The Finance Minister, Mr P. Chidambaram, is a fiscal innovator. The stabilisation of basic income-tax rates at 10 per cent, 20 per cent and 30 per cent for corporate and non-corporate taxpayers had earned him a reputation of a dream-merchant. The dream soured a bit with the surcharge and cess, not to speak of the fringe benefit tax, the cash transactions tax and the securities transactions taxes.

Having had little success with the Finance Minister in getting through their plea for a trade-off higher corporate tax rate for the withdrawal of the FBT corporate houses have been pitching for relaxation of the rigors of the FBT. There is no justification for levying FBT even on companies incurring losses. Again, the levy of FBT on foreign companies is highly debatable asthey cannot get tax credit for paying the tax in India in their home countries. The banking cash transactions tax has been objected to by State governments as even their transactions are subjected to this levy. According to analysts, the securities transactions tax can have no place in the Income-Tax Act as it is levied on the turnover regardless of profit or loss in the securities transactions.

Taxing Capital Gains

The Government has taken considerable credit for the big boost to the stock market. In March 2005, the Sensex stood at 6,595 and the market capitalisation at Rs 16.61 lakh crore. As we approach the Budget day, the Sensex has crossed the 14,000-mark and the market capitalisation stands at nearly Rs 40 lakh crore. According to government observers, the new law on capital gains tax has opened up the real value of equities and attracted investors both Indian and foreign to the stock market.

The revenue loss suffered by the abolition of long-term capital gains tax on securities and the nominal levy of 10 per cent on short-term capital gains have been ignored; at any rate, no attempt has been made to quantify the loss sustained by these measures. Fiscal expert Prof Amaresh Bagchi estimates the loss at Rs 29,000 crore. This would have accrued to the exchequer had no change been made in the capital gains tax regime. The revenue gathered from the STT is a mere Rs 3,000 crore.

In a study in the Economic and Political Weekly, Prof Bagchi observes: "Apart from being a tax of a different character being essentially a tax on sales with all its distortionary effects, unlike a destination - based VAT revenue-wise, STT and 10 per cent tax on STGG, are far from being substitutes for the tax on capital gains."

The argument for the soft treatment to equities in the matter of levying capital gains tax arises from the belief that it will lead to growth and boom in the market conditions. Economists have disputed this belief. Prof Joseph Stiglitz points out that, "There is no very direct or strong relationship between the effect of the capital gains tax on the performance of the stock market and the decisions made by managers and owners of firms concerning investment and production" (Economics of the Public Sector 1999, page 595).

Prof George Zodrow carried out an economic analysis of the capital gains taxation in a seminal essay in Tax Law Review. According to him, there is "Considerable uncertainty in attempting to determine the effects of capital gains tax cuts on saving, investment and growth." He concludes that the effect on domestic investment and growth is likely to be quite muted" and further, "it is rather unlikely that such a (cut) will result in a significant increase in economic growth."

Canada, Australia and the UK levy tax on capital gains on realisation with arrangements to take care of bunching and inflation. The American Tax Reform Panel, 2005, recommended a Growth and Investment Tax plan for bringing capital gains to tax. The plan suggests taxation on dividends, capital gains and interest at a flat rate of 15 per cent. World-over, capital income is always taxed at a rate lower than other incomes.

It is recognised in this system that in a globalised world, no country can afford to tax capital at a rate higher than that prevailing elsewhere.

The present tax exemption for long-term securities in India violates the canon of equity; this is also true of the lower levy of tax on short-term capital gains.

The treatment given for taxing gains from other assets is discriminatory. All this calls for a re-look at the entire scheme for taxation of capital gains.

There must be a fiscal disincentive for foreign institutional investors against moving out of the stock market at will. Taxes on financial transactions or transfers outside India (something like the Tobin Tax) will go a long way in preventing volatility in the stock market.

Inflation and Bracket Creep

Inflation is at a two-year high. The duty cuts on imports have not had any significant effect. The rise in interest rates can affect corporate profits. The attempt to keep the rupee exchange rate low to help exporters is resulting in import costs going up. Exporters get all encouragement by way of fiscal concessions such as the SEZ and EPZ.

It cannot be denied that inflation is a tax most damaging to the poor. The least the Finance Minister can do to help the middle-class taxpayer is to index incomes to inflation, in the manner that Dr Manmohan Singh did with capital assets in 1992. That will earn Mr Chidambaram the eternal gratitude of those relying on fixed income.

Need for an M&A Policy

Indian companies are truly becoming multinational. Many of them are now involved in major cross-border acquisitions. The income-tax law must keep up to the changing times.

There is need to amend the provisions relating to amalgamations, demergers and takeovers to encourage Indian multinationals go global in a big way.

Much that has been done in the past three years requires to be un-done. Much more needs to be done to make the income-tax law simpler and equitable.

T. C. A. RAMANUJAM
(The author is a former Chief Commissioner of Income-Tax.)