Some results from the theory of optimal taxation and their relevance for increasing the progressiveness of Indian tax structure

Results in the theoretical literature on optimal taxation are reviewed to study their relevance for the design of income and commodity tax reforms in India. Given the recent steep increase in inequality, there is a need to increase significantly the overall progressiveness of the Indian tax structure. In the absence of a comprehensive income tax base in India, where much of income escapes taxation, this can be done by greater reliance on commodity taxation. GST slabs and GST rates have to be fixed in accordance with the “many-person Ramsey rule” for commodity taxation that is based on both equity and efficiency considerations. Currently, there is not much variation in the marginal income tax rates faced by people at the high end of the income distribution, even though there is a lot of variation in their incomes. This implies that the existing income tax design gives nearly the same social welfare weights to both billionaires and salaried people with incomes close to Rs. 10,00,000. Thus, to combat the growing inequality in India, the progressiveness of income taxation at the tail of the income distribution also needs to be significantly increased, as this will be equivalent to making social preferences more inequality-averse.