Who pays our income tax ?

One of the longest ongoing discussions I see in social media ( mainly LinkedIn and Twitter ) all the time, is about how we Indians are paying too much tax and how the government isn't doing anything, and comparing India with the "heaven on earth, the holy land" that is Arab countries, where there is no Income tax. Something makes me wonder about that sort of argument every time. Are people who earn a lot, really "contributing"/"helping" the economy that much, or is something else going on ?

 Income tax never made any sense to me when I was small. I understood that government taxed stuff like Cinema, food items, cigarettes as they are commodities. But why would a government want to tax an individual's earnings ? I see many economically inclined people say that Income tax is not a good thing, even economically speaking and indirect tax all the way is the way to go. I never understood their reasoning too. 

Recently though, I have started to gain some understanding in why income tax made some sense. Through some arguments with my friends/ YouTube videos / Books etc., I have developed a rather different opinion on this subject.

So let me start at the top with the basics. Why cant non-monopolistic companies arbitrarily decide to hike up their prices of their goods are rake in profits ? High school economics has taught us that in a market economy, competition tends to bring the prices of goods to an equilibrium. Why does it do that ? The market players are motivated by their profits, but the consumers are motivated by low prices, so eventually if someone charges too much for a product, people will move to the others. Easy thing.

Yearly during the budget season, we all see entire newspapers dedicated to how prices of goods are going to be affected by the budget. Is it due to the companies sentiments on how confident they are on the government helping the people, like what happens in the share market ? No. Most of those changes are easily due to the increase/decrease in tariffs, taxes, levies, duties and whatever. So if the government decides to increase duties on goods, we brilliantly understand that companies are not going to bear it, and we conclude that the prices of goods are going to increase to compensate for that. Why ? All these taxes/charges apply to all the players in the market. So suddenly the profits these goods were making are going to change. And in a rational economy, all players in it know that all the other players know this. Since everyone is losing "equally", a new equilibrium will be formed which will be above or below the existing one, depending on the direction the tax moves. Simple. We now understand that if taxes change, the price of goods change to compensate for it, at least eventually.

Companies earn profit by selling goods/services or in case of some companies, making fools of normal people. But what is the cost of this ? One of the major ones is labour. But in that case, the company becomes the buyer, and the common man becomes the seller.. Aha ! How the turntables !! 

Sadly, as much as we would like to think that we are much noble compared to a heartless organization, when it comes to economics, we tend to behave similarly. So imagine if suddenly the Indian government, under whoever rule you prefer, decides to decrease the income tax. What an amazing decision! Everyone is going to get some extra money due to the reduced tax burden. Right ? Right ?

Basic economics might say No ! Income tax applies to almost everyone in the country, who earns an income, and if it is reduced universally, It is going to affect everyone. Just like how we know that a tax reduction, will be followed by a price reduction, the companies must also be eagerly waiting for a reduction in their wage expenses. And since even labour is a competitive market ( excluding unionized industries ) , this will eventually happen. Ofcourse, economy is not that simple. But a change in tax, will definitely affect the price and the direction of the price move. If the income tax is reduced, more people will be willing to take in low paying jobs, because of the reduction in burden -> More supply ( for the lower paying job ) -> Reduction in prices. Classic economics. 

So, if the prices gets affected by the tax, and will increase or decrease based on the it, who really pays the tax ? The buyer or the seller ? It must be understandable by now that

            Selling price = Cost Price + Profit + Tax

And when tax moves up, Selling price moves up, and the profit remains the same. So the seller really doesnt pay anything, the profit the seller is getting is still the same. But it is the buyer who is paying the extra bucks to buy the same thing.

In the income tax sense though, the company is the buyer. So it is only logical that the tax burden is on the company hiring us. Maybe that's the reason, why heartless companies like to see our pay as a "Cost to Company (CTC)". A similar phenomenon, is the reason why people get paid very differently based on where the person lives. All we puny humans care about is how much we can buy with that job. Not how much is the dollar amount that we "technically" get.

So, that means that the salaried person isn't even paying the income tax. It is the entity that consumes that resource that ends up paying. In that case, why are we rioting in social media shouting around about "contributing" to the country, and not getting anything back, when we technically aren't even paying ? The person who should be actually proud in this case is the "courageous" person who imports a PS5 from US, because scalpers have made it cheaper to import something than buy something locally. This champion has contributed a whopping 30% on the cost of the PS5 to the country.

Next time, when you see a bad road or a pothole, instead of coming onto Linkedin, and posting the same old shit, consider importing a Rolls Royce ( and pay the import duty, unlike a certain someone ). You can proudly call yourself a warrior of the Indian economy.

End Note : I am still exploring this topic, and If you feel that in some way I am failing to see an angle in this argument where I am absolutely wrong. I am very open to a discussion. Comment here or just ping me in whatsapp if you are too embarrassed to associate yourself with this blog. I actually love arguments like this.

An Opinion on criticism of candidates shopping for offers, which promise a better pay. ( Alt-title: Is it fair to consider an organization and a job-seeker as comparable entities ? )

DISCLAIMER: Not that anyone cares, but the data mentioned in the below article may not be accurate and paragraphs i quoted in the text may well be inaccurate. I am not making any claims about the authenticity of the experiment or the data used.

