Taxes, equity, simplicity and budget pronouncements
July, 01st 2009
The T20 cricket season in 2009, coming close to budget presentation, is perhaps a metaphor. As much as T20 can exist without cheerleaders, fiscal reforms can progress bereft of the annual ritual of budget presentation. Be that as it may, this article examines the progress of fiscal regime in post-reforms India on two of the canons of taxation, namely equity and simplicity.
First, equity. The power to tax is the prime manifestation of the State and also its chief sustainer. Taxes can be in two forms --- direct and indirect, each with its different macroeconomic impact. To illustrate, take two individuals A & B with monthly income of Rs. 20,000 and Rs. 2,000 respectively. If both were to buy a pen costing Rs. 10, having excise duty @ 10% (Rs. 1), then B pays a very high portion of his income (1/2,000) by way of indirect tax, compared with A (1/20,000). Indirect taxes are regressive as they reduce the purchasing power of the poor at a higher proportion than the rich, resulting in relative redistribution of income, perpetuating poverty.
What then has been the progress on 'equity' in the post reform period? Indirect tax collection has shown relative decline in the post-reforms period from 83.5% to 71.1% of the tax collected, accompanied by decline in poverty level from 36% to 27.8%, as given in table below.
Correlation need not necessarily be causal. Accordingly, the impact of relatively high indirect taxes in creating, sustaining and perpetuating poverty in pre-reforms India can be taken up as topic for Ph D thesis.
Notwithstanding the aforesaid progress, the medium term objective of fiscal reforms should be to collect 80% of taxes through direct taxes, as it will foster a more equitable society. Further, it will strengthen democracy by imposing accountability on elected representatives by the tax payers.
Achieving the 80% target would require phenomenal and sustained effort. However, the target can be achieved even while lowering the direct tax rates, by continuously widening the tax base.
For widening the base for income tax, creation of a registry of all citizens / issue of citizenship-cum-identity (ID) card is a prerequisite (ID cards are scheduled to be issued to all citizens by 2012).
Augmenting the tax information network (TIN) database and integrating it with ID card numbers and bank accounts can contribute in achieving the target. For widening the base for corporate tax, integrating financial filing in MCA-21 with the TIN can be helpful.
Wide publicity of the benefits of '80% direct tax' can help in generating fresh ideas from all stakeholders to achieve this goal. All the aforesaid need not wait for budget presentation.
Second, simplicity. The effectiveness of public policy implementation is directly proportional to its simplicity. On one hand simplicity eludes indirect taxes despite reduction in its rate of dispersion. On the other hand, the benefits of a single rate Goods and Service Tax (GST) are well recognised (read, Mission GST by Dr. Ajay Shah, BS 17.01.07) and switching over to GST is a stated public policy goal. Simplification and switching over to GST are two sides of the same coin and can be co-terminus.
Given the experience with implementing VAT in India, the target of 2010 for commencing GST appears ambitious (will be glad to be proved wrong!). The innumerable hurdles in implementing VAT viz. protracted haggling with recalcitrant state governments, compensation during the transition period, indifferent bureaucracy, resistance to computerisation etc. resulted in routine missing of deadlines. Therefore, the lesson learnt is that gradualism and perseverance pays.
Accordingly, instead of the tinkering with rates of indirect taxes in the budget as usual, the GST rate may be announced along with medium term (say, 5 years) road map for phased convergence of all existing indirect tax rates to the GST rate. To illustrate: let's say GST is fixed at 16%, items having tax rate of say, 150% shall be phased to converge to 16% over a period of 5 years and items having tax rate of, say,10% shall converge to 16% over 1 year. By announcing a timeframe for convergence, all economic agents / stakeholders will have sufficient advance notice to reassess their competitive position / consumption pattern viz, the new tax structure and take appropriate counter measures. The switching over to GST can coincide with the end of the convergence period. In the interim, the complex back office expertise required to handle GST can be finetuned to perfection.
Besides simplifying the tax structure, GST will in itself contribute to 'equity' (non-cascading nature) and will also have positive externalities, two of which are traversed here.
First, the aforesaid roadmap for convergence will eliminate scope for lobbying for fiscal concessions thereby, curtailing the capture of polity by corporates / vested interest. Secondly, upon implementation, GST will drastically reduce incremental tax litigations. Judiciary will be relatively free of this civil burden and can better focus on quick delivery of criminal justice. To conclude, genuine fiscal reforms can be initiated and implemented bereft of the distraction of the annual ritual of budget presentation; an event inevitably preceded by lobbying for sundry change in tax rates and still worse, followed by its 'analysis' by the experts!