It
is not just a revamp, claims the government, but altogether
new. After many rounds of reduction of the marginal
tax rate and years of tinkering with the structure
of direct taxes it claims to have decided to drastically
alter the direct tax regime. To that end it has launched
a debate that would lead up to the introduction of
legislation to put in place a new direct tax code.
The discussion paper accompanying the draft code attempts
to draw attention to a number of features of the new
code: the definition of income, clarity regarding
who can be taxed and the treatment of exemptions.
But discussion on the code is likely to be dominated
by the extent of taxation of personal and corporate
incomes that the new regime would involve.
In this regard there is one aspect of the new code
that is welcome. It seeks to rationalize the innumerable
tax exemptions given to both high-income personal
income tax payers and corporations. The consequence
of this would be enhanced revenue generation and a
greater degree of transparency in the tax structure.
It would also possibly lead to greater equity, since
most tax exemptions are either directed at or more
easily exploited by those in higher income tax brackets.
Budget documents for 2009-10 estimate that the “tax
expenditures” on account of foregone taxes during
2008-09 amounted to Rs. 68,914 crore in the case of
corporate taxes, Rs. 5116 crore in the case of non-corporate
(partnerships, associations of persons, bodies of
individuals) tax payers and Rs. 34,437 crore in the
case of income taxes. This amounts to around 17 per
cent of the gross tax revenues which accrued to the
central government according to the revised estimates
for that year. Recouping a significant share of this
would make a considerable difference to the budgetary
position of the government and increase its fiscal
manoeuvrability.
However, if this and greater transparency and equity
were the objectives that the government was pursuing
then a revamp of the existing tax law to get rid of
a wide range of unnecessary exemptions would have
been adequate. That the government is pursuing objectives
other than these is clear from its unorthodox decision
to include in the documents for discussion on the
proposed Direct Tax Bill a proposal for a new structure
of direct tax rates. That structure could lead to
a sharp reduction of taxes currently paid by individuals
and corporates in different tax brackets under the
present tax regime.
The way this is to be ensured is a significant widening
of the tax slabs leading to a situation where individuals
would pay only 10 per cent tax as long as they remain
in the slab Rs.1,60,000 to Rs. 10,00,000, 20 per cent
in the slab Rs.10,00,000 to Rs. 25,00,000 and 30 per
cent thereafter. Further, the corporate tax rate is
to be reduced from 30 per cent to 25 per cent and
the minimum alternate tax (MAT) is to be calculated
on the value of gross assets, 2 per cent of which
will have to be paid at the minimum by all non-banking
companies.
Currently, the income tax payer pays 10 per cent tax
on income between Rs. 1.6 lakh and Rs. 3 lakh, 20
per cent between Rs. 3 lakh and Rs. 5 lakh, and 30
per cent beyond Rs. 5 lakh. This means, for example
that an individual who earns a lakh of rupees every
month by way of taxable salary will see a substantial
reduction in the amount of income tax paid. Moreover,
the ceiling on tax-free acquisition of savings instruments
has been increased from Rs.1 lakh to Rs. 3 lakh, even
though the range of instruments eligible for that
concession has been reduced.
By specifying these rates and ranges, even while indicating
that they are also subject to discussion, clearly
ties the hand of the government. Taxes, which are
increasingly seen as “hurting” the tax payer and not
as financing beneficial public provision, are such
that once the government proposes a level it can go
downwards from there but not upwards without opposition.
This implies that the government has chosen to significantly
cut rates by widening tax slabs and adjusting the
number of rates.
The government’s own view is that such comparisons
between the proposed direct tax regime and the existing
one are not valid, because what we have is a structural
transformation in regime. One way of interpreting
that statement could be that it is implicitly declaring
that the potential reduction in revenues as a result
of wider slabs and lower rates would be more than
neutralised by the reduction in exemptions under the
proposed regime and by the increased compliance that
a lighter tax regime would encourage. For example
salaries in the private sector are expected to be
computed on a cost-to-company basis and the imputed
rental value of rent free accommodation (for example)
is to be treated as part of the salary.
The danger here as can be seen even in the early responses
to the draft code is that the debate in the run up
to legislative action would force the restoration
of a range of exemptions while sticking with the proposed
new slabs and rates. Moreover, monitoring whether
value of perquisites are actually computed and included
in salary would be difficult and evasion through such
exclusion can be as much or higher than in the case
of evasion of post-exemption income and tax calculations.
The expected quid-pro-quo may not materialise and
revenues may in fact decline.
Given this, the belief that the new code would contribute
to an increase in tax collections is largely based
on the faith that reduced tax rates would contribute
to better compliance. Needless to say, this faith
in the “Laffer curve” is neither theoretically nor
empirically grounded. In the event, the new tax code
is ill-advised for at least two reasons. The first
is that it comes at a time when despite the consensus
that public capital formation and public expenditure
on social infrastructure and social protection are
grossly inadequate in India, the deficit in the budget
of the central government is rising. Even though there
are expectations that the deceleration in growth in
India induced by the global crisis is hitting bottom,
there is substantial agreement that the government
must keep expenditure high if the rate of growth is
not to slump further. This would lead to inflation
if it is financed by borrowing rather than by a draft
on private savings through taxation given the fact
that food price inflation is already high and a truant
monsoon is likely to intensify supply constraints.
This then is the least propitious time to launch an
adventurous experiment in resource mobilisation involving
a cut in direct tax rates.
But the case against the code is not just short term.
It would also abort the much-needed correction of
the decline and stagnation of the tax-GDP ratio at
the centre. One striking feature of the 1990s, which
was the first decade of accelerated economic reform,
is that despite evidence of reasonably good growth
rates and signs of growing inequality, there was no
improvement in the Centre’s ability to garner a larger
share of resources to finance expenditures it considered
crucial. Even when corporate profits and managerial
salaries were reported to be rising sharply, taxes
did not appear as buoyant. The Central tax GDP ratios
in India were declining for much of this period. And
despite the increase in the ratio in recent years,
they exceeded the level they were at in 1989-90 only
in 2006-07 (Chart ). Despite high growth, improved
profitability and signs of increased inequality (which
should improve tax collection), the increase has been
adequate to just about put the tax GDP ratio back
to its immediate pre-liberalisation levels. Thus an
effort to raise this ratio even further is what is
called for.
If these imperatives have been ignored in the new
code it must be because of the view that households
taxed lightly would increase their consumption and
firms taxed lightly would invest more, and enhance
consumption and investment would drive growth. There
are three problems with this argument. First, it underestimates
the role that public expenditure in general and public
capital formation in particular plays in crowding
in private investment, as amply illustrated by past
Indian experience. Second, it privileges GDP growth
even at the cost of reducing the role of direct taxation
in moderating the inequalising character of recent
economic growth. Finally, it completely ignores the
important role of tax-financed public expenditure
in alleviating poverty, providing social protection
and advancing human development.
The tax code is a signal that UPA II plans to continue
with the policy of cajoling private capital into investing
for growth with concessions that have adverse equity
and welfare implications.
Chart
1 >> Click
to Enlarge
