The Hindu Business Line : Tinkering with tax reforms

The Kelkar Task Force may have had to do a rush job; nevertheless it is surprising that it has not looked at some of the crucial issues and challenges facing the tax regime, addressed by many panels and Finance Ministers. Unfortunately, says S. D. Naik, because of a number of controversial proposals, even some of the more pragmatic suggestions of the Kelkar panel are likely to be ignored.

V. P. Singh

THE reactions to the recommendations of the two high-level task forces headed by Dr Vijay Kelkar, Economic Advisor to the Finance Ministry, on reform of direct and indirect taxes have been mixed. While some have hailed them as sweeping and "big bang", others have termed them half-baked prescriptions that are too harsh on the honest tax-payer and not in conformity with the basic objectives of tax reforms.

Considering the time given to the panels to frame their recommendations, they had to do a rush job, drawing heavily on some of the earlier committees. Even so, it is rather surprising that they have failed to address some of the crucial issues and challenges that have already been discussed threadbare by some of the earlier committees, more recently by the Planning Commission Advisory Group on Tax Policy and Tax Administration.

In this context, it would be worthwhile to briefly review the efforts by different governments in recent years to reform the country's tax system and see if the reforms introduced thus far have had the desired effect. Serious efforts in this direction were made for the first time in the second half of the 1980s, when Mr V. P. Singh's Budget for 1985-86 introduced the concept of long-term fiscal policy (LTFP) and committed the government to implementing a modified system of value-added tax (Modvat). The LTFP had stated: "A broader base taxation... combined with moderate rates of taxes and stricter enforcement can yield better revenue results." Mr Singh also acted swiftly to implement Modvat for the first set of industries in his 1986-87 Budget. The system of Modvat was gradually extended to cover virtually the whole of industry. The 1985-86 Budget reduced the personal income-tax slabs from eight to four and cut the top marginal rate to 50 per cent from the absurdly high levels prevailing earlier.

Manmohan Singh

Dr Manmohan Singh, the chief architect of India's economic reforms, reduced the top income-tax rate further to 40 per cent in his Budget for 1992-93 and compressed the slabs to just three. He also acted on the Chelliah Committee recommendations and scaled down the corporate tax rate to 40 per cent in 1994-95 and reduced the number of exemptions. In his 1994-95 Budget, Dr Manmohan Singh extended the reforms to indirect taxes by chopping the number of excise duty rates by half and making a major transition to ad valorem rates and reducing substantially the myriad end-use specific concessions. He also brought down the Customs duty rates drastically between 1991 and 1995, the peak tariff rate falling from over 200 per cent to 50 per cent.

P. Chidambaram

Thereafter Mr P. Chidambaram took the bold step of reducing the marginal rate of personal income-tax to 30 per cent in his `dream Budget" of 1997-98. He also reduced the rate of company taxation to 35 per cent for Indian firms, and to 48 per cent for foreign outfits from 55 per cent. He also announced a rationalisation of excise duties, lowered the peak Customs duty rate from 50 per cent to 40 per cent.

Yashwant Sinha

Mr Yashwant Sinha carried forward the process of tax reforms by reducing the number of excise duty rates from 11 to one — that is, 16 per cent Cenvat. However, because of the introduction of a number of exceptions and special rates, there remained a wide gap from the goal of a single-rated retail stage VAT.

The objectives of tax reforms were to simplify the rules and procedures, lower the tax rates and widen the tax net so as to ensure better compliance and raise the tax-GDP ratio. However, despite lowering the tax rates and doing away with many of the rigidities, the successive governments have not been able to widen the tax net and strengthen the tax administration. Agricultural income is totally out of the tax net, and services, which today account for a little over 50 per cent of GDP, are also largely out of the tax net. The recent efforts to extend the tax net to services have met with little success. The Centre's tax-GDP ratio has, in fact, fallen from 10.10 in 1989-90 to 9.10 in 2001-02.

Available evidence suggests that there is large-scale evasion of both direct and indirect taxes. In the case of personal income-tax, almost the entire burden falls on the salaried class, as the tax is deducted at source. Traders, businessmen, transport operators and professionals hardly pay any income-tax and a majority of them remain out of the tax net. According to data compiled by the Finance Ministry, of the 28.2 million income-tax assessees, not more than 6.2 million, or 22 per cent, had an income of Rs 1-4 lakh, and not more than 3 per cent above Rs 4 lakh. And this in a country where the sales of cars and other luxury goods have been booming.

