n

CHAPTER V

INFLATION ADJUSTMENT IN INCOME TAX STRUCTURE

In this chapter, the need of inflation adjustment in Indian

income-tax structure, has been discussed. The first part

of the chapter examines the effect of inflation on the tax

liabilities of individuals at different inflation rates.

The second part examines the various possible inflation
adjustment schemes. The third part examines the experience

of other countries on this aspect and last part suggests the

measures to neutralise the impact of inflation from the

income-tax system. The study is made on the basis of

personal income tax rates for the assessment year 1992-93

i.e., the Finance Act. 1991.

The effect of inflation on the tax burdens of individuals

particularly the fixed income group has heightened interest

in these days. It is said that the inflation not only

reduces the value of income but also raises the tax burdens
of many people1. Here an attempt has been made to examine

the impact of inflation on the tax burdens of individuals.

Although the inflation affects all the direct and indirect

taxes but the scope of this chapter is limited to personal

income tax only.

To assess the effect of inflation, before inflation and

after inflation tax liabilities are calculated on selected

income levels at different inflation rates. Table 5.1 shows

126
the effect of three per cent inflation on the tax

liabilities of an individual at selected income levels. The

table reveals that on the income level of Rs. 25,000, the

tax before inflation is Rs.600, the effective rate of tax is

2.4 per cent. After three per cent inflation, the tax
liability increased to Rs.750 with an effective tax rate of

2.91 per cent. The monetary income of the assessee is

increased just three per cent while his tax liability

increased by 25 per cent. The effective tax rate is also

increased by 0.51 percentage point.

On the income levels Rs.30,000, the tax liability is

increased by 16.87 per cent. There are two reasons behind
this increase in tax liability. First, the monetary income
of the assessee is increased by Rs.900, however there is no

change in his real income. Second, previously only one tax

rate of 20 per cent was applicable on him. But now, as his

monetary income is increased, the second rate of 30 percent

is also applicable on him. So the assessee is pushed into
high tax tax rate bracket and the tax becomes progressive.

The percentage increase in the tax liability on the income

levels of Rs.75,000, is 17.73 per cent. This high increase

in liability is, because previously the assessee was not

liable to pay surcharge which is applicable on the income

level of above Rs.75,000. But after inflation as his

monetary income crossed the Rs.75,000 level, he is also

liable to pay surcharge @ 12 per cent and consequently the
tax liability is substantially increased.

127
The inflation has the greatest effect on the tax liability
*

at the lowest end of the income scale as transpired from

column 6 of table 5.1. However, the effect of inflation on

effective rates as shown in the column 7 of the table, is

much more uniform by income classes.

Table 5.2 gives the effect of 5 per cent inflation on the

tax liabilities of individuals at selected income levels.

The table shows that the tax liability at income level of

Rs.25,000 is increased by 41.6 per cent when there is only 5

per cent increase in monetary income at that level. The

increase in tax liability is 28.13 per cent on income level

of Rs. 30,000 and 13.04 per cent on income level of

Rs.40,000. On the income level of Rs.75,000, the tax

liability is increased by 21.55 per cent and the percentage

point increase is 3.69, due to the changes in tax bracket.

The effect of inflation on tax burden is decreased to 9.06

per cent on income level of Rs. 1,00,000 and again shows

decline on higher income levels. The percentage point
increase in effective tax rates is highest at income level

of Rs.75,000. It is because at Rs.75,000 of income, there

is no surcharge, but during inflation period due to the

increase in nominal (monetary) income, the income will

attract 12 per cent surcharge. After the Rs.75,000 income

slab the effective tax rates show declining trend. The

table reveals that the effect of inflation on tax burdens is

not similar on all income groups. The major effect of

128
inflation is on the low income groups and less effect on the

high income groups.

Table 5.3 shows the effect of 7 per cent inflation on the

tax burdens at selected income levels. On the income level

of Rs .25,000, the increase in tax liability, due to
inflation, is 58.33 per cent in comparison to 7 per cent

increase in monetary income. The effect is decreasing up to

the income level of Rs.60,000 and increases at income level

of Rs.75,000. The effect, which is 25.36 per cent at

Rs.75,000 level, decreases to 8.23 per cent at income level

of Rs.3,00,000. The major conclusion that emerges from the

table, is that the effect increases when there is any change

in tax brackets due to inflation and if the same rate is

applicable even after the inflation, the effect shows

decline.

The effect on effective tax rate is much uniform on

different income groups in comparison to the effect on the

tax liabilities.

Table 5.4 gives the effect of 10 per cent inflation. It

shows that on the lower income group, say Rs.25,000, there

is an increase of 83.33 per cent in the tax liability while

there was only 10 per cent increase in the monetary income

and the real income remains constant. The effect on higher

income group is also significant at this rate of inflation.

The effect is 31.09 per cent at income level of Rs.75,000

which is reduced to 11.76 per cent at income level of

129
Rs.3,00,000. The percentage point increase in effective tax

rate varies from 0.76 to 4.5 among different income classes

which is very significant.

