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'No urgency to revise income tax rates now
January, 14th 2008

Parthasarathy Shome , during his over three-years-and-three-months stint in North Block as advisor to Union finance minister P Chidam-baram, has overseen the rolling out of state-level value added tax. The noted economist, especially known for his grip of taxation, has served as the crucial link between the Centre and states in the discussion for the structuring of the proposed GST. Mr Shome, the architect of the Fringe Benefit Tax which is marked by Corporate Indias dislike of it, will join Her Majestys Revenues & Customs, the UKs main tax collection agency as chief economist soon. Mr Shome discuss on how he saw Indian tax system evolving. Excerpts:

How do you explain the revenue buoyancy we are now witnessing? Is it due to the high GDP growth, predominantly?

The revenue productivity (of the central government) has improved remarkably in the last two-three years the collection of PIT (personal income tax) has grown 50% so far this financial year and that of corporate tax, 40%. Indirect tax receipts are also generally doing very well. Even on a cross-country comparison, this appears to me as an unparalleled feat. At least no major economy has ever seen such a sharp increase in tax receipts in any year. Much of this buoyancy has been due to the high GDP growth, but not all of it. Right policies coupled with administrative efficiency have played a major supportive role.

There has been significant improvement in taxpayer compliance which has also resulted in a good increase the number of taxpayers. A large database has been shored up by the annual information returns (AIR) on high value transactions (filed by various financial sector entities) and this database is increasingly being made use of to identify those dont pay (or under-pay) their taxes. The AIR information now goes into a computer-assisted scrutiny system.

This ensures that only chosen cases are taken up for scrutiny. All returns of income taxes in the country are now stored in a pan-India pool thanks to the integration of computer systems. With this, over 12,000 offices in various states can now simultaneously log in, verify and cross-check the returns against each PAN (permanent account number). A similar system integration process would soon be implemented for the Customs and central excise also.

The revenue department, I understand, will approach the Cabinet for this in a few days. The idea is that these two integrated systems for direct and indirect tax administrations would establish a link for interaction and information exchange, which could also be a very useful equipment for the intelligence officers. I must add that there is definite increase in voluntary compliance among professionals.

I think the government can now consider making electronic payment of taxes mandatory. (Companies and section of the high net worth individuals are now paying their taxes electronically). With the taxpayer help scheme and the rather widespread use of the Net, electronic filing would not be difficult. In Brazil, which may not be as IT-savvy as India, 98% of tax payments are done through the electronic mode.

Would the current revenue buoyancy be sustained at this level over the next three-four years, assuming the GDP grows at 8-9%?

Taxpayer compliance has already reached a certain level. We may be nearing the saturation level in the case of newly utilising the hitherto untapped tax-paying capacity of most existing taxpayers. This would be partly offset by the widening of the tax net. Overall, the current level of buoyancy could still be sustained at least in the short term.

Dont you think Indias taxpayer base (no of people paying income tax as compared to the potential taxpayers) can still be expanded con-siderably?

In may view, this base is already good. If you just take out 30% of Indians living below or at the subsistence level, there are over 700 million people, of which 140 million could be income-earners (supposing that one in an average household of five is an earning member). Of this 140 million, about a half have their income from agriculture which is not taxed. So, the potential number of taxpayers could be 50-55 million, and we have already 35 million of them in the net. (About nine years ago, there were just 14 million taxpayers in India). The challenge now is get the 20 million or so into the tax net.

With this kind of revenue buoyancy, it is hoped by taxpayers that the situation could be quite tempting for the finance minister to lower the income tax rates, especially those on the personal income tax side, in the coming Budget. The contrarian view is that the rates are already moderate.

At 30%, Indias maximum marginal rate of income tax on individuals is less than that in many developed countries. But on purchasing power parity basis, the rate is not that low either. On the scale of tax-GDP ratio (which is the ratio of total tax receipts direct and indirect to GDP), if you do take out the contribution to GDP of those below subsistence level, we would be somewhere near the top end. On whether the income tax rates should change now, it is for the finance minister to take a call. I dont see any urgency either for a change in the rates or for raising the exemption limit of personal income tax at this juncture. Anyway, the new income tax code will be a vehicle for not only simplification of the tax system but also a structural revamp. With the recent administrative and policy changes, the finance minister is at a commanding height to decide on the future course. So, I thought it is perfect time for me to leave.

The stagnation in excise collection doesnt tally with the smart growth in industrial production during most part of this fiscal.

A good part of this can be explained by the fact the receipts from excise on imports (countervailing duty) are now reckoned as part of the Customs revenue. If it were the other way round, I guess the customs collection would have stagnated and excise grown.

A surge in investment in the manufacturing industry has resulted in increased imports of capital goods and raw materials. The 4% duty over and above the basic customs duty on these imports is being cen-vated against excise. This is a statistical flaw.

Then there are various incentive schemes like (the two kinds of) area-based exemptions. At some places, these exemptions work in such a way that if you pay the excise in cash, you get full refund, whereas for the rest of the country, you get the refund if you use the credit to pay. This is distortive. Of course, there are issues like clandestine removal of manufactured goods, but I doubt, in the light of a recent study, that whether this (clandestine removal) is as big a problem as it is often made out to be. SEZs might have begin affecting the excise revenue growth.

Over 100 services are now taxed by the centre. Isnt this comprehensive enough?

Yes, the coverage is already very comprehensive as most major services expect some professional services are now taxed. One good thing is that in the Cenvat chain, now you get full credit for the input service tax. The policy, as we move towards the GST, is that states get to have the power to tax services directly. Already, the proceeds from the tax on 33 of the 100 taxable services go to the states.

You were the co-convenor of the technical report on GST by the centre-state joint working group. Wont the model suggested by you result in build-up of enormous amounts of unusable credit with the taxpayers, defeating the very purpose of GST as a system devoid of cascading of taxes?

What we have recommended is a dual GST (VAT) system which will comprise central GST levied by the centre and state GST levied by the state on mostly the same goods and services. There two chains wont intersect that is, you get the input tax credit for central GST from the centre and state GST from the state. If this model is implemented without any dilution, then it would be a more less perfect VAT system. A refund mechanism to address credit accumulation beyond a level could be thought of. I hope the government would stick to the report of the joint working group while implementing the GST.

Revenue-neutrality would be one guiding factor while deciding the GST rates. The idea is that both the centre and states benefit from the new system.

Is there a case for taxing farm income?

In fact, a lot of the agriculture income, as it pertains to value added farm goods, are within the ambit of some tax or the other. I think theres a bit of excess estimate about the revenue-generating potential of the farm income tax. Anyway, it should be a political decision.

What about expanding the scope of wealth tax, given that we have more and more HNIs and HNIs whose net worth surges pretty too fast?

One will have to first define wealth in this context. Rather than physical assets such as gold and land which were reckoned as wealth traditionally, now there are sundry other things stocks, bonds, other intangible assets. However, I dont intend to take a policy stance here.

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