In the case of indirect taxes, there is evidence of large-scale evasion of excise duties, particularly by small-scale units, and Customs duties, by way of duty drawback benefits based on manipulated invoices. Consequently, while there has been a small improvement in direct tax collections following a widening of the base, indirect tax collections actually declined over the past 12 years. The Kelkar panel proposals need to be evaluated against this backdrop of declining tax-GDP ratio over the past decade and the urgent need to increase the gross-savings-to-GDP ratio to step up the growth rate of the economy during the Tenth Plan. In respect of direct taxes, the panel's proposal to raise the exemption limit on personal income tax to Rs1 lakh will not provide any relief to taxpayers, particularly the salaried, as it is to be accompanied by abolition of standard deduction and all tax exemptions on specified investments.

Doing away with standard deduction is unfair and would amount to discrimination against salary earners, as it is intended to provide relief against expenses incurred for earning salary such as travel, purchase of books, and so on. When professionals and those in business are allowed all kinds of expenses, why should the salary earner be denied the same?

By not providing any real relief to taxpayers, the proposals would result in some 75 per cent of assessees going out of the tax net. In other words, the number of persons coming under the tax net will come down drastically to around seven million compared to 12 million in 1990-91. Since India's income-tax base is as yet too small, it would be imprudent to leave 75 per cent of the assessees out of the net, after all the efforts made to widen the net over the past decade.

A better course would be to keep the current 10 per cent slab for the lower income group by raising the exemption limit to, say, Rs 60,000 from the present Rs 50,000 without disturbing the tax exemption regime. In fact, some experts have suggested an additional slab of 5 per cent at the entry level in order to reduce the tax burden on those in the Rs 1-1.5 lakh income category.

The Kelkar panel proposals also include other unfavourable provisions, such as phasing out the deduction for mortgage interest in respect of loans for acquiring a owner occupied dwelling by 2006-07; eliminating income-based deduction under Section 80L for interest income and dividend; and removing Section 88C rebate for women taxpayers below the age of 65. The unkindest cut is proposed for senior citizens, by doing away with the Section 88B rebate. They will also be denied rebate on medical expenses.

The proposal to withdraw tax breaks on housing loans is retrograde, as it would deny the salaried middle-class the opportunity to have a house of their own. This would also hit the housing sector hard.

Known for its employment-generation potential, this is one sector that has started looking up despite the prevailing recessionary conditions in the economy. Even in the West, where housing is not as acute a problem, exemptions are provided for housing mortgage and servicing payments.

The unjust and retrograde proposals prompted the Finance Minister, Mr Jaswant Singh, to state that the Government cannot renege on commitments made to the taxpayers and that the exemptions given to promote employment and investment in the infrastructure sector, particularly housing, will not be rolled back.

If the existing tax incentives on specified savings are abolished, there is a real danger of the savings rate in the economy falling and affecting the investment rate. The need of the hour is to make all-out efforts to raise the savings and investment rates and push up the growth rate of the economy as proposed in the Tenth Plan.

One should not blindly follow developed country models and abolish the incentives for savings. Rather, we should be guided by the policies pursued by the newly industrialising economies (NIEs) of Asia to actively promote savings.

For instance, the average gross savings rate in the 1990s was 47.6 per cent of GDP in Singapore, 40.6 per cent in Malaysia, 40.7 per cent in China and 35.4 per cent in the Republic of Korea compared to 23 per cent in India. Incidentally, East Asia has relatively low rates of taxation, which are applied to high rates of incomes. According to some tax experts, if the prevailing tax incentives are abolished, the savings rate in India could fall to below 20 per cent. Unfortunately, because of a number of retrograde and controversial proposals, even some of the more sensible and pragmatic suggestions are likely to be ignored. These include the proposal to set up a national Tax Information Network (TIN) on a build, operate and transfer basis; implement a State-level VAT by April 2003 and move to a two-slab Customs duty structure by 2005 (20 per cent on finished goods and 10 per cent on raw materials); reduce the peak Customs tariff to 25 per cent from 30 per cent by 2003-04; and abolish dividend tax, minimum alternative tax (MAT), wealth tax and long-term capital gains tax.

Notwithstanding the many shortcomings, it is a matter of some satisfaction that the two consultation papers of the Kelkar Committee may not be a futile exercise after all. They have generated widespread debate on the desired roadmap for further reforms in the tax system and helped in moving towards greater transparency in the Budget-making exercise, which continues to be shrouded in too much secrecy.

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