Table 5.5 shows the effect of 12 per cent inflation at

different income levels. It can be visualised from the
table that the tax burden on Rs.25,000 level of income has

doubled due to inflation and the effective tax rate also

records 1.89 percentage point increase. The effect on tax
liability at Rs.30,000 level of income is decreased to 67.50
per cent but the effective tax rate is increased to 2.65
percentage point. The highest effect is on the income level
of Rs.75,000 where the effective tax rate has increased to

4.8 percentage point. After that the effect shows declines

and at the income level of Rs. 3,00,000 the effect on tax

liability is 14.11 per cent and the percentage point

increase in effective tax rate is 0.89. The effect of

inflation at 12 per cent rate is higher in comparison to

that at the lower rates.

In table 5.6, the effect of 15 per cent inflation has been

analysed. Columns 6 and 7 of the table reveal that the

effect on this rate of inflation is more than that was in

the previous table. On the income level of Rs. 25,000,

the effect on tax liability has increased to 125 per cent

which was 100 per cent at 12 per cent inflation rate.. The

increase of 125 per cent in tax liability in consequent upon

merely 15 per cent increase in monetary income is really

very serious. The effect on the income level of Rs. 75,000

130
is 40.64 per cent with an increase in the effective tax rate

by 5.23 percentage point. The effect on Rs. 3,00,000 income

level is 17.63 per cent, although it is less than that in

the lower income group but still it is very significant and

is followed by 1.09 percentage point increase in effective

tax rate. Table 5.7 demonstrates the effect of 17 per cent

inflation on the tax burden of an individual at selected

income levels. It shows that the effect on low income

level, say Rs. 25000, is 141.67 per cent increase in tax

liability due to 2.56 percentage point increase in effective

tax rate. The effect is decreasing upto income level of Rs.

60,000 and than again increases at income level of, Rs.

75.000, due to the change in tax bracket resulted by the

surcharge. Even on the higher income group, say Rs.

3.00. 000, the tax liability is increased by about 20 per

cent followed by 1.21 percentage point increase in effective

tax rate. Combined results of the above seven tables are :

1. The inflation causes significant increases in the

tax burdens of individuals. The increase in tax burden
is several times more than the increase in monetary

income. It causes a person to pay a different amount

of tax than he would pay on the same real income in a

non-inflationary period.

2. Inflation causes significant increase in the

effective rate of the individual income tax.

3. The inflation alters the structure of income tax

131
rates, the real width of tax brackets and real value of
all exemptions, deductions and allowances fixed in

nominal terms.

4. The effect of inflation on the tax liabilities of

individual is not uniform on different levels of
incomes. The low income group is affected more and

comparatively less effects are recorded on high income

group.

5. When the rates of inflation are relatively low, say

upto 5 per cent, its effects on individual tax
liabilities is limited, but when the rate of inflation

goes up in two digits, it starts to hunt the taxpayers.

6. Inflation generates fictitious increase in income

and pushes the taxpayers into higher tax-rate slab and

the tax becomes more progressive. Therefore, a

taxpayer will find himself climbing the tax ladder at

the progressive rates, even when his real income has

not changed.

7. The inflation reduces the real value of all

exemptions, deductions and allowances fixed in nominal

(monetary) terms. When a person's money income

increases by the amount just enough or not enough even

to offset inflation, his real income is constant or

decreases. But as his money income increases, the

person is thrown into higher tax brackets and the fixed

132
 rupee deductions, exemptions eliminate a lesser

fraction of income and hence subject to tax. The

result is that the tax liabilities increase faster than
inflation and take away an increasing percentage of the

real income of the taxpayers.

8. The salaried persons are affected more by the

inflation because of a fixed 'standard deduction' for

them in lieu of allowing expenditure in computing the

taxable income and the inflation reduces the real value

of 'standard deduction' which is fixed in monetary ‘

terms.2

In India personal incomes above certain exempted level are

taxed with progressive rates. These rates apply to income
brackets specified in monetary terms in the taxation law.
Many exemptions and deductions are also fixed in current
values. In inflationary period it may happen that while

money income is rising, real income may actually be

falling. Some persons, who because of their low income in
relation to 'minimum taxable limit' and due to deductions to

which they are entitled, have previously been exempted from

paying tax, may now be liable to pay tax. Others who were
already taxed may become subject to higher average rate of

tax even when their real income has not been changed.

If the income-tax were proportional i.e., if there were no

progressive rate and no exemption or if the exemptions were

a fixed proportion of income, the average tax rates would

133
not be affected by inflation3 and therefore, there would be

no increase in the tax burdens.

In the light of foregoing discussion, it seems that it has

become necessary to protect the income-tax system from-the

effects of inflation.

In this respect we have two basic alternatives; we can

introduce periodic adjustment or introduce permanent
automatic adjustment schemes without leaving the taxpayers
on the mercy of the Finance Minister.

To permanently overcome this problem, we need an 'inflation

proof tax system'. An inflation free tax system is one that

imposes the same real tax burden on a particular amount of

real 'before tax income' regardless of the rate of
inflation. For given 'before tax income' the real tax base
and the rate structure must be unaffected by inflation., If

the tax system were truly inflation-proof, neither the tax

burden nor the distribution of that burden among the

taxpayers would be affected by inflation. Although, the

existence of such a system is very difficult, however, much

can be done to neutralize the impact of inflation from the

tax system particularly the income-tax.

