Don’t Flog The Tax Policy

There are many good ways to empower women. Playing around with taxes is not one of them

My colleague Nitin Pai has argued that abolishing income tax for women is a good starting point for increasing the female workforce participation rate in India. He also proposed that a double tax exemption on wages paid to women can encourage companies to hire, retain and compensate women better.

The objective is laudable. Indeed, India’s female labour participation rate is low even if other economies in our region are considered as the reference points. World Bank data shows that India fares worse on this count than Nepal, Bangladesh, Maldives, Bangladesh, Sri Lanka, and China. Even if we discard this comparison with other economies, India cannot possibly achieve the target of creating 20 million jobs per year, a national priority, without a substantial rise in the number of women joining and staying in the workforce.

Women labour-participation rates in 2017 (Source: World Bank)

Even so, flogging the tax policy until it confesses to delivering more jobs for women is a notion that flies in the face of evidence gathered from tweaking income tax policies across the world. Let me explain.

Until the 1980s, it was widely accepted that personal income tax could be an effective instrument for reducing inequalities. As a result, income tax slabs used to be highly progressive even in countries such as US and UK, allowing for a number of exemptions at the lower end of the spectrum even as the marginal tax rates at the highest end used to be as high as 95 percent. However, these highly progressive tax systems did little to reduce inequality. As this NIPFP paper notes, an empirical study in Chile showed that the Gini coefficient—an indicator of inequality—increased after a highly progressive tax system was put into place. The learning from this phase in taxation history was that it is futile to address multiple objectives through the tax system. Instead, it was better to deal with systemic problems such as inequality or women’s employment rates through the expenditure side of the budget, and design tax rates for simplicity and effectiveness.

Broadening the base, lowering the tax rates for all individuals and companies, and getting rid of tax exemptions has thus been the operating paradigm for over three decades now. In India, however, introducing tax exemptions of various kinds remains extremely popular. I have argued earlier that when taxation policies try to attempt hyper multi-objective optimisation, it meets none of the objectives it was set up to attain. Dr Govinda Rao summarises this best:

Although many countries’ tax policy is used as an instrument to accelerate investment, encourage savings, increase exports and pursue some other objectives, India’s obsession is perhaps unique. In addition to the above, India’s tax policy is loaded with objectives such as industrialisation of backward regions, encouraging infrastructure ventures, promotion of small scale industries, generation of employment, encouragement to charitable activities and scientific research, and promotion of enclave-type development through Special Economic Zones (SEZs). These objectives are pursued through various exemptions, differentiation in rates and preferences which enormously complicate the tax structure and open up avenues for evasion and avoidance of tax and create rent-seeking opportunities.

Now, the latest addition to this obsession seems to be to incentivise women to join the workforce. Even if we ignore the unintended yet easily anticipated consequences of this proposal, it ignores the fiscal reality that India is already an undertaxed economy. The suggestion that this proposal ‘will not hurt the exchequer much’ assumes that there is room to burden the tax policy with another objective when there really isn’t. An NIPFP study showed that India’s tax-GDP ratio of 16.5 percent is lower than the average of Lower Middle Income group of 17.8 percent and much lower than the predicted estimate for India at 19.95 percent.

My second objection to this proposal is that there is little evidence to suggest that at the margin, women in India will choose to join the formal workforce just because they will end up paying less or no taxes. This article for instance lists various studies that investigated the cause for the low women labour-force participation. Some of the structural issues are safety at the workplace, a stigma against women working outside the home, and increasing returns to home production, particularly if the domestic production is childcare. The proposal to exempt women from paying taxes doesn’t address any of these factors, and hence is unlikely to contribute significantly to the 20-million-jobs-per-year challenge. If anything, the drop in tax collections will leave the government with even lesser fiscal space to invest in childcare, public safety, and policing, factors that actually impede women employment.

Fixing these structural issues requires governments to focus on the expenditure side of their budgets. In every budget of Union and state governments, there is an anodyne section on ‘Gender Budget’. It is time to invigorate this exercise by spending on areas that will target specific outcomes such as increasing the number of working women. It also requires us to learn from the experiences of our neighbouring countries.

Finally, burdening the taxation policy with another well-intentioned outcome might well be the lowest hanging fruit, but not all fruits that hang low are ripe for picking.