Can India transition to a single income tax rate?

Inspired by developed nations, this progressive tax system is designed to promote fairness by imposing incrementally higher tax rates on higher income brackets. 

For instance, an individual earning ₹5,00,000 pays tax at 5%, while someone with an income of ₹7,00,000 is taxed 5% on the first ₹5,00,000 and 20% on the additional ₹2,00,000. This ensures a degree of equity as individuals with higher incomes contribute more in taxes.

However, the introduction of dual tax regimes—one catering to individuals who claim deductions and another for those opting out—has introduced significant complexity. Additionally, special tax rates ranging from 12.5% to 30%, applicable to various income streams such as capital gains and cryptocurrencies, further complicate compliance, making the tax landscape more challenging for taxpayers to navigate. 

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While progressive taxation is widely practiced, including in developed countries like the USA and UK, it has its share of criticisms. In India, factors such as bracket creep, where inflation pushes individuals into higher tax slabs without a corresponding increase in real income, and the complexity of compliance with multiple slabs and deductions have led to dissatisfaction, particularly among salaried individuals.

Many also perceive the system as a disincentive to earn more, as higher incomes are taxed at significantly higher rates, reducing the motivation for increased productivity. Additionally, the impact of higher taxes on disposable income can restrict both consumption and savings, further amplifying discontent. This raises a crucial question: can India transition to a single tax rate, and if so, would it lead to a simpler, more equitable system?

Breaking down India’s tax trends

A closer look at the income tax return statistics released by the Income Tax Department for AY 2022–23 reveals notable trends. Of the approximately 6.9 crore individuals who filed returns, the gross total income reported was ₹53.7 lakh crore, while the total tax liability amounted to just ₹5.7 lakh crore—an effective tax rate of only 10.64%. This relatively low rate can be attributed to factors such as deductions, slab rates, special tax treatments, tax rebates, and other provisions.

This trend is consistent with data from the preceding three years, where the effective tax rate on gross income stood at 9.55% for AY 2021–22, 9.66% for AY 2020–21, and 9.58% for AY 2019–20. In sharp contrast, companies bear a much heavier burden, with effective tax rates ranging between 21% and 30% of their gross income.

What is even more interesting—and perhaps surprising—is the average tax rate paid by ultra-high-net-worth individuals (HNIs). While the highest slab rate applicable to individuals earning over ₹5 crore stands at 39%, the reality tells a different story. For AY 2022–23, the average total tax liability to gross income ratio for these individuals was just 18.17%.

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This significant discrepancy arises because a substantial portion of HNIs’ income comes from capital gains, which is taxed at much lower special rates, typically 12.5% or 20%. This contrast begs the question: are the complicated slab rates and deductions truly necessary?

For instance, an individual with a gross income of ₹15,00,000 currently pays an average tax rate of 10%, while someone earning ₹25,00,000 sees their average tax rate rise to 18%. By contrast, implementing a single tax rate of, say, 12.5% on income above ₹3,00,000 could significantly simplify the tax structure while potentially yielding a similar overall tax collection. 

To ensure fairness to the weaker sections of society, the minimum threshold limit for tax-free income (currently ₹3,00,000 in this scenario) can be retained and periodically adjusted to account for inflation or other economic factors. This would ensure that lower-income groups remain exempt from taxation, allowing them greater disposable income to meet their daily needs. Such an approach would strike a balance between equity for the poor and simplicity in the overall tax structure.

A uniform tax rate for various types of investment income—such as interest, dividends, and capital gains—could further level the playing field. By eliminating preferential tax treatments, it would ensure that investment decisions are driven by financial goals rather than tax advantages, fostering a more equitable and transparent investment environment.

The concept of a single tax rate is not entirely new. In fact, companies and firms in India to a limited extent already follow a uniform tax rate on profits.

Extending this principle to individual taxpayers could not only simplify compliance but also significantly reduce administrative burdens.

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If implemented thoughtfully—ensuring measures to protect lower-income groups and maintain revenue neutrality—a single tax rate could serve as the much-needed reform to modernise India’s taxation system. Such a shift could promote economic growth, enhance compliance, and reinforce equity in the system.

Neeraj Agarwala is partner, Nangia & Co LLP

(With inputs from Neetu Brahma, consultant, Nangia & Co LLP)