DIFFERENT INFLATION ADJUSTMENT SCHEMES

There are two conceptually distinct forms of inflation

adjustment of income tax system.4 The first type of

adjustment, which is quite complicated, is the adjustment of

134
the measurement of income from business and capital. If the

measurement of income is not protected from the effects of

inflation, taxable income will be either understated or
overstated. Inflation adjustment is thus needed in order to
provide both equity and neutrality. Second and the easier
alternative is the adjustment of inflation in the income tax
structure. This adjustment is needed in order to prevent

bracket creep, the tendency for inflation to cause taxpayers

with a given real income to pay at increasing effective tax

rates.

In the second system of 'inflation adjustment', three

different schemes have been proposed by the experts to

neutralize inflationary effect.

Under the first scheme, all statutory tax rates would be

lowered proportionately to eliminate the increase in the tax

burden due to inflation. This scheme can prevent the growth

in the effective tax rates, but it would not prevent the

unintended redistribution of tax burdens among taxpayers.

For example, a person who was not subject to income tax

because of his low income but is subject to tax due to

inflation, would remain liable to pay tax even if the

statutory rates were reduced and the uhdesired

administrative burden would remain on the tax collection

authority. By this scheme, the high income group would

benefit from progressively lower marginal tax rates. So the

scheme is not free from defects. 5

135
The second scheme would exempt that income of an individual

which is attributed by inflation. For example, cost -of-

living adjustments in salaries(D.A.) would automatically be

exempt from tax and other assessees can be allowed an

'inflation deduction' that would depend on the rate of
inflation. This inflation deduction would be calculated by
multiplying the gross income of the assessees by the rate of

inflation. This scheme is unsatisfactory because taxable

income would remain constant in nominal terms but would

decline in real terms, consequently real tax payments and

the average effective tax rate would also fall.6

Table 5.8 shows the effect of 12 per cent inflation

adjustment under this scheme and reveals that the effective
tax rate has been decreased by 1.87 percentage point. This
scheme stops the growth of revenue and not advisable because
the revenue from income tax should also be increased atleast

equal to the rate of inflation. This scheme was adopted by

Israel but abolished in July 1975 and replaced by another

scheme discussed below.

The Third scheme indexes the whole Income Tax structure with

the prices level, so that tax rates apply to real incomes

rather than to nominal income resulted by inflation. All

the brackets, exemptions, deductions and all the other

provisions expressed in fixed monetary values would be

increased annually at a rate equal to the rate, of

inflation.7 This scheme has been introduced in a number of

136
countries 8

As already discussed, the first two schemes are not

advisable. So the third scheme is examined in 12 per cent

inflation period. The results of indexing applied to a
salaried person with an annual income of Rs.70,000 at 1991
level, assuming his income increases at the rate just enough

to offset the effect of inflation, are shown in table 5.10.

Before inflation the assessee would pay a tax of Rs. 10,800

on annual income of Rs. 70,000 forming an effective tax rate

of 15.43 per cent. Inflation of 12 per cent increases the

assessee's income to Rs. 78,400. Unless there is an

inflation adjustment, tax would increase by 31 percent to

Rs. 14,160. If the Income tax structure is indexed, tax

would increase only by 12 per cent to Rs. 12,096 and thus

there would be no increase in the effective tax rate.

Table 5.11 shows the 12 per cent inflation adjusted tax

bracket schedule. By 12 per cent inflation the 'minimum

taxable limit' would be increased from 22.000 to 24,640.
The second rate slab would be increased from 30,000 to

33,600 and the third slab would be increased from 50,000 to

56.000. The maximum marginal rate will now be applicable on

the income above Rs. 1,12,000 which was on above Rs.

1.00. 000 previously and the 12 per cent surcharge would be

on the income above Rs. 84,000 instead of Rs. 75,000,

previously. The 'standard deduction' ceiling would increase

from 12,000 to 13,440.

137
Table 5.12 gives the effect of a 12 per cent inflation on
the tax liability of a salaried person at selected levels of

income. Inflation has the highest effect on tax liability

at the lower levels of the income as is transpired from

column viii of table 5.12. However, the effect of inflation
on effective rates of tax and on income after tax, as shown

in columns ix and x of table 5.12, is almost uniform at

different income levels. If the indexation is not done at
the inflation rate, the burden of tax will be comparatively
higher at lower income levels. As the income increases, the

percentage increase in tax goes on reducing as is evident

from column ix of table 5.12.

The table also reveals (column vii) that if indexation is

done at all levels of income at the inflation rate the tax
revenue will be increase but the effective tax rate will

remain the same and it will be beneficial both to the

assessees and the exchequer.

It is wrongly believed that the adoption of •'automatic

inflation adjustment scheme" can stop the annual increase in

the income tax revenue. Tables 5.10 and 5.12 clearly shows
that even after inflation adjustment, there is an increase

in tax revenue,equal to the rate of inflation.

The operational question now is, whether the government of

India should enact legislation that will permit the

automatic adjustment of inflation in income-tax law ? If so,

which scheme is suitable in Indian circumstances ?

138
Before answering this question, we should examine the

experience of the countries that have ' inflation adjustment

scheme' in their income tax laws.

THE FOREIGN EXPERIENCE

India is one of the few countries of the world which, have

not adjusted the taxation system for inflation. Others
include Canada,9 the United Kingdom,9 France,9 West Germany

and many others who have taken measures to adjust for the
effects of price increase on income-tax system.10 Several

countries including Latin American countries, Indonesia,

Israel, Japan, Korea and some countries of Eastern Europe

have recognised the effects of inflation on business income
also.10 The inflation adjustment scheme does not resemble

all over the world. Some countries have rules that allow
for full adjustment for inflation on an annual basis and

others make annual adjustment only for part of the

inflationary change.

