exempted from the purview of income taxation and excluded from the tax base in the interest of certain socio economic objectives. Major exclusions are all agricultural incomes, superannuaation funds etc. Deductions are normally permitted because they are in the nature of expenses to earn income and also because equal incomes do not necessarily represent equal taxable capacity. Exemptions. These are allowed with a view 0 permit a minimum standard of living or some amount of money income which does not reflect the tax-paying ability of the individual. This provision of exemption brings that element of progress in the income tax into the tax policy. The major exemptions are classified under Section 80L of Income Tax Act. Major items under this are as follows: (a) Interest from deposits in Nationalised Banks, dividends from companies and other specified incomes upto Rs. 7,000/-. (b) Interest from the investments in Unit Trust of India upto Rs.3,000/Deductions. According to this certain percentage of tax deductions are allowed if investment is made in specific category as announced by the Government from time to time. These investments are mostly in the Goyernment funds and it is utilised for the utility of the public. The investment policy of public is very much dependent upon the percentage of allowance given at different investment slabs. The money to be procured by the Government by this method can be predicted. They are given as Section 80 C of Income Tax Act. For the year 1985-86 the following investments will fall under this category (Sanghania, 1985). (a) Premia paid to the Life Insurance Corporation of India· (b) Provident Fund which is deducted from the salary (c) Public Provident Fund Scheme which enables the self emplo yed persons and others to save income tax. This is at present collected by the nationalised banks. (d) Investment under unit linked insurance plan of Unit Trust of India. (e) National Saving Certificates of VI & VII Series. Other major deduction is under Section 80CC of Income Tax Act. Under this investment in newly established companies is encouraged. Fifty percent of the investment in a new company or Rs.10,000/-

whichever is less is exempted from the taxable income. The rate of tax deductions under Section 80 C in the 1985-86 is as follows: a~ First 6000 Rs. - 100% deduction Next 6000 Rs. - 50% deduction Above12000 Rs. - 40% deduction

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INCOME TAX SLABS, WIDTH AND RATES The income tax slabs for the year and the income limit of the people to be exempted completely from the tax are to be decided depending upon several socio-economic considerations. Initially the slabs and slab widths can be put as parameters. In 1985-86 income tax policy the following considerations are made for Slabs and slab width tSanghania, 1985) (a) Upto Rs. 18,000 No Tax (b) Rs.18,000 - ~ .25,000 25% of the amount by which the total income exceeds Rs. 18,000/-. (c) Rs.25,000 - Rs.50,000 Rs.1,750 + 30% of the amount by which the total income exceeds Rs.25,000/-. (d) Rs.50,000 - Rs.1,00,000 Rs. 9,250 + 40% of the amount by which the total income exceeds Rs. 50,000/(e) RS.1,00,000/- and above Rs.29,250 + 50% of the amount by which the total income exceeds Rs. 1,00,000/-. FORMULATION OF THE PROBLEM It is always expected by the income tax policy makers to collect certain amount of income by way of income tax. The objective of the policy is to attain this pre-conceived amount by way of taxation. As we a re not sure about the attainment of this amount a goal programming model is formulated to obtain a satisfying solution. Notations Xj = The rate of income tax at jth slab expre s sed as proportion A. The slab width of the jth income J tax s l ab. That is the difference between the upper and lower limit of the jth slab. Ao The lower limit of the 1st income tax slab. That is tax exemption is provided to an individual upto Ao income Umi t. nj = No. of taxable people in the jth income tax slab. No. of people fallin g in the jth income slab with gross income. Taxable income of the ith individual in the jth income tax slab. ~ Average taxable income of the indilJ viduals of the jth slab. gij = Gross income of the ith individual in the jth slab. Here slabs for the gros s income is taken as the same as that of the proposed taxable income slabs. U. ,Lj=The upper and lower limits of x . • J That is the range in which the J taxation rate can vary in jth income tax slab.

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Macroecollomic Model for Inco me Tax Assessment

M

+ d,d

= The pre-conceived amount to be recovered by income tax from the country. = The over achievement and under achievement of the amount M by way of income tax. = The proportion of saving possible in the .th gross income tax slab J under Section 80 C of Income tax. = The amount considered for the jth rate of deduction under Section 80 C of income tax. jth rate of deduction under Section 80 C of income tax.

