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Don't bet much on direct tax reforms in this Budget
February, 15th 2010

As we wait for the 2010 Union Budget, experts are all agog about the fiscal numbers that will come out and whether the so-called stimulus will be withdrawn. However, the rest of us ordinary mortals who earn, save and invest, are a bit more worried about what impact the Budget will have on the taxes we will have to pay next year.

Every year, for crores of middle class Indians, the most hotly-anticipated part of the Budget is whether the various limits, slabs and exemptions will be raised or not. Thats the part that directly affects our bank accounts.

If the limits and the slabs are raised, we feel thankful towards the government of the day and if they arent, then we feel a little resentful. When the general elections are near, we feel theres a higher chance that we will get some scraps of lower tax liability and when the next elections are far away (as they are this year), we feel a little less hopeful.

I dont know about you but personally, I think that having fixed limits for income tax exemption and slabs is a sort of a fraud that the Government of India has pulled on the people from the very beginning. Theres a basic asymmetry in the way the whole deal is structured. The tax that you pay is set as a percentage of your income and thus goes up automatically as your income goes up.

However, the slabs and exemption limits are fixed as actual rupee amount and thus do not go up as inflation erodes the real value of the rupee. Think about it. If fixed amounts are the right way, then the tax code should have said something like you should pay X amount for income above Y amount. Instead, what we have is pay X percentage above Y amount.

Much of the income increase that a salary earner gets every year just compensates for inflation and to tax this is grossly unjust. The government runs various inflation and cost indices, including the cost-inflation index, which is used to adjust long-term capital gains tax to inflation. Theres no reason that slabs and exemptions of personal income tax cannot be adjusted upwards automatically every year in step with the cost inflation index.

However, realistically, what Im describing is a pipedream. Finance ministers get an annual chance to stand in the Parliament and dole out slab and exemption increases as largesse that they are grandly bestowing on the aam janta because of the milk of human kindness that is flowing in their hearts. They arent going to give up this grandstanding opportunity and replace it with a calculation that anyone can do.

In any case, the hope of direct tax reform that had risen with the release of the draft Direct Tax Code stands tempered. I dont know whether Im right but theres a clear sense that the opponents of the code - those whose power and livelihood would be most threatened by the simplification that it shall bring - now have the upper hand.

The Code is not actually dead but its certainly in hibernation and its far from certain whether it will emerge in anything resembling the form we have seen last year. So dont get your hopes too high. Direct tax reforms may still be as far as they always were.

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