The Canadian scheme indexes the whole nominal structure of

the personal income tax annually.11 The adjustment is based

on the increase in the consumer price index of the previous

year. Argentina has also an 'automatic indexation scheme'

for exemptions, deductions and the tax brackets. The

indexation for exemptions was intended to keep off the tax

rolls of those taxpayers who, because of their low income,

should have not been subjected to any income taxation.12

139
The Uruguayan scheme was almost identical to the Canadian
one. The income tax structure was adjusted fully, annually
and automatically for the change in cost of living. But in
1974, the government abolished the individual income tax.13

Obviously, without a tax, there can be no indexing. On the

recommendation of the Mathews Committee on personal income
tax, Australia also introduced an automatic indexation in

the personal income tax structure on the basis of changes in

the consumer price index.14 The indexation applies to tax

rates, income brackets and most of the exemptions,

deductions and allowances, only at the time of increase in

prices but not for decline in prices.

Upto 1975, Israel had a scheme that provided the cost-of-

living adjustment component of salary exempted from personal
taxation. It was not an automatic indexation. There was

also a provision for adjusting the profits for inflation.

In 1975, this scheme was replaced by another scheme similar

to the Canadian scheme.15 Peru has a partial adjustment

scheme since 1973. In this scheme, exemptions and

deductions are adjusted by an index related to the consumer

price index. There is no automatic adjustments for the tax

1 fi
brackets.

The indexation in Sweden was adopted in 1977, after heated

discussions in parliament. Indexation is based on

coefficients fixed by the national tax board. But in

Sweden, there is only a partial indexation as only brackets

140
are indexed and not the exemptions and the deductions which

are fixed in monetary terms. Therefore, the effect of

inflation on personal income tax structure is not completely
removed.17 The United Kingdom chose to index the exemptions

and deductions but not the brackets, since 1977. The

indexation scheme is based on retail price index for the

previous year. °

In France, partial system of indexing is used.19 The

adjustments may occur only when the rate of inflation

exceeds a particular limit. No adjustment is required if

inflation remains below five per cent. The authorities may

adjust various brackets differently. The indexation is

based on consumer price index. The France approach fails to
deal with creeping inflation. Luxembourg also has a partial

system of indexing. The scheme provides a revision of the

nominal tax structure in proportion to the variation in the

consumer price index.

Netherland also has an inflation adjustment system in the

income tax law.21 But the adjustment is limited to eight

percent of the rise in the relevant index and only for

taxable incomes subject to marginal income tax rates of 49

per cent and lower. The Danish scheme of indexing has gone
beyond inflation adjustment ,22 The personal deduction and

brackets are now related to changes in the index for the

hourly earnings of an industrial worker. This index

reflects changes not only in prices but also in real wages.

The scheme was motivated by the belief that indexing for

141 **
price changes alone does not prevent sharp increases in tax

burden on the middle income groups brought about by

interaction between economic growth and a very progressive

structure.

Chile has developed the most comprehensive system of

correction of income tax for inflation.23 Since 1954, the

Chilean government adjusts the exemptions and the tax

brackets. The income-tax is adjusted on the basis of a
basic tax unit that is calculated by the tax authorities on

the basis of the rate of inflation. The Brazilian income-

tax law provides the inflation adjustment if the inflation

exceeds 10 per cent in a given year or 15 per cent in three
years.24 Actually, in Brazil, indexing has been used to

achieve an objective of redistribution of tax burden and not

for the neutralization of inflation effect.25

Iceland has had a provision in its income tax law for the
indexation of nominal structure of the income tax.25 The

scheme adjusts all the brackets, personal allowances and

certain other deductions on the basis of an index that would

reflect increases in prices as well as in real incomes.

Colombia has taken important steps to establish an
inflation-proof tax system.27 The system provides for

annual adjustment of personal exemptions, bracket limit and

other magnitudes fixed in nominal amounts. Complete

inflation adjustment is also available for capital gains and

only real capital gains are legally taxable. The

142
inflationary component of interest income is excluded from
the tax base of individuals. Inflation adjustment of
business income is also m practice. ° Colombia has one of
the best income tax structure from the inflation point of
view.

The review of various countries shows that Canada, Uruguay,

Israel, Denmark, Chile and Colombia and fully, annually and
automatic indexation scheme. Other note-worthy countries

are Argentina, Peru, Sweden, U.K., France, Luxembourg and

the Netherland which have the partial systems of indexing.

In some other countries the indexing mechanisms are not

directly related to inflation but to other indexes which are

based on earnings of industrial workers, minimum wages or

per capita income. But in most of the countries, either the

consumer price index or the wholesale price index is used.

Three major conclusions can be drawn from the experience of

various countries. First, indexing the rate structure does

not present serious administrative problems. The tax

authorities can easily produce new tables and the taxpayers

can easily compute their tax liabilities with the hew

tables. Second, indexing comes in many forms; simple

increases in the nominal structure are most popular. Third

the search for an index, responsive to the actual rather

than to past rates of inflation, continues in most of the

countries.29

Now, the question is, like many other nations, should India

143
adopt the 'automatic inflation adjustment scheme' or should
it be left to ad hoc remedy by periodic revisions?

