Waiting for ‘Historic’ Direct Tax Reforms

Every major reform in India tends to be historic when it comes to be. Historic because they are in the making for years and arrive in the wake of decade-plus history of political promise and perfidy.

Published: 21st January 2018 04:00 AM  |   Last Updated: 21st January 2018 07:20 AM   |  A+A-

Every major reform in India tends to be historic when it comes to be. Historic because they are in the making for years and arrive in the wake of decade-plus history of political promise and perfidy. 

Typically, next generation reforms are left to generation next. The saga of allowing FDI in insurance exemplifies the truism — from father Yashwant Sinha to son Jayant Sinha. The much discussed Goods and Services Tax was first mooted in 2004, the Constitutional amendment enacted in 2016, and implemented in 2017. 

The stand of political parties often depends on where they sit — conviction it would seem is politically worthless if it is not electorally convenient. Among the victims of the start and stall politics is the promise of new direct tax code. The Income Tax Act of 1961 was cast for and in the socialist era when India’s GDP was around $38 billion –in 2018 this would be roughly a week’s output at India’s current GDP of $ 2 trillion plus. 

The 56-year-old Act is riveted with amendments, spread over 1,326 pages for just the bare act and pock-marked with exemptions across 120 pages. Unsurprisingly, complexity resulted in a pile up of litigation. As of December 2017, there are over four lakh cases pending — 2,70,503 in CIT appeals, 90,252 in tribunals, 38,864 in High Courts and 5,876 in the Supreme Court. The amount stuck in litigation just in direct taxes is a whopping `8.24 lakh crore — roughly the amount collected in 2016-17 in income and corporate taxes.

The saga of the need for modernising tax laws dates back to 1991 in the path-breaking work by the tax reforms committee led by Raja Chelliah. Thereafter, the beed for a new  direct taxes Bill found mention in the 1997 Bidget Speech — an expert group was to deliver but nothing came of it. It was only in 2002 that the process was kick-started. The first template of direct tax reforms was put out in November 2002 by the Task Force on Direct Taxes. Vijay Kelkar, who led the task force, pointed out that the new template was based on three principles “simplicity, simplicity and simplicity” to rid the system of exemptions raj, crony capitalism and creation of rent opportunities. 

In the 2003 Budget, Finance Minister Jaswant Singh described the initiative rather eloquently. He said, “Mr Speaker, Sir, this will be a move away from a suspicion-ridden, harassment generating, coercion-inclined regime to a trust-based, ‘green channel’ system. I do this entirely on the basis of my faith in my countrymen and women.” Between 2003 and 2016, the need and the promise was repeated in varied language in nine Budget Speeches but intent did not quite translate into outcome. During the tenure of P Chidambaram, the UPA did try to push legislation. The Direct Taxes Code Bill introduced in September 2010 and critiqued by Yashwant Sinha-led Standing Committee died an unnatural death — thanks to the lack of political will and ownership within and outside the UPA.

In fact, between 1997  and 2017 finance ministers have lamented on the paradox of rising consumptionand the low number of taxable returns, on the gap between rising incomes implicit in consumption data and explicit tax revenues. Last year, Finance Minister Arun Jaitley went so far as to say Indians “are largely a tax non-complaint society”, pointing out that only 1.72 lakh persons out of a population of 131 crore showed an income of `50 lakh.

Arguably, there is tax evasion. Equally indisputable is the fact that the code is conceptually flawed — on notions of achieving multiple objectives including savings, investments and even behavioural change. This has resulted in a complicated code replete with a plethora of exemptions and distortions. Multiple objectives have led to multiple failures. 

The discourse in the political economy accords taxation and tax reforms its annual Andy Warhol moment of attention mostly around the budget exercise. The debate about ‘less or more’ is essentially whether the government will borrow less and tax more, or tax less and borrow more. The focus this year is on long term capital gains tax. There is the argument that the combination of lower interest rates and capital gains tax boosts investment and growth. There is the political counter that rising numbers of Indian dollar billionaires and those profiting must pay their dues to society — and anyway only a handful of countries, tax havens included, do not tax long term capital gains. Given the politics that defines management of deficit redefinition of long term capital gains tax does seem to be a given. 

Context is critical for policy. Globally, the race is about capital and opportunities. The recasting of the tax regime by the Trump administration brings in new challenges. It renders the US an attractive destination — some have estimated that $2 trillion of money in tax havens could return to the US. It will also trigger a global competition of lower tax rates. Can an economy now listed among the world’s top five continue to live with an archaic system?

For a decade and more India has lived with tinkering of tax rates to meet political expediencies. The 2015 Budget promised “putting in place a direct tax regime, which is internationally competitive”. The first step came through only in November 2017. A task force, led by Arbind Modi who worked on the 2002 exercise, is expected to deliver a new code by May 2018. That leaves, depending on political risk appetite, little or no room for legislation of a new direct tax code before 2019 polls. For sure, the new direct tax code — as and when it does arrive — will qualify to be ‘historic’. The political class must reflect if India can afford ‘historic’ reforms!

Shankkar Aiyar
Author of Aadhaar: A Biometric 
History of India’s 12 Digit Revolution, and Accidental India



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