Suppose the tax slab is like the
following:
(Figures
in Rupees)
Tax bracket Tax rate Actual income Income when indexed with inflation
0-3L 0% 2.9L 3.045L
3.01-5L 10% 4.9L 5.145L
5.01-10L 20% 9.9L 10.4L
Start with an inflation rate of 0%. Assume
that one’s income falls in the first category where he does not have to pay tax.
Now inflation climbs up to, say, 5%. Assume that in the economy, people’s income/salary
is tied to the inflation rate. As a result, see what happens to the fourth
column. Now one’s income has shifted to tax category. For example, in the first
case, as his income has risen to above 3lakhs (3.045L to be precise) as a
result of salary tied with inflation, he has to pay a flat 10% income tax which
is (3.045-3)*10%=Rs 1450.
Imagine how much money the government
is collecting income tax due to this slab system.
So, if the government has data
regarding mean income of each tax slab, and if income is indexed, this example
shows government can create the necessary amount of inflation so as to push
them to the next tax slab where they have to pay tax. In this way government
can collect revenue.
But does it make sense for the
government given that people dislike inflation and government will earn a
public ire? If the mean income in the tax slab is close to the upper boarder
(that is, close to 3L in the exempted tax slab), then government may go for it.
If the average income is much lower than the upper boarder, then it has no
incentive to create more inflation so as to push the tax payers to the next tax
slab. But here’s is the catch. If government is seriously considering
generating revenue through this way, then it can redesign the tax slab very
close to the average income in each tax slab. For example, in the first
category which is exempted, the mean income is, say, 2.4L. So, the government
can redesign the tax slab in the budget from 0-2.5L. Then with little effort it
can push the inflation.
