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 two 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, which included 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, defense and quality primary education and health, and to redistribute income, from non-poor to the poor, from the young to the retired pensioners. To achieve this, the tax to GDP ratio for most developed economies in OECD and others like Brazil and Argentina is more than 35 percent. For the USA, it is 27 percent. For India, inclusive of state and local taxes, the ratio is 17 percent, 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 getting a good return in the form of services, public goods and social stability. Supreme Court Justice Oliver Wendell Holmes famously said, “Taxes are what we pay for a civilized society. They are like our membership fees to be in a civilized and socially stable society”.
India recently jumped 30 ranks in the global ranking of the ease of doing business, as measured by the World Bank. 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 the 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 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 half job 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 from what source. It would have low tax rates with minimal exemptions, and it 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 percent. 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 monthly pay-check. Thus, income from capital and labour has to be taxed with uniform and fair treatment.
A new DTC was proposed in 2010, and a draft was ready to be passed by parliament in 2013. Unfortunately, it lapsed with the fifteenth Lok Sabha. Its demise may be a blessing in disguise, because the final version had too many elements of compromise which had diluted the essential and reformist features. Indian lawmakers have the genius of doing the right thing, after trying out everything else! It is good that a new panel has been formed headed by tax veteran Arbind Modi, who was a member of the original Kelkar Task Forces and 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, and friendly to the taxpayer.
The writer is an economist and Senior Fellow, Takshashila Institution.