In yesteryears, India has experienced very high rate of

inflation. The increase in prices has come on the top with
a 16 per cent rise during the 12 months ending October,
1991.30 This means, statistically, that there has been an

increase of over 25 per cent m the WPI m two years. A

When the rate of inflation was relatively low, its effect on

income taxpayers was less. But now when the rate of

inflation has gone up in two digits, It has started hunting
the income taxpayers.32 the inflation causes a person to

pay much more amount of tax than he would pay on the same
real income in a non-inflationary period. So the inflation

adjustment system is urgently required to achieve the

objective of redistribution of tax burden and for the

neutralization of inflation effect.

Besides the exemptions, deductions and the rate structure,

there are many other provisions in our income-tax law, which

are fixed in nominal terms.33 The inflation has either made

the provisions superfluous or inconsistent with the

objectives for which they were designed. In various tax

seminars, tax journals and meetings organised by the chamber

of commerce, the demand that is most vociferously made

relates to the revision of these provisions which are fixed

in monetary values.34 But the revision in monetary ceiling

will be an ad hoc solution of the problem. Unless an

'inflation proof tax system' is adopted, the problem will

144
arise again and again.

India has an unstable income-tax system. The frequent

changes in the tax law is a sign of immature tax system. It

generates inevitable strains on the planning machinery and

also causes heavy expenditure for the government. The

taxpayers find themselves in uncertainty while planning

their tax affairs. So, a stable tax system is the need of

the hour and the automatic adjustment of inflation can play

a great role to meet the goal.

Today the problem of evasion of income tax is on its peak.

It is argued that taxpayers resentment against being pushed

by inflation into higher marginal tax rates and increase in

average effective tax rates, even when their real income has
not changed, has led to lower degrees of tax compliance.35

The reduction in the real value of exemption limit due to

inflation, led to a significant increase in the number of
salaried taxpayers36 and this has placed inevitable strains

on the tax administration. The result is an increase in tax

evasion.

Ever since, the Rao Government came into power, India has
taken a bold and determined move towards globalisation of
Indian economy.37 Instead of mere tinkering with the

existing tax system, the Finance Minister took up the

historic task of a adopting bold and innovative structural

reforms in the economy as a whole. It included widespread

and fundamental restructuring of the direct and indirect

145
 O o
taxes as well. ° The government has also ensured to
introduce major changes in tax structure to put it on the
line with those in other countries.39 As the several

countries have introduced inflation adjustment scheme in

their tax system, steps should also be taken by India to

meet the demand of globalisation of the tax structure.

Concluding the chapter, it is suggested that the 'automatic

inflation adjustment scheme' should also be introduced in

India.40 The whole Income tax Structure should be indexed

in line with that of in Canada. The consumer price index of

the income earning year may be adopted as the base of

indexing.

146
 NOTES AND REFERENCES

1. Indian Institute of Management Ahmedabad: Inflation

and Tax Reforms in Industrial Taxation, A discussion
paper available with the Ministry of Finance Library,
Govt, of India at No.336-292 G. 95 I.

2. Chapter 3 Table 3.2

3. Vito Tanzi: Inflation and the personal Income Tax,
IMF, Cambridge University Press, Cambridge.
4. Boskin (Michael J) and Charles (E Me Lure): World Tax
Reform, International Centre for Economic Grpwth, ICS
press San Francisco, California, 1990. Executive
Summary P.8.
5. Chahal S.S. and Raj Singh " Inflation adjustment in
Income Tax Structure: International Experience; Case
for India, paper presented at 46th All India Commerce
conference. Dec. 1992.
6. Ibid.

7. Raj Singh: Inflation adjustment in Income Tax Law,

Financial Express. June 24, 1991. p.7.
8. Ibid.

9. IMF, Taxation, Inflation and Interest Rates, 1984.

Washington DC. p.12-13.
10. Aaron, H.J. Inflation and the Income Tax, Washington
D.C. 1976.
11. IMF Taxation, Inflation and Interest rates 1984
Washington D.C. p.12-13.

12. Vito Tanzi, Ibid p.26. and Financial Times (London) Nov.
1974 p.12.
13. Vito Tanzi. Ibid p.27.

14. Milton Friedman: "Monetary Corrections, American

Enterprises Institute, Washington D.C. AEI 1974 and
Bulletin for International Fiscal Documentation, An
Official Journal of the International Fiscal
Association, 1992 volume no.7.
15. Vito Tanzi, Ibid p.33.

16. Ibid p.30.

147
17. IMF, Taxation, Inflation and Taxation rates, 1984.
Washington D.C. p.13. and Vinto Tanzi Ibid p.29.

18. IMF Ibid p.13 and Vinto Tanzi Ibid P.29.

19. Vito Tanzi Ibid p.30.

20. Ibid p.31

21. Mongia, J.N., Tax Pattern around the globe. Neera

Enterprise, New Delhi 1984 p.320.

22. Aaron A. Henry, Inflation and Income Tax, Washington

D.C. Brooking Institute, 1976 p.66.
23. Boskin (Michael) and Mclure (Charles) Ibid p.205.

