Moving away from high theory and science of taxation, with apologies to the expert fraternity, it would not be far from truth to say that there are many reasons why citizens must contribute by way of taxes. Maintenance of internal security, upholding justice and ensuring freedom from external aggression are the vital functions a government must perform and the government, however formed, will need to tax the people in order to provide the essential services.

Modern governments go well beyond the minimal tasks and undertake a number of welfare measures, including making investments in education, health, water supply, sanitation, etc. It is the justified government expenditures that indirectly justify the taxes levied.

A government that keeps on taxing, that too relatively heavily, will do a lot of damage to the economic and social fabric of the nation, as the intellect and time of the citizens are spent in planning tax avoidance, if not evasion. If planned government expenditures are well justified, even then, heavy taxation must be avoided for reasons of not only minimising avoidance/evasion, but also to ensure that investment and work are not discouraged. Governments lose credibility by following inappropriate taxation measures and funds disappearing into bottomless pits. In democracies, loss of credibility could mean that a party at the helm will have to vacate and give way to another.

Hurting indirect taxes

Heavy doses of indirect taxation could add to inflationary pressures. Perceived laxity in governance could lead to hoarding of essential commodities, creating artificial scarcities and contributing to inflation. At the middle school, the history teacher used to poke fun at the emperor who levied the jijia tax; but a service tax on hair-cut would not be far from that. Wide ranging indirect taxes on goods and services of ever-day use will hurt one and all equally and in quantitative and qualitative terms, hurt the low-income groups more.

Why do governments resort to indirect taxes at all? It is convenience in levying and collecting the tax; the levy is generally not seen (it is tucked away somewhere in the MRP); and evasion is relatively more difficult.

Some reasons on welfare grounds too can be adduced one way or the other, such as the heavy tax curbing the consumption of cigarettes, though there is no empirical evidence that people have stopped smoking because of higher prices due to taxation. Often, the real motive of governments in levying indirect taxes is one of augmenting revenues. If expenditures are justified for ensuring governance of the highest quality and welfare of one and all, then people may pay taxes willingly or grudgingly.

Direct Taxes: International Evidence

The most common of the direct taxes are those on incomes of individuals and corporations. Let me venture an oversimplification of the rationale for income taxation. Government arranges a conducive atmosphere to invest and work and earn income. It is only fair to expect that those profiting pay a part of the gain back to society as tax and the funds so raised would be used by the government to sustain the environment to invest and work. The creation and maintenance of the environment includes ensuring that none in society is excluded from sharing the opportunities.

Personal income-tax: The web site of the Heritage Foundation provides data on the background indicators used to arrive at the Index of Economic Freedom, 2007. Two of the indicators are the personal income-tax rate (at the highest slab) and the corporate income-tax rate for 156 economies. As many as 25 economies, including India, have personal income-tax rates in the 30-33 per cent range; 57 have imposts lower than 30 per cent; and 74 levy over 33 per cent. Fourteen economies have rates in the 50-65 per cent range. They include the five `developed' economies of Austria, Belgium, the Netherlands, Denmark and Sweden, besides nine developing countries. Thus, one must not think that India's personal income-tax rate is on the high side or that developed countries generally are generous on taxation.

Corporate tax: The 30 per cent rate is the most popular in regard to corporate tax, with 31 economies levying that rate. While 74 economies have rates below 30 per cent, there are 51 with rates above 30 per cent, with the maximum rate at 45 per cent. Thirty economies tax corporate income relatively more heavily compared to personal income. In 50, the rates are the same, while the corporate income-tax rate is lower than the personal income-tax rate in 76 economies. If one goes by the majority rule, the imperative is that corporations are treated slightly leniently.

Issue of Competitiveness

The World Economic Forum web site provides the Global Competitiveness Report (GCR) Score for 2006 for 124 economies. Switzerland has the top score of 5.81, most of the industrialised economies and the newly industrialising economies of East Asia have scores above 5, and Angola has the lowest score of 2.5. GCR of 4.44 with a rank of 43 for India is not bad at all, given all the complaints over tax rates, incentives, and so on.

Of interest is the question of how the personal and corporate income-tax rates relate to the GCR. The Table summarises the data and it is easy to note that there is no earthshaking evidence that India must re-think its income-tax rates to ensure a good GCR score.

Bhanoji Rao
(The author, formerly with the National University of Singapore and the World Bank, is Professor Emeritus, GITAM Institute of Foreign Trade, Visakhapatnam and Visiting Faculty, Sri Sathya Sai University, Prashanti Nilayam.)