The Hindu Business Line : Introducing justice in taxation

The burden of taxation has to be such that it does not affect savings and investment. A measure of redistributive justice has to be inducted into the tax laws. If we do not do this, and if the need for some exemption is not considered, especially for unorganised sector workers, justice would be sacrificed in favour of simplification, argues P. R. Brahmananda.

WHY should the Government collect resources signifying command over purchasing power from the public? The straight answer is that the Government has its expenditure, and resources are collected from the public to meet these expenses. In a democracy the public have decided that the Government must have a portion of the annual resource flows in order that it performs certain functions delegated to it by the public as a part of an invisible social contract.

This social contract is not once over but gets renewed through elections etc. Here, the Government is an instrument or intermediary devised by the society to perform functions assigned to it by the public. Government in this theory has come to existence by public choice and the public has voluntarily agreed to part with some portions of its resource flows to the Government for performing the agreed functions.

Implicitly, the idea is that the institution of a Government performs these functions most economically. Such functions performed in other ways would be more expensive; nor can the individual members of a community get these functions performed on their own or through groups.

The functions themselves have to be visualised as universally agreed in a social contract. The maintenance of law and order, Defence, justice, the provision of universally required basic amenities that cannot be supplied through private agencies operating on a profit motive, and the management of currency and money are all functions which a Government has to perform.

Nowadays, the proper maintenance of the common resources accessible to all as well as the safeguard of the natural, physical and geographical environment, are deemed proper and primary functions of a Government. In practice, the Government has taken on many more functions of a developmental nature. Development of the community in its initial stages can be deemed a function assigned to government in the implicit social contract.

The terms "justice" and "provision of basic amenities" have now a wide sweep. Justice now encompasses social and economic justice, which, in their turn, imply much more than a framework for the regulation of contracts among the members of the community. It now connotes a set of redistributive responsibilities, which should culminate in a more equal society than otherwise.

Basic amenities involve such functions as provision of common community needs unfulfilled for significant portions of the population, apart from the construction of roads, bridges, parks, reservoirs, dams, ports, railways, and so on. This group of functions can also get enlarged in developing societies. The developmental function also requires initiatives in the real and financial sectors for building and operating new institutions as well as industries in the early stages of development.

The maintenance of existing public assets is a most important responsibility both to the present and the future generations.

To what extent is the redistributive function fundamental in a social contract? Here, the initial situation is very important, and since social contracts are constantly renewed in a democracy, the initial situation itself goes on changing.

The redistribution function affects both taxation and related ways of collecting resources and expenditure. It is good to treat the resource mobilisation and expenditure angles separately. The alteration in the initial states occurs additively because of the separate effects of the manner of mobilisation and the patterns of expenditure.

Taxes and other methods of collection of resources for given expenditures as following from the functions have, therefore, a redistributive goal built into them, apart from the size, components and effects of expenditures. A given volume of resources has to be mobilised through the tax, non-tax and borrowing channels. Borrowing involves a deficit with its own implications on distribution. Non-tax resources involve user charges to cover costs of enterprises, etc. To the extent the user charges are not covered, there are subsidies involved and this itself has a distributive effect.

Thus, all the three channels have their distributive effects and these have to conform to the canons of justice implied in the contracts. The distinction between the incidence on the haves and have-nots is significant here.

Any method of collection of revenues to meet expenditures is not sanctioned in the economic theory of public finance. It is assumed that taxation has to be neutral in its effects on aggregate production. The alteration of aggregate production is a function of expenditures. The neutrality aspect of taxation has a very important significance in fiscal economics. It is probably here that incentives as would effect aggregate production become relevant. The concept of redistribution here pertains to justice in matter of inter-generational effects of production, and growth in all its aspects becomes an issue here.

The burden of taxation has to be such that it will not affect savings and investment. A poor society, which is developing the concept of neutrality between generations, has to be modified according a bias in favour of the future generations in a general sense and not in the sense of the concrete consumption status of the better-off sections.

Taxation has to be such as would promote the maximum of savings taking into account the consumption requirements, both in terms of efforts and incentives for the different categories of workers and producers in the current generations. This is the rationale of an expenditure tax which discourages excessive consumption.

A balanced and reasonably progressive and marginally high expenditure tax operates as a powerful disincentive against excess consumption. Though the system makes for high rates of accumulation of capital and other wealth, the tax itself discourages the use of increasing wealth for dissipation in increased excess consumptions.

The inequality in incomes and wealth does not matter in such a society so long as the differences in consumption status of different workers and producers is not large, and certainly not glaringly large. A progressive expenditure tax with reasonably high rates at the top levels is the best tax for a developing economy like India where inequalities in consumption status are quite large.

In calculating the expenditure base for taxation, the modern theory of human capital introduces important changes in the manner of taxation. Exemptions have to be provided for expenditures on education and maintenance of health, etc. In the Indian context, the family cannot be considered as mostly nuclear. Maintenance of relatives who have no other resources, especially the maintenance of old persons, unsupported children and relatives, as well as unsupported widows, involves expenditure on consumption and education, and these have to be recognised in the tax laws. To support small family norms and restrain population growth, the incentives in the form of exemptions and reliefs have to be introduced in the tax laws. Unsupported senior citizens, who are not getting the benefit of index-linked pensions, do need special attention.

The problem here is that only a small portion has the benefit of old-age incomes through pensions. Most old people, who have been workers in the past, do not get even the benefit of provident funds and income from provident funds are a function of interest rates, etc. When interest rates are falling, there is a huge discrimination and injustice against those who had not been linked with the public sector in the past.

It is, therefore, not proper to rule out all exemptions in a country like India with its historical social situations. Tax simplification can be very cruel and insensitive to the sufferings of a large portion of the earners. If it does not discriminate in favour of savings, it will be consciously hurtful to the future; and if it does not recognise the human capital theory, it will make society more highly biased in favour of the rich.

In India currently, the organised sector workers, especially in the public domain, have to some extent been pampered. Just note that about 1.75 lakh workers have an average income of Rs 1.74 lakh per year, or of Rs.15,000 per month. The average income per year of unorganised workers in urban areas would be about Rs 3,000 per month, and in rural areas somewhat less, probably about Rs 1,200-1,500 per month.

If the top salaried bracket earner gets about Rs 3-4 lakh per year, or about Rs 25,000-30,000 per month the ratio between the unorganised urban worker and the top group becomes 1:10 or so. This is too high a differential for a country with so much unemployment and poverty. A measure of redistributive justice has to be inducted into the tax laws and if we do not do this, and also if we do not take care of the need for some exemption, as mentioned earlier, we would be sacrificing justice in favour of simplification, to say the least.

I would suggest that even when he wants to remove the standard deduction, Dr Kelkar must modify the proposal such that the deductions can be waived if the amounts are saved and invested in specific items of the public domain. This is a way where tax reforms help to benefit the future. Of course, an expenditure tax as such may be difficult, but there is always scope for a disguised expenditure tax, which promotes savings and human capital formation.

Send this article to Friends by E-Mail
Comment on this article to BLFeedback@thehindu.co.in

Stories in this Section
Are banks really healthy?

Dabhol: What domestic lenders should do

Introducing justice in taxation

The officer, a gentleman?

Shady money in `real' deals

Service to the rescue

Why deep pockets strew small change