24. M. Eshaq Nadiri "Indexation, the Brazilian Experience"

National Bureau of Economic Research, Occasional Papers
vol.4. No.1 (winter 1977)

25. Ana Lucia Goncalves Soares: "Brazil Tax Reform", Inti.

Fiscal Bulletin Nov. 1992. p.556.

26. Vito Tanzi, Ibid p.39-40.

27. Baskin (Michael) and Mclure (Charles) Ibid p.205-225.

28. Ibid.

29. Edward F. Denison "Price Series for Indexing the Income

Tax System" in Aaron ed. "Inflation and the income tax"
p.248.
30. Hindustan Times, Editorial" The Inflection puzzle,
Dec.1, 1992.
31. Ibid.

32. Raj Singh: "Inflation Adjustment in Income Tax Law,

Financial Express, Jun.24, 1991 p.7.
33. For example; Maintenance of Account (Sec. 44AA (2) (i)
and (ii), Auditing of Accounts (Sec. 44 AB), Valuations
of perquisites in respect of car, domestic servants
etc.
34. Quoted by T.N. Pandey "Income Tax revision for
entertainment expenditure" Fin. Exp. June 3, 1991, p.7.
35. Chahal, S.S. & Raj Singh, Inflation adjustment in
Income Tax structure: International Experience: Case
for India, paper presented at 46th All India Commerce
Conference, Dec.1992.
36. Based on the Data given in All India Income Tax

148
 Statistics.

37. Vena, S.K. Reorientation of Direct Taxes

Administration to meet the demand of Globalisation,
paper presented at International Tax Conference Nov. 6-
7, 1992, New Delhi.
38. Dr. Manmohan Singh, A major tax reform within a year "in
the Economic Times, Sept. 17, 1992.

39. R.N. Lakhotia, Point of view, on July 4, 1991

supporting the article "Inflation adjustment in Income
Tax Law" by Raj Singh on Jun. 24, 1991 in Financial
Express.

149
 TABLE : 5.1

Effect of 3 per cent inflation on the tax liabilities.of an Individual at selected income level
(Fin. Act. 1991).

Income before Tax before Tax after 3 per cent Effect of inflation
inflation inflation inflation

(Amt in Rs) Amt. Effective Rate Amt. Effective Rate Percentage Percentage
per cent per cent increase in increase in
tax liability eff.tax rate
(1) (2) (3) (4) (5) (6) (7)

25,000 600 2.40 750 2.91 25.00 0.51

30,000 1600 5.33 1870 6.10 16.87 0.77

40,000 4600 11.50 4960 12.04 7.83 0.54

50,000 7600 15.20 8200 15.92 7.89 0.72

60,000 11600 19.33 12320 19.94 7.20 0.61

75,000 17600 23.47 20720 26.82 17.73 3.35

1,00,000 30912 30.91 32592 31.64 5.43 0.73

1,50,000 58912 39.27 61432 39.76 4.28 0.49

2,00,000 86912 43.46 90272 43.82 2.72 0.36

2,50,000 114912 45.96 119112 46.26 3.65 0.30

3,00,000 142912 47.64 147952 47.88 3.53 0.24

SOURCE : Developed by Researcher from the Finance Act 1991.

150
 Table -5.2

Effect of 5 per cent inflation on the tax liabilities of an individual at selected Income leve
(Fin. Act. 1991)

Income before Tax before Tax after 3 per cent Effect of inflation
inflation inflation inflation

(Amt in Rs) Amt. Effective Rate Amt. Effective Rate Percentage Percentage
per cent per cent increase in increase in
tax liability eff.tax rate
(1) (2) (3) (4) (5) (6) (7)

25,000 600 2.40 850 3.24 41.67 0.8

30,000 1600 5.33 2050 6.51 28.13 1.18

40,000 4600 11.50 5200 12.38 13.04 0.88

50,000 7600 15.20 8600 16.38 13.16 1.18

60,000 11600 19.33 12800 20.32 10.34 0.99

75,000 17600 23.47 21392 27.16 21.55 3.69

1,00,000 30912 30.91 33712 32.11 9.06 1.20

1,50,000 58912 39.27 63112 40.07 7.13 0.80

2,00,000 86912 43.46 92512 44.05 6.44 0.59

2,50,000 114912 45.96 121912 46.44 6.09 0.48

3,00,000 142912 47.64 151312 48.04 5.88 0.40

SOURCE : Developed by Researcher from the Finance Act 1991.

151
 Table -5.3

Effect of 7 per cent inflation on the tax liabilities of an individual at selected Income level
(Fin. Act. 1991)

Income before Tax before Tax after 3 per cent Effect of inflation
inflation inflation inflation

(Amt in Rs) Amt. Effective Rate Amt. Effective Rate Percentage Percentage
per cent per cent increase in increase in
tax liability eff.tax rate
(1) (2) (3) (4) (5) (6) (7)

25,000 600 2.40 950 3.55 58.33 1.15

30,000 1600 5.33 2230 6.95 39.38 1.62

40,000 4600 11.50 5440 12.71 18.26 1.01

50,000 7600 15.20 9000 16.82 18.42 1.62

60,000 11600 19.33 13280 20.69 14.48 1.36

75,000 17600 23.47 22064 27.49 25.36 4.02

1,00,000 30912 30.91 34832 32.55 12.68 1.64

1,50,000 58912 39.27 64792 40.37 9.98 1.11

2,00,000 86912 43.46 94752 44.28 9.02 0.82

2,50,000 114912 45.96 124712 46.62 8.5 0.66

3,00,000 142912 47.64 154672 48.18 8.23 0.54

SOURCE : Developed by Researcher from the Finance Act 1991.