I frequent LinkedIn, against my own aversions for it, for ruining the little peace I have. There are a lot of recurring content in LinkedIn that grates my cheese. This one is about one of them, which I feel is completely trivializing a dilemma regularly faced by job-seekers. 

If you have been to LinkedIn before, you have definitely seen posts from HRs / CXOs , cursing, deriding people who have accepted their offer only to reject it later for a better offer. Recently I have been seeing lots of "what-if" posts , asking what if the employer also starts doing the same, and reject an offer if another candidate accepts lesser pay for the same job. The way I see it, this argument has multiple issues, and I am not even talking about the fact that companies actually already do this, granted not as frequently as job seekers. One of the main issues I have with this kind of thinking is, Companies and job seekers ( people ) are not interchangeable. The assumption in that scenario is, they are both equal entities, so if it is fair in one direction, it is fair in the other too. But obviously they aren't, for a lot of reasons apart from the fact that, one of them doesn't have a family to feed apart from its own expenses.

But this article is not about all those reasons. While I would love to write about it, I think I lack the clarity to make a blog post about it. This article is just to point out an interesting similarity between a bit mentioned in one of my favourite books called Freakonomics and this problem.

 

In the first chapter of that book, an interesting counter-intuitive "study" ( Freakonomics/its authors have a lot of critics, and many of them are critical about the fundamentals of the experiments. Regardless, I think it is an interesting thought experiment. ) about how real-estate agents don't work in the best interest of their clients, even after the incentive structure seemingly favouring the case. 

...You hire a real-estate agent to sell your home.

She sizes up its charms, snaps some pictures, sets the price, writes a seductive ad, shows the house aggressively, negotiates the offers, and sees the deal through to its end. Sure, it’s a lot of work, but she’s getting a nice cut. On the sale of a $300,000 house, a typical 6 percent agent fee yields $18,000. Eighteen thousand dollars, you say to yourself: that’s a lot of money. But you also tell yourself that you never
could have sold the house for $300,000 on your own. The agent knew
how to—what’s that phrase she used?—“maximize the house’s value.”
She got you top dollar, right? 

Right ?

If the agent is getting a percentage of the final deal, It is mathematically better for the agent, if the client gets a better deal for their home. So will agents get the best deal for all their clients ?

Freakonomics gives a counter-intuitive perspective  backed by data.

But as incentives go, commissions are tricky. First of all, a 6 percent real-estate commission is typically split between the seller’s agent and the buyer’s. Each agent then kicks back roughly half of her take to the agency. Which means that only 1.5 percent of the purchase price goes directly into your agent’s pocket.
 

So on the sale of your $300,000 house, her personal take of the $18,000 commission is $4,500. Still not bad, you say. But what if the house was actually worth more than $300,000? What if, with a little more effort and patience and a few more newspaper ads, she could have sold it for $310,000? After the commission, that puts an additional $9,400 in your pocket. But the agent’s additional share - her personal 1.5 percent of the extra $10,000—is a mere $150. If you earn $9,400 while she earns only $150, maybe your incentives aren’t aligned after all. (Especially when she’s the one paying for the ads and doing all the work.) Is the agent willing to put out all that extra time, money, and energy for just $150?

There’s one way to find out: measure the difference between the sales data for houses that belong to real-estate agents themselves and the houses they sold on behalf of clients. Using the data from the sales of those 100,000 Chicago homes, and controlling for any number of variables—location, age and quality of the house, aesthetics, whether or not the property was an investment, and so on—it turns out that a real-estate agent keeps her own home on the market an average of ten days longer and sells it for an extra 3-plus percent, or $10,000 on a $300,000 house. When she sells her own house, an agent holds out for the best offer; when she sells yours, she encourages you to take the first decent offer that comes along. Like a stockbroker churning commissions, she wants to make deals and make them fast. Why not? Her share of a better offer—$150—is too puny an incentive to encourage her to do otherwise.

The idea here is, even though the percentage increase in the reward is the same for both parties, One of them may be more interested in the increase than the other, and the agent might not optimize for the best rate.

Why did I quote this here ? Think of a company with multiple crores ( say 5 ) in expenditure. They decide to provide an offer to a candidate, for say, 10 Lakhs. The candidate goes back, and shops with the new baseline and gets an offer for 12 Lakhs. The company is furious, and says they can't provide this 2 lakhs extra and the HR in charge, storms to LinkedIn to post about this horrible candidate, who behaved utterly selfishly for some puny bucks, while the company has generously offered him a lot of monies.

Before siding with the HR or the candidate, the incentive difference for both of them must be noticed here. The candidate getting 2 Lakhs extra means, that he gets almost 20% extra than what his previous offer gives him. Thats a 20% increase in the monthly income for his family ( assuming sole-earner ). But for the company, the extra 2 Lakhs is a 0.4% increase in expenditure. This is almost like the inverse problem of the one mentioned in the book.

So before vilifying every single candidate, for opting for " just extra money ", please kindly gently note that the incentive is not uniform. By opting for the few extra bucks, the candidate has a much larger portion to gain than the company has to lose.

Please voice out your opinion on this trend in the comments. Do you still think a candidate chasing money is comparable to a company on a low-balling spree ?