Why abolishing income tax is necessary while other prescribable measures are in place already

While a post claiming Mississippi has abolished income tax went viral on X (formerly Twitter), the American state has not fully done so while passing legislation to phase it out over time. But the fact that residents of Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington and Wyoming do not pay a state income tax and have no broad-based personal income tax imposed on wages, salaries or other earned income at the state level reminds Indians of a tentative promise made by members and supporters of the BJP before coming to power in 2014 (it wasn’t a part of the party manifesto in that election).

We did it, Mississippi! We just eliminated the income tax!

Today is a day that will be remembered — not just for the headlines, not just for the politics, but for the profound, generational change it represents.

Today, I was proud to sign into law a complete elimination of the… pic.twitter.com/wMsS59JGyz

— Governor Tate Reeves (@tatereeves) March 27, 2025

Prime Minister Narendra Modi’s colleague, who was the most upbeat about abolishing income tax, was Subramanian Swamy, whose relationship with the BJP leadership had not soured yet. However, he never became India’s finance minister, a portfolio close to his heart, nor has his idea of abolition of income tax come to fruition.

The state must appreciate that income tax is philosophically wrong, as rich businessmen get away with under-reporting their income while the poor do not pay this tax at all, leaving the salaried class as the only section that cannot cheat, as their earnings reach them after income tax is deducted at source (TDS) already.

Why a proposed income tax substitute, transaction tax, was rejected

Right after Prime Minister Modi assumed office in 2014, a band of economic amateurs led by part-guru-part-activist Baba Ramdev proposed a transaction tax as a replacement for income tax, but the government’s advisers found a whole lot of flaws in the proposed revenue model.

Economists pointed out that transaction taxes

• would tax the same money multiple times,
• would tax the poor and the rich equally based on transaction value rather than their ability to pay,
• could reduce economic activity, as people might avoid transactions to minimise tax,
• would keep the informal sector that operates outside banks untaxed,
• would make it difficult for banks to collect taxes on every transaction,
• would burden ordinary citizens if everyday transactions like ATM withdrawals or bill payments are taxed and
• might conflict with state tax powers, affecting federal revenue sharing.

This has been the experience worldwide. Similar taxes, like the Tobin tax, have not been widely adopted due to market disruption risks. Even American economist and Nobel laureate James Tobin, after whom it’s named, disowned it later.

Why not be inspired by leaders of all countries that did better than us?

Abolishing income tax in India could indeed send a powerful message that making money is not a sin, aligning with successful economic transformations like the US adopting capitalism, China’s shift under Deng Xiaoping or Singapore’s growth under Lee Kuan Yew. Such a message, especially if it comes from a mass leader like Prime Minister Modi, will have the potential to electrify economic activities by increasing disposable income, encouraging entrepreneurship and attracting investment, which might accelerate GDP growth in India’s already developing economy.

The impact will depend on how the government compensates for the revenue lost by the abolition of income tax, estimated at ₹10.44 lakh crore in FY 2023-24.

India cannot become rich without its people becoming richer, as a country’s wealth is measured by GDP per capita, which reflects the average income of its citizens. If most Indians remain poor, the national average will stay low, limiting overall development.

For FY 2023-24, India’s nominal GDP was ₹295.41 lakh crore, with a population of approximately 1.44 billion, giving a GDP per capita of around ₹2.05 lakh. For India to be considered rich, like high-income countries with GDP per capita above $12,000 (e.g., Singapore at $82,794), a large portion of the population needs higher incomes.

Sceptics will say countries with no income tax, like the UAE and Qatar, rely on oil revenues, which do not apply to India. Small tax havens like Bermuda differ in structure too. Hong Kong, with a top income tax rate of 15%, shows that low rates can coexist with economic success, but it still has an income tax. It is compelling to think whether complete abolition would be risky for large economies like ours.

However, merely being a larger country does not make the application of an economic theory go haywire, does it? If ours is a larger country than those in West Asia, we are also much smaller than countries like Canada, China, the United States and Australia by geographical area, each of which has a freer market than ours. If largeness is about diverse populations, the United States is the famous “melting pot” and Canada and Australia will get there in a few decades with their liberal immigration policies.

Modi had the potential to be India's Deng Xiaoping, but...

Today’s successful economies, such as the United States after it adopted capitalism and China since Deng Xiaoping switched their economic policy from communism to state capitalism, have had leaders who encouraged wealth creation. Recall Deng’s “to get rich is glorious”.

Abolishing income tax could send a similar message to Indians, already citizens of the best post-COVID economy, further boosting economic activities and GDP growth.

Decades of socialist governance have left most Indians associating earning with guilt. Modi did not come from the stock that Congress leaders like Jawaharlal Nehru, Indira Gandhi, Rajiv Gandhi and PV Narasimha Rao did — the last of whom unleashed liberalisation under the compulsion of the balance of payment crisis. The prime minister is not even from the same school of economics as was Morarji Desai, Charan Singh, VP Singh and Chandrashekhar. However, the quintessential Gujarati the nation had got in May 2014 mellowed down considerably after the BJP’s defeat in the November 2015 Bihar assembly election, beginning with which he not only incorporated “gareeb aadmi” as the leitmotif of his election rhetoric but also adopted the same approach to welfare that he used to mock the Congress for — a plethora of government schemes, made better albeit with direct benefit transfer.

Modi apparently realised that cultural attitudes, aggravated by the demagoguery of the opposition — such as Rahul Gandhi’s “suit-boot ki sarkar” or “Adani-Ambani ki sarkar”, Lalu Prasad Yadav’s MK Gandhi-like cultivated rusticity and Nitish Kumar’s Jayaprakash Narayan-like humility — shaped the economic mindset in the hinterlands. Besides the invincible arithmetic of castes the Mahagathbandhan had thrown as a challenge at the BJP’s rag-tag alliance, the Bihari voter might have been repelled by the alien sophistication of the Modi-Shah duo and the late Arun Jaitley’s aristocracy, the three leaders at the forefront of the NDA’s Bihar campaign in 2015.