152
 Table £ 5.4

Effect of 10 per cent inflation on the tax liabilities of an Individual at selected income level
(Fin. Act. 1991).

Income before Tax before Tax after 3 per cent Effect of inflation
inflation inflation inflation

(Amt in Rs) Amt. Effective Rate Amt. Effective Rate Percentage Percentage
per cent per cent increase in increase in
tax liability eff.tax rate
(1) (2) (3) (4) (5) (6) (7)

25,000 600 2.40 1100 4.00 83.33 1.6

30,000 1600 5.33 2500 7.58 56.25 2.25

40,000 4600 11.50 5800 13.18 26.09 1.68

50,000 7600 15.20 9600 17.45 26.32 2.25

60,000 11600 19.33 14000 21.21 20.69 1.88

75,000 17600 23.47 23072 27.97 31.09 4.5

1,00,000 30912 30.91 36512 33.19 18.12 2.28

1,50,000 58912 39.27 67312 40.80 14.26 1.53

2,00,000 86912 43.46 98112 44.60 12.89 1.14

2,50,000 114912 45.96 128912 46.88 12.18 0.92

3,00,000 142912 47.64 159712 48.40 11.76 0.76

SOURCE : Developed by Researcher from the Finance Act 1991.

153
 Table : 5.5

Effect of 12 per cent inflation on the tax liabilities of an individual at selected Income level
(Fin. Act. 1991)

Income before Tax before Tax after 3 per cent Effect of inflation
inflation inflation inflation

(Amt in Rs) Amt. Effective Rate Amt. Effective Rate Percentage Percentage
per cent per cent increase in increase In
tax liability eff.tax rate
(1) (2) (3) (4) (5) (6) (7)

25,000 600 2.40 1200 4.29 100.00 1.89

30,000 1600 5.33 2680 7.98 67.50 2.65

40,000 4600 11.50 6040 13.48 31.30 1.98

50,000 7600 15.20 10000 17.86 31.58 2.66

60,000 11600 19.33 14480 21.55 24.83 2.22

75,000 17600 23.47 23744 28.27 34.91 4.80

1,00,000 30912 30.91 37632 33.60 21.74 2.69

1,50,000 58912 39.27 68992 41.07 17.11 1.80

2,00,000 86912 43.46 100352 44.80 15.46 1.34

2,50,000 114912 45.96 131712 47.04 14.62 1.08

3,00,000 142912 47.64 163072 48.53 14.11 0.89

SOURCE : Developed by Researcher from the Finance Act 1991.

154
 Table - 5.6

Effect of 15 per cent inflation on the tax liabilities of an individual at selected income level
(Fin. Act. 1991)

Income before Tax before Tax after 3 per cent Effect of inflation
inflation inflation inflation

(Amt in Rs.) Amt. Effective Rate Amt. Effective Rate Percentage Percentage
per cent per cent increase in increase in
tax liability eff.tax rate
(1) (2) (3) (4) (5) (6) (7)

25,000 600 2.40 1350 4.70 125.00 2.3

30,000 1600 5.33 2950 8.55 84.38 3.22

60,000 4600 11.50 6400 13.91 39.13 2.41

50,000 7600 15.20 10600 18.43 39.47 3.23

60,000 11600 19.33 15200 22.03 31.03 2.70

75,000 17600 23.47 24752 28.70 40.64 5.23

1,00,000 30912 30.91 39312 34.18 27.17 3.27

1,50,000 58912 39.27 71512 41.46 21.39 2.19

2,00,000 86912 43.46 103712 45.09 19.33 1.63

2,50,000 114912 45.96 135912 47.27 18.27 1.31

3,00,000 142912 47.64 168112 48.73 17.63 1.09

SOURCE : Developed by Researcher from the Finance Act 1991.

155
 Table - 5.7

Effect of 17 per cent inflation on the tax liabilities of an individual at selected income level
(Fin. Act. 1991)

Income before Tax before Tax after 3 per cent Effect of inflation
inflation inflation inflation

(Amt in Rs.) Amt. Effective Rate Amt. Effective Rate Percentage Percentage
per cent per cent increase in increase in
tax liability eff.tax rate
(1) (2) (3) (4) (5) (6) (7)

25,000 600 2.40 1450 4.96 141.67 2.56

30,000 1600 5.33 3130 8.92 95.63 3.59

40,000 4600 11.50 6640 14.19 44.35 2.69

50,000 7600 15.20 11000 18.80 44.74 3.60

60,000 11600 19.33 15680 22.34 35.17 3.01

75,000 17600 23.47 25424 28.97 44.45 5.5

1,00,000 30912 30.91 40432 34.56 30.80 3.65

1,50,000 58912 39.27 73192 41.70 24.24 2.43

2,00,000 86912 43.46 105952 45.28 21.91 1.82

2,50,000 114912 45.96 138712 47.42 20.71 1.46

3,00,000 142912 47.64 171472 48.85 19.98 1.21

SOURCE : Developed by Researcher from the Finance Act 1991.

