How much taxes are you actually paying? The answer will shock you

Have you ever calculated how much tax you are actually paying. Not your tax slab, but overall effective taxes. Please note, that by “you” I refer to salaried middle-class with incomes between 6 lakhs and 25 lakhs. I will answer the question: “How much taxes are you actually paying?“. The answer will shock you.

Assumption

  1. Let us say your gross income (CTC) is Rs 18 lakhs, or a gross of Rs 1.5 lakh per month. This means that you are in the 30% slab.
  2. We also assume that you avail all possible tax-saving ooptions under 80C and you get tax benefits upto Rs 1.5 Lakhs.
  3. Also let us assume that you are a native of Guwahati (Assam) or Shimla, and are working in Bangalore and staying in a rented house of Rs 15,000 per month.
  4. You have been working for 10-15 years and have a corpus of Rs 24 lakhs in Fixed Deposits paying 8% per annum. Hence your gross interest income is Rs 1.9 lakhs per annum or Rs 16,000 per month.

Analysis

1. Income Tax

You pay a rent of Rs 15,000 per month, yet your land-lord does not give you a proper rent recipt with his PAN number, as he does not want to declare his income. At most he will give you a Rs 8000 rent receipt, becuase that is the largest he can show without needing PAN details. You therefore lose the tax benefits on the Rs 84,000 (Rs 7000*12). Your tax beneifts are much reduced.

Your total taxabale income is approximately Rs 16.0 lakhs after all deductions (80C and HRA) and that you have no PF (to keep things simple).

Hence your estimated tax @30% would be Rs 3.15 lakhs. This works out to 18% effective tax.

Summary
Gross Monthly Income = 1.5 Lakhs
Tax per Month = 26,000
Net take home = 1.24 Lakhs

2. Savings and Investments

Let us assume that out of 1.24 lakhs every month you save 50% and spend the remaining 50%. That is you save and invest Rs 62,000 per month.

Summary
Net Take Home = Rs 123,000
Spending = Rs 62,000
Investment = Rs 62,000

3. Investment

Let us asssume that you are a conservative Indian investor and invest only in Fixed Deposits. You have Rs 24 lakhs FD which fethces you an interest of Rs 1.9 lakhs per annum (Rs 16,000 per month).

However interest on FD’s is taxable and is reported in “Income from Other Sources”. At 30% slab you have to pay Rs 58,000 tax on this for the year or Rs 4,800 monthly on an average.

For this year you invest, Rs 62000 per month (Rs 7.44 lakhs annually). This will fetch you an average monthly interest of Rs 2700. Tax @30% on this amount is Rs 800.

Summary
Interest Income = Rs 16,000
Income Tax on Existing Pool = Rs 4,800
Income Tax on New Investment = Rs 800
Interest on Svaing Account = Rs 400

4. Spending

Let us assume the following breakup.
Living Cost/ Household Items = Rs 22,000
Eating out/ Movies / Petrol = Rs 20,000
Rent, Maintenance and Grocery = Rs 20,000

Now the interesting portion starts.

Living Cost
Companies have to pay corporate taxes of 34%. Plus many companies pay huge excise duties. They will never absorb the cost, but rather pass on the higher prices to consumers.

So, out of Rs 20,000 that you actually spend, the implied taxes are 40% or close to Rs 9000.

Eating out/ Movies / Petrol
– When you eat out, you have to pay VAT ad Service Tax, which comes to 30%.
– Tax collected on petrol by government is around 66%
– Multiplexes have taxes of 50% built into ticket price

On an average, of the Rs 20,000 spent on entertainment, almost Rs 8,000 goes towards government as service and other indirect taxes.

Rent, Maintenance and Grocery
Your landlord or your local kirana store,will adjust their rents and prices accordinly with respect to their estimated tax flows and estimated petrol and other expenditure. Alawyas remember, you are the end cutsomer and everyone, starting from the government and including all intermediaries will pass on their increased cost to you. There is thus a multipker effect at work here against you.

We can conservatively assume 31% built in taxes, which wouldbe equal to Rs 7000.

Summary
Implied Taxes on Houseohold Items = Rs 9000
Indirect Taxes/ Service Taxes = Rs 8,000
Rent, Maintenance and Grocery Taxes = Rs 6,600
Total Hidden Taxes = Rs 23,600

5. Putting it All Together

Your total monthly gross income is as follows.

Salary = 150,000
Interest = 18,700
Total = 168,700

Your total tax:
Income Tax on Salary = 26,000
Tax on Interest Income = 6,000
Implied Taxes on Houseohold Items = Rs 9000
Indirect Taxes/ Service Taxes = Rs 8,000
Rent, Maintenance and Grocery Taxes = Rs 7000
Total Taxes = 56,000

Therefore estimated effective tax is 33% (Rs 56,000/ Rs 168,700) or almost 1/3rd – which is quite a high number in itself.

But even this calculation, which is traditional method, is flawed.

Why is this calculation flawed? How much taxes are you really paying?

Because of multiple levels of taxation.

Let me explain how.

  • You are taxed on income first.
  • With your post-tax money, using your investing acumen, you invest in a Fixed Deposit.
  • That is taxed again.
  • Your interest accrues in a Saving Account.
  • That amount is taxed again.

So to effectively calculate the true effect of taxation, the calculations should be based only on your salary.

Hence actual effective tax is 38% (Rs 56,000/ Rs 150,000) or close to 40% of your income, which is an absurdly high number.

Every month you give up 40% of your hard earned money as taxes (direct, indirect and implied) to governments which do not care about you.

Just think about it.

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Reference

https://en.wikipedia.org/wiki/Taxation_in_India

A Few Last Words

Before making any investment decision, please contact your financial adviser. I have provided this article for educational purpose only.

I hope you found this article on How much taxes are you actually paying? interesting. If you have something to add please leave a comment in the post. Please feel free to contact me.

Subhodeep Mukhopadhyay

I am a Management Consultant in the Education Sector. In my previous corporate career, I have worked in Banking, Private Equity and Software industry. I am an MBA in Finance/ Computer Engineer and enjoy doing equity research and financial analysis in my free time.

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