Determination of Number of Persons in S!,n Income Tax Slab The number of people falling in the j th taxable income group can be predicted from the number of people with gross income falling in the jth, (j+1)th, income group and other influential factors. nj = f(n gj , ngj +1 , Sj' Sj+1' k j , k j +1 , Yj' Yj+1) It is unlikely that a person belonging to (j+2)th or higher income slab can belong th to taxable income of j slab. So, ngj+2 and higher income slabs are not considered. a can be obtained separately by ij ~ecasting or can be approximated as a x n .• Here ~ value is predicted ij J ~J th with the gross income level in the j slab and (j+1)th slab as (j+2)th slab and above are negligible and so the approximation is valid.

Determination of Average Taxable Income Depending upon the previous year's data one can forecast the average taxable income of the individuals in the jth income tax slab. This is a function depending upon several influential factors and can be expressed as follows:

aij

Amount collected from income tax slab 1 = n 1 X L (a 1j - Aa) 1 j=1 For income tax slab 2 upto the upper limit of first slab the total amount recovered is x1 A1 n 2 • For the remaining amount which falls in the second slab the rate is x2 • Therefore, this will amount to

n2

x2 L (a 2j - Aa - A1 ) j=1 So, the total amount collected from the individual which falls in the second income tax slab n

= x1 A1 n 2 + x2

L

2

(a 2j - Aa - A1 ) j=1 Similar way the tax collected with the rates x1 ,x 2 ,x 3 ,x 4 , from the slabs 1,2,3 and 4 respectively can be found out. Total tax collected n1 n2 x 1 L (a 1j -Aa)+x 1 A1 n 2+x 2L j=1 j=1

(a3j-AO-A1-A2) + x1 A1 n4 + x2 ~ n4 + n4 x3 A3 n4 + x4 ~ (a4j-AO-A1-A2-A3) j=1

'oJ

= f(gij' Sj' kj' k j +1 , Yj' Yj+1' n j ,

gij+1' s j+1 ) GOAL PROGRANMING MODEL FOR THE INCOME TAX POLICY d+ Over achievement or excess over the amount M. d- = Under aChievement or deficit over the amount M. Then the problem having only one goal, the objective function can be stated as Minimize Z = d(1 ) Here we want to minimize the under achievement only and over achievement is beneficial to the decision makers in this case. The constraints are as follows: (1) The amount to be collected and its deviations should be equal to M. Taking 4 income tax slab as at present tax collected at different slabs can be found out.

So, the constraint which satisfies this condition is

X'~,"'j

+ A,(.,.o 3+n 4 ) -

x,~, ",j+">

.,~

(.3.0 4 )-.,(AO" ,

J+

+

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Sanghania, V.K. (1985). Direct taxes Ready Recko¥er 1985-8 , Taxmann Pub Ications Private Limi ted, Delhi.

It is always necessary to satisfy certain obligations to the society so that the tax rate should not exceed certain limits in different income slabs. Also a new proposal for income tax considers the modifications necessary for the earlier one. With these considerations the upper and lower limits for the tax rates are to be determined. This leads to the following constraints:

L.L J_

L

Xj _ Uj j=1, 2, 3, 4

(3)

Other constraints if any arising out of special requirements can be incorporated. So, the solution to the problem with equation (1) as to objective function and equation (2) and the 4 equations in (3) will give a satisfying results. If the objective function is not giving the solution as zero the limits and the parameters are to be changed to attain the amount M fully.

REMARKS AND MODIFICATIONS The slabs ranges, AD, A1 , ~, A3 the amounts K1 , K2 and the rates Y1' Y2 (which are considered under Section 80 C) can be put in parametric form. Sensitivity analysis can be done on these parameters so that the tax rates and slabs are to be realistic. For getting the deductions under section 80 C an individual has to invest in certain specified items which are used by the Government mostly for public utility. The values for k1' k2' Y1' and Y2 can be properly determined to recover the amount required for this purpose. CONCLUSIONS The goal programming approach to income tax policy gives an easy and practical approach to decide the tax rates and slabs for different income groups. Since the method used is goal programming, it gives more flexibility to the solution and gives a satisfying solution rather than a linear programming method. If this is to applied to the entire country, it requires a great effort for data collection. REFERENCES Chawla, O.P. (1981). Personal Taxation in India, Himalaya Publishing House, Bombay. Gandhi Ved, P. (1978). Some Aspects of India's Tax Structure, Vora & Co; Bombay. Lee Sang, M. l1972). Goal Programming for Decision AnalysIs, Auerback Publishers, Philadelphia.