The United Progressive Alliance-II government started its mandate in May 2009 with a very ambitious agenda for tax reforms, which included the twin-ticket reforms - the goods and services tax (GST) and the direct taxes code (DTC). Dogged by scams and policy paralysis, it squandered this opportunity and failed to implement either of them. The government now ends its mandate with reaffirmation in the vote-on-account of the same goals, for which it claims to have a clear line of sight.
Who blocked the GST? The finance minister raised this question in Parliament, expressing disappointment about its non-implementation. Industry is equally disappointed. Since it was introduced, the constitutional amendment Bill for the GST has seen multiple revisions to accommodate the states' demands on the GST design and other aspects. The states' continued resistance to the implementation of the GST does not appear to be on account of the way the tax is designed as much as the lack of trust and confidence that their interests would be protected.
The blame for the failure of the DTC lies with the government alone. The broad thrust of reforms in the original DTC white paper was laudable. It proposed broadening the tax base and lowering the top personal and corporate tax rates to 25 per cent. However, the DTC contained proposals that were controversial and widely perceived as unfair, arbitrary and unworkable. The most notable was the new minimum alternate tax based on corporations' gross assets instead of book profits. This form of tax has not worked well elsewhere in any part of the world. Without it, the government found it difficult to balance the books.
The government mishandled both the reforms. To make matters worse, its 2012 Budget took a sudden and dramatic U-turn on the vision for tax reforms. It introduced an unprecedented proposal reversing the Supreme Court verdict on the taxability of capital gains in the Vodafone-Hutchison Essar transaction. It contained numerous retrospective amendments, some going back to 1962, all in the name of providing clarity on the intentions of Parliament at the time.
Investors were angered by this irrational move and India paid a price for this. For instance, net investments by foreign institutional investors in India fell from about Rs 97,000 crore in the first quarter of 2012, to negative Rs 4,900 crore in April 2012. The total value of participatory notes in foreign institutional investments also declined from Rs 1,28,606 crore in February 2012 to Rs 86,785 crore in April 2012.
The government tried to revive investor sentiment by constituting an expert committee chaired by Parthasarathi Shome to re-examine the provisions on General Anti-Avoidance Rules (GAAR) and retrospective amendments. The committee recommended a significant curtailment of GAAR and cautioned against retrospective amendments, except in the rarest of rare cases.
Unfortunately, the Shome Committee's efforts are turning out to be a waste with little or no action on its recommendations, barring some of the GAAR recommendations.
India's need for fundamental reforms in the tax system is as great as it was in 2009, if not more. What the country really needs is a tax system that stimulates entrepreneurship and strengthens India's competitive position in the global markets, facilitates starting of a business with ease and allows frictionless compliance and administration. The finance minister himself promised in the last Budget that an emerging economy must have a tax system that reflects the best global practices. He also promised a clear, stable and non-adversarial tax environment.
On the indirect tax front, the GST will go a long way towards providing a boost to entrepreneurship. It will significantly enhance India's competitive position in global markets by shifting taxes from investment and production to consumption. It will replace a plethora of indirect taxes and provide a single window for dealing with the tax authorities through the GST network. If the GST is levied in a comprehensive manner at a single rate, it will be the simplest of all taxes to comply with, with little need for interaction with the tax authorities.
The reform of direct taxes will require some more thinking and the DTC should go back to the drawing board. The basic objective should be to lower the top personal and corporate rates to 25 per cent through broadening of the tax, minimisation of selective incentives and more effective monitoring of tax evaders. The new rate structures should be more progressive to arrest the increasing inequalities in the distribution of income.
Another important area of reform would be strengthening of annual property tax system to finance the needs of rapid urbanisation. As noted by Isher Judge Ahluwalia, urbanisation is the engine of growth, and property tax would be a progressive means of financing it. The finance minister has also noted in his vote-on-account speech, "Cities have wealth, cities also create wealth. That wealth should be tapped for resources to rebuild the cities…"
Above all, India needs a responsive and cooperative tax administration to reduce the high levels of disputes and expedite their resolution. The number of income tax disputes pending at various levels at the end of 2011 was more than 250,000 and is growing faster than the growth in revenues.
Some of the disputes relate to international taxation. It is true that there is a need to curtail aggressive tax planning by multinationals - an issue that is being discussed actively across jurisdictions. However, tackling these issues requires a substantial change in the rules of the game. India should not rush in with unilateral changes in its law. In today's multilateral world, these changes can only be developed through discussions and dialogue with other trading partners.
A fundamental tax reform doesn't need a new tax system. It only needs going back to the basics of a broader base and lower rates for the taxes that we have, and flushing out ad hoc and selective provisions.