Why Only 5% Indians Pay Tax? Reasons Behind & What’s Ahead

As 31^st July is approaching, the employees of the service sector are queuing up to file Income Tax Returns! Reasons? Not to add up the penalties and interest on late filings. But why only the people of the tertiary sector (service sector) are on the list of “ITR filings”? Are they the only income taxpayers in India? Apart from that, there have been recent reports mentioning that hardly 8 crores out of 130 crore Indians actually pay income tax. That counts for merely 5% of our total population. 

These factors boil down to one question- Why do only 5% of Indians pay tax?

Doesn’t it feel like a small portion of the population bears an enormous burden in terms of ITR? Why the rest 95% of Indians are not under the umbrella of ITR? Your mind must be hovering with such questions. That’s why to clear your doubts, we are presenting this write-up to explain the taxation system in India. Also, we will explain the reasons why only 5% of Indians pay income tax.

Taxation System in India

“Tax” is a term that has been in the administration since ancient times. Not a single region of the world is tax-free! 

(A) What is tax?

It is a mandatory fee or a financial charge that you need to pay to the government. Why does the government collect taxes? To carry out its governmental activities and provide service to the public. These services may include health services, projects like building bridges or dams, providing clean drinking water, etc. 

Do you know that you pay tax on the packet of chips too? Well, if you are a grown-up you must already be aware of this fact.

(B) Why do we pay taxes in India?

Folks often raise the query- “Why should we pay tax? Despite paying the expenses through our own pocket, we need to pay additional money to the government.” As per their argument, they pay for their food, shelter, travel, medical treatment, vehicle, etc. Unlike the USA, UK, etc. Indians are deprived of social security and free medical facilities.

Government answers- “Although we don’t provide free medical facilities or social security like developed countries, we discharge some of the heavy responsibilities. Such as National Defense, Infrastructure Development, Health care through government hospitals, Education through government schools, Subsidized cooking gas, etc.” 

In short, the government gets money through taxes to carry out these programs and welfare schemes. Thus, we contribute to the development of our nation by paying taxes!

(C) Classification of Taxes

Now, let’s have a brief look at the taxation system of India.

As per the topic, our major focus is on the “Income Tax.” Let’s look into it.

(D) What is Income Tax? Who introduced Income tax in India?

The Income Tax is a form of direct tax that the government levies on your income/earnings. Let me tell you an interesting fact. The Income tax in India existed even before our independence in 1947! Yes, Income Tax was introduced by Sir James Wilson in the British Regime. He was the Finance Minister of British India when he introduced the Income-tax Act in February 1860.

Do you remember, in the Union Budget 2023, our Finance Minister introduced changes to the new tax regime? It included several changes that exempt many people from paying income taxes. We will discuss it in the upcoming sections.

Number of Taxpayers in India (Year Wise)

Before diving deep, let’s have a look at the number of taxpayers in India on a yearly basis. The following data is given for the last six fiscal years-

If you look at the data carefully, you will notice that hardly 5% of the total Indian population is paying income tax. This is the point that makes us wonder- “Why do only 5% of Indians pay tax?” You will get the answer in the next section.

Reasons for only 5% of taxpayers in India

Now, here comes the crucial part of this write-up. “Why do only 5% of Indians pay tax?” Some of the major reasons are described below-

1. Employment Inequalities

What is the first thing that comes to your mind when you see the sensational news headlines? That states only 5% of taxpayers in India. You may think that again the middle class is on the guillotine. But this assessment isn’t completely true. You can’t compare the 5% of taxpayers to 130 crore Indians. Why? You may ask. Because hardly 40% of Indians are currently employed. And less than 3% of them make an annual salary of more than Rs.7 lakhs. So how is this factor related to the Income Tax Returns?

See, as per the latest update on the Indian tax regime, if your annual income is less than Rs.7 lakh. Then, you are not obliged to pay the income tax! Over half of the total employees of the service sector fall into this category. Thus, they are exempted from paying income tax. 

Only the remaining 3% of salaried individuals with annual income over Rs.7 lakh pay the income tax. This unemployment inequality is the major factor behind less number of income taxpayers in India.

2. Income Tax Threshold

According to the Income Tax Regime of India, individuals with annual salaries below Rs.7 lakh are exempted from ITR. This Rs.7 lakh threshold is more than 3 times of per capita GDP of India. However, this threshold is periodically adjusted to account for inflation and economic conditions.

Let’s compare the income tax threshold of India with other countries-

The lower the threshold level, the more the government can capture the income of people in its tax net. So, for India, the higher threshold level means the government has less control to charge taxes on people’s income.

3. Agriculture & Rural Income

A significant portion of the Indian population depends on agriculture and rural income sources. It includes farming, handicraft, herding, etc. Most of the people belonging to this domain struggle to make a living. Even if a few of them make a decent sum, the government exempts them. This factor further reduces the number of individuals who are liable to pay taxes.

 4. Informal Income

India has a substantial informal economy, where economic activities are often unreported or conducted in cash. For instance- the milkman and milkmaids, house servants, hawkers, vendors, etc. Many individuals working in the informal sector don’t have a regular income. As a result, they do not fall under the tax-paying bracket.

5. Low Awareness of Financial Literacy

Many individuals, particularly in rural areas or economically disadvantaged sections of society, may have limited awareness of tax obligations. Such as rich farmers or unofficial lenders. This results in lower tax compliance and a perception that a smaller percentage of the population pays taxes.

6. Tax-Evasion and Non-Compliance

Do you know a lot of people don’t file taxes and use illegal means to get away with it? This is a significant challenge in India. Some individuals, particularly those engaged in high-value transactions or with complex financial structures, may attempt to evade taxes. Also, they misreport their income. 

Now, you must have understood why only 5% of Indians pay tax and the rest 95% don’t! Are that 95% of people out of the taxation net? You will get the explanation in the next section.

Do the remaining 95% of people pay tax?

Yes! They do. Look at the table of classification of taxes given in the above sections. Do you know how you pay tax for every commodity that you purchase from the market? Through indirect taxes! GST is an excellent example of indirect tax. Whenever you buy a packet of chips, shampoo, or buy fuel, you pay taxes.

Who pays the most tax in India?

As per the Income Tax department, Akshay Kumar (Bollywood Actor) was the highest taxpayer in 2022. He paid an income tax of Rs.29.5 crore. This number was the highest among individual personal taxes in India.

Final Words: What’s ahead?

Now, you know the prime reasons for a very low share of taxpayers in India. So, what can we do to increase this number? By increasing the level of education and employment. Yes, the government can do it. But some other steps may include-

• Simplifying the tax laws.
• Raise awareness and educate the public about the significance of tax. Also, the government must explain the significance of taxes in the development of the nation.
• Improve tax administration and services
• Address the grievances of taxpayers.

Thus, with these steps, we can increase the number of taxpayers in India!