156
 Table -5.8

12 per cent inflation adjustment on the tax liabilities of a person with an Annual Income of Rs
55,000, 1991.

Item 1991 Level 1991 Level plus 12 % inflation

No Adjustment After Adjustment

For Inflation for Inflation
Rs. Rs. Rs.

Income 55,000 61,600 61,600

Less minimum taxable limit 22,000 22,000 22,000

33,000 39,600 39,600

Less Inflation deduction

12X of Gross Income - - 6,600

Taxable Income 33,000 39,600 33,000

Tax liability 9,600 12,240 9,600

Effective tax rate 17.45% 19.87% 15.58%

SOURCE : Developed by Researcher from the Finance Act 1991.

157
 Table - 5.9

Countries that Adjusting Income-Tax System for Inflation

Country Year of Indexing Index Used

introduced

Argentina 1972 Consumer Price Index

Australia 1976 Consumer Price Index
Austria 1948 Government Coefficients
Brazil 1961 Minimum Wages or Consumer Price Index
Belgium 1947 Appraisal, within specified limits
Bolivia 1972 Depreciation of currency
Canada 1974 Consumer Price Index
Colombia 1960 Consumer Price Index
Chile 1954 Consumer Price Index
Denmark 1970 Government Coefficients
France 1969 Consumer Price Index
Iceland 1966 Change in nominal income
Indonesia 1971 Indexes of prices
Israel 1975 Consumer Price Index
Italy 1946 Government Coefficient
Japan 1950 Wholesale Price Index
Korea 1958 Wholesale Price Index
Luxembourg 1968 Consumer Price Index
Mexico 1954 Appraisal, within specified limit
Netherland 1971 Government Coefficient
Peru 1973 Consumer Price Index
Sweden 1977 Government Coefficients
Spain 1961 Government Coefficient
United Kingdom 1977 Retail Price Index
Uruguay 1968 Consumer Price Index

SOURCE : Canadian Tax Foundation (Toronto Annual Publication),

OECD, The Adjustment of Personal Income-tax System for inflation
Paris 1975, Ministerio Da Fazenda, Anuario Economic-Fiscal
(1970) National Economic Instiute of Iceland.

158
 Table - 5.10

Effect of 12 per cent inflation on the Tax 1liabilities of a salaried person with an Annual
Income of Rs. 70,000, 1991.

Item 1991 Level 1991 Level plus 12 % inflation

No Adjustment After Adjustment

For inflation for Inflation
Rs. Rs. Rs.
a b c

Income 70,000 78,400 78,400

Less minimum taxable limit 22,000 22,000 24,640

Less Standard deduction 12,000 12,000 13,440

Taxable Income 36,000 44,400 40,320

Tax liability 10,800 14,160 12,096

Effective tax rate 15.43% 18.06% 15.43%

SOURCE : Developed by Researcher a,,b calculated from provisions of the

1991 tax law. C, calculated from the adjusted rate schedule as in

table 5.11.

159
 Table - 5.11

The before inflation rate schedule and inflation-adjusted rate schedule for the relevant
brackets for Individual Assessees (Inflation rate 12 per cent).

Before Inflation Rate Schedule Inflation Adjusted Rate Schedule

(a) (b)

Income Slab Rate Income Slab Rate

Amt. Rs. X Amt. Rs. X

Below 22,000 Nil 8elow 24,640 Nil

22,000 to 30,000 20 24,640 to 33,640 20

30,000 to 50,000 30 33,640 to 56,000 30

50,000 to 1,00,000 40 56,000 to 1,12,000 40

above 1,00,000 50 above 1,12,000 50

Surcharge above 75,000 12 Surcharge above 84,000 12

SOURCE : a. Finance Act 1991.

b. Developed by Researcher.

NOTE : Rate Schedule given in this table is just to illustrate the

inflation adjustment scheme and not a Suggested Rate Schedule.

160
 Table i 5.12

Effect of 12 per cent inflation on the tax liabilities of a salaried person at selected Income
levels, 1991

Income Tax after 12 per cent Inflation Effect of not indexing

before Tax before Inflation No indexing With indexina Percentage Percentage Percentage
Increase point inc* reduction
Inflation Amt . Effective Rate Amt. Effective Amt. Effective in tax crease in in income
Rs. Rs. Per cent Rs. Rate per Rs. Rate per Eff. Rate after tax

I II III IV V VI VII VIII IX X

36000 400 1.11 1264 3.13 448 1.11 182.14 2.02 2.05

40000 1200 3.00 2440 5.45 1344 3.00 81.55 2.45 2.52

50000 4000 8.00 5800 10.36 4480 8.00 29.46 2.36 2.56

60000 7000 11.67 9680 14.40 7840 11.67 23.47 2.73 3.10

75000 12800 17.07 18368 21.87 14336 17.07 28.13 4.80 - 5.79

100000 25536 25.54 30912 27.60 28600 25.54 8.08 2.06 2.77

150000 52192 34.79 62272 37.07 58455 34.79 6.53 2.28 3.48

200000 80192 40.10 93632 41.80 89815 40.10 4.25 1.70 2.84

250000 108192 43.28 124992 44.64 121175 43.28 3.15 1.36 2.40

SOURCE : Developed from the provisions of Finance Act 1991

and adjusted rate schedule in table 6.11.

161