India’s modern tax reform agenda was defined by the reports of two celebrated task forces, both chaired by Vijay Kelkar. This was during the previous NDA regime of Prime Minister Vajpayee. Those reports, on direct and indirect taxes, are still refreshingly relevant. The main thrust of the reforms was to have low tax rates, simplification of the code, very few exemptions and a wide tax net. The proposals also included substantial administrative reforms, including service orientation of the tax department, removal of discretion, comprehensive use of PAN, reducing scope for litigation and focus on the citizen as a “customer” of government services.
Modern societies need taxes to provide for public goods, including law and order, defence and quality primary education and health, and to redistribute income. To achieve this, the tax to GDP ratio for most developed economies in the OECD and others like Brazil and Argentina is more than 35 per cent. For the USA it is 27 per cent.
For India, inclusive of state and local taxes, the ratio is 17 per cent, among the lowest in comparison to its peers. The grand agreement on taxes between citizens and the government is based on the trust that services will be commensurate with taxes paid. So for instance in many Scandinavian countries the tax to GDP ratio is much higher, but citizens are not fleeing those high tax jurisdictions. Presumably because they perceive their tax money is returning in the form of services, public goods and social stability.
India recently jumped up 30 ranks in World Bank’s Ease of Doing Business rankings. One of the metrics that goes into this measurement is called “paying taxes” which stands for the ease, fairness, and transparency of the tax system. India’s rank jumped up before the rollout of the Goods and Services Tax (GST). This is a landmark tax reform which unifies the country into one indirect tax zone, and removes several frictions of interstate taxes. Its key strength is full computerisation and interlocking incentives for compliance. You don’t get a tax refund unless you produce proof that your supplier has paid taxes.
Of course the implementation of the GST has been messy, partly reflecting compromises made to reach a consensus within the GST council, and partly because the rates were kept too high, fearing tax revenue losses. All this is being addressed quickly, and hopefully we will converge to two or three rate slabs, low rates and wide tax coverage, including the hitherto excluded items like electricity, petrol, diesel and real estate.
But even a well-crafted and implemented GST is only a job half done for tax reforms. The other half comes from the second report of the Kelkar Task Force, i.e. on direct taxes. India’s income tax Act is 56 years old. Every year it undergoes amendments that are part of the Union Budget, or rather the Finance Bill. Cumulatively over the years the changes to the direct tax statute constitutes some kind of reform. Thus it is true that tax rates have come down, and anomalies have been ironed out.
There is a considerable amount of consistency in the present status of direct taxes. Yet this piecemeal approach cannot ever make up for a genuine comprehensive overhaul, or true tax reform. The ‘fixes’ done every year are part of a giant patchwork which keep the income tax statute together. But we do need a new direct tax code (DTC), which will be the true reform complement to GST. This new DTC would start afresh, and crystalise the blueprint laid out in the 2002 Kelkar committee report. Basically it would tax income, no matter what the source. It would have low tax rates with minimal exemptions, and would widen the tax net to the maximum extent possible. It would leave very little room for tax officer discretion and income holidays.
Recently the chairman to the prime minister’s Economic Advisory Council said that if exemptions are removed, India’s tax to GDP ratio can rise from 17 to 22 per cent. That’s a huge jump. The complicated structure of exemptions benefits only large corporations who can have an army of tax experts to advise them on “tax planning”. High exemptions also act as a barrier to lowering overall tax rates, since exemptions represent tax leakage.
Removing exemptions would mean also looking at large loopholes like exemptions for capital gains in stock markets. Income tax is imposed on human beings, not inanimate objects like companies. So while we cannot completely do away with corporate income tax, we should move to lower taxes on companies, and instead focus on imposing taxes on humans, i.e. shareholders. We are taxing income not savings. But if those savings generate more income, that income too should be subject to tax. We are trying to encourage long-term savings, but that does not mean we violate this basic principle of taxing income whatever its source. Often the salaried class feels unfairly targeted because that is the only class whose tax is cut, even before they see their paycheck. Thus income from capital and labour has to be taxed with fair treatment.
A new DTC was proposed in 2010, and a draft was ready to be passed by the Parliament in 2013. Unfortunately it lapsed with the 15th Lok Sabha. Its demise may be a blessing in disguise, because the final version had too many elements of compromise which had diluted the reformist features. Indian lawmakers have the genius of doing the right thing, after trying out everything else! It is good a new panel has been formed headed by tax veteran Arbind Modi, a member of the original Kelkar Task Forces who also helped draft the DTC which lapsed in 2013. We hope that under him, the panel proposes a bold, simple, fair and comprehensive direct tax code with minimal exemptions, which is friendly to the taxpayer.
(Syndicate: The Billion Press)
Ajit Ranade
Economist and Senior Fellow, Takshashila Institution
Email: editor@thebillionpress.org