Another lesson was taken in 2017: People’s hypocrisy. ‘I want to be rich, but rich is evil and the rich must be punished!’

Remember how Uttar Pradesh brought the BJP to power in 2017 after a long time, despite the demonetisation of late 2016, while the same executive order made the party nearly lose Gujarat later in the same year. Seeing the handful of rich people hassled, the financially struggling lot of UP experienced schadenfreude, whereas relatively richer Gujaratis cursed Modi for suddenly stripping them of all their notes of denominations ₹500 and ₹1,000.

But reasons are secondary when one considers the fact that from Nehru to Modi, India sorely lacked a Ronald Reagan or a Margaret Thatcher, a leader who would scream from the rooftops about the virtues of richness and declare there is no philosophical profundity in wallowing in poverty.

Lower taxes – higher compliance – greater revenue

During the Reagan administration in the US, tax cuts were associated with economic expansion. While theoretical economists will always differ on whether this was a cause-effect phenomenon, even the Indian experience shows the 97.5% income tax and up to 60% corporate tax by Indira Gandhi kept India dirt poor while causing a massive flight of capital outside the country whereas all governments that have reduced taxes substantially since the 1990s saw a remarkable surge in revenue.

According to a Global Financial Integrity (GFI) report, India lost approximately $27 billion in illicit financial flows between 1948 and 2008. A large portion of this occurred in the 1970s and 1980s when tax rates were at their highest.

Industrial growth slowed to 4.1% per year in the 1970s, compared to 6.1% in the 1950s and 5.3% in the 1960s. Excessive taxation discouraged private sector investment.

Between 1991 and 1996, the Rao government’s act of bringing the top income tax rate down to 40% made direct tax revenue rise from ₹9,328 crore to ₹18,701 crore.

The Laffer Curve Effect was seen again in 2000-2010 when corporate tax rates were gradually reduced from 35% in 2000 to 30% in 2010. Corporate tax collection surged from ₹36,700 crore in 2000-01 to ₹1,88,000 crore in 2010-11.

During Modi 2.0, as tax rates were rationalised (on various goods from 28% to 18% or 12%) and compliance increased also due to digitisation and input tax credit benefits, monthly GST collections crossed ₹1.5 lakh crore in 2022-23, up from around ₹90,000 crore in 2017-18.

Revenue replacement challenges

But the Modi government is well aware of the truism above. This piece is essentially to urge the prime minister to send his people a message: ‘Dear fellow Indians, make money unabashedly! You won’t be punished for that.’

Abolishing income tax will help get rid of India’s Marxist, anarchist and Lohiaite socialism by signalling government support for wealth creation, though broader educational and social initiatives are needed for lasting change. There are surely ways to compensate for the loss of revenue other than the asinine idea of a transaction tax.

How about replacing income tax with a calibrated increase in Goods and Services Tax (GST)? Say, common salt in a 1% GST slab and a Mercedes-Benz car in the 28% slab that it is already in? At present, essential goods attract 0% GST. Salt, rice, wheat, pulses, essential medicinal drugs, etc, would still be affordable if they were taxed up to 1%.

This is not to argue that making up for the loss of ₹10.44 lakh crore would be a mean task. The GST revenue in FY 2023-24 was ₹20.18 lakh crore. To reach ₹30.62 lakh crore, the average rate would need to increase alarmingly. This may lead to inflation and reduced consumption.

Then, the administrative complexity of replacing income tax revenue may push up GST rates, which could cause inflation and regressivity. Businessmen and chartered accountants already complain that the Central Board of Direct Taxes (CBDT) has turned menacing under Modi’s rule.

But the odds of high rates on luxury items leading to evasion through black markets, undermining revenue goals, are lower, considering that the real estate market is now under strict vigilance of the Modi government, as well as the Supreme Court, and tax evasion in vehicle purchases is too cumbersome to become rampant.

If innumerable taxes are needed to fund India’s infrastructure development and social welfare, the current regime has provided the economy with this Keynesian booster enough in the past 11 years. If John Maynard Keynes were right, neither industrialists nor paupers would need state incentives anymore.

Abolishing income tax in itself will not be enough, but nobody is asking for an end to enablers like Skill India, Mudra loans or the Vishwakarma Yojana. It’s the bottomless pit of doles with zero ROI that must stop. If you’re poor, ask the government for money only on the promise that after a deadline that is mutually agreed upon, you will stand on your feet and not ask for further state assistance.

Macroeconomic policies, such as improving the ease of doing business, are already in progress. India ranked 142nd in 2014; by 2020, India had climbed to the 63rd position.

Centre-state quarrels irrelevant

Can some Indian states not get inspired by their counterparts in the US? While income tax is not in the state’s purview, they may reduce the share of GST they earn from every product sold in their respective territories.

States have been expressing dissatisfaction with their share of the revenue. In 2022-23, the total GST collection was ₹14.44 lakh crore, but the states’ share was only ₹7.45 lakh crore, for example.

What needs to be fixed here is the union government’s compensation to states for any revenue loss due to GST implementation, based on a fixed growth rate, which may not accurately reflect the actual revenue growth. The complexity of the IGST settlement process causes delays and disputes between the union and the states. Further, the erosion of the GST base due to exemptions and rate reductions has impacted revenue collections. However, the proposed substitution of income tax by increased GST will not lessen or exacerbate these Centre-state squabbles.