Financial Daily from THE HINDU group of publications
Thursday, Dec 08, 2005
What has been ailing the tax-GDP ratio?
T. C. A. Ramanujam
The more you earn, the less you keep.
And now I lay me down to sleep.
I pray the Lord my soul to take, if the
tax-collector hasn't got it `fore I wake.
TAX reform is an ongoing exercise. Apart from committees set up by the government, independent public institutions have been delving into the causes and cures for the phenomenon of stagnation in the ratio, which even the reform process, set in motion from 1991 onwards, has not succeeded in pulling up.
We need not compare ourselves with OECD countries such as Sweden, where the ratio was 50 per cent in 2004 or even with the US and Japan, where it stands at 25 per cent. In the Euro area, on an average, the ratio reaches 40 per cent of GDP.
Comparison with our South-East Asian neighbours, too, is adverse (see Table 1 for 2002 figures).
It is only in the current year that the ratio has touched 10.5 per cent for India. Why this stagnation?
Plethora of tax concessions
The National Institute of Public Finance and Policy (NIPFP) estimates the revenue losses due to fiscal concessions at Rs 54,560 crore. The break-up is given in Table 2.
This adds up to about 1.6 per cent of GDP. The question has been posed whether these fiscal incentives achieved the intended objective. ICRIER studied this situation in various Asian countries and found that India's market size, the availability of skilled labour and electricity were statistically more significant than fiscal incentives. More than 50 per cent of our charitable institutions are engaged in business but claim tax exemption. Tax holidays have not improved matters in the North-East. The NIPFP study recommended a tax levy on farm income wherever the agricultural holdings exceed eight hectares.
The Indian Liberal Group, in its version of the Budget for 2006-2007, has suggested that a person having both agricultural and non-agricultural income should be taxed on non-agricultural income in a way that he pays slightly higher tax than what he would have paid on the same non-agricultural income if he had no agricultural income. The rate can be higher, at perhaps 40 per cent. The Group has also suggested refinement of the 1/6 scheme to ensure that all individual and HUF returns-filers other than senior citizens pay a tax of Rs 1,000 per year so that it will instil a sense of pride in those filing tax returns, and add about Rs 3,000 crore to government revenues.
Much has been done on the administrative side. Tax administration is considered the soft underbelly of the system. Because of the tightening of the TDS (tax deduction at source) provisions, revenue from this source increased to 50 per cent in 1996-97 and 67 per cent in 2001-02. Correspondingly, the advance tax receipts declined. Departmental lapses accounted for leakages in revenue by way of interest on tax refunds, as shown in Table 3.
There has been a phenomenal growth in individual and corporate wealth in the past three years, and this is reflected in the stock market indices. Yet, the number of non-corporate taxpayers with incomes of Rs 10 lakh and above stands at just one lakh (0.3 per cent of the total number of tax-payers). This is partly due to the exemption given for dividends in the hands of individuals and HUFs. An analysis of corporate tax collections will show that public sector undertakings contribute about 38 per cent towards corporate tax and 42 per cent towards central excise tax. This is a sad commentary on the working of the Income-Tax Department vis-à-vis the private sector companies. The Centre for Economic Studies and Planning estimates that the black economy has grown from 7 per cent to 40 per cent of GDP in 10 years. It is time we looked into the distortions brought into the tax code by the tax policy flip-flop.
Guidelines for a good tax policy
The American Institute of Certified Public Accountants has come up with several guiding principles for tax reforms:
Simplicity: The tax law should be simple so that taxpayers understand the rules and can comply with them correctly and cost-efficiently.
Fairness: Similarly situated taxpayers should be taxed similarly.
Economic growth and efficiency: The tax system should not impede or reduce the productive capacity of the economy.
Neutrality: The effect of the tax law on a taxpayer's decisions on how to carry out a particular transaction or whether to engage in it at all should be kept to a minimum.
Transparency: Taxpayers should know that a tax exists and how and when it is imposed on them and others.
Minimising non-compliance: A tax should be structured to minimise non-compliance.
Cost-effective collection: The cost of collecting a tax should be kept to a minimum, for the government and taxpayers.
Impact on government revenues: The tax system should enable the government to determine how much tax revenue is likely to be collected and when.
Certainty: The tax rules should clearly specify when and how the tax is to be paid, and how the amount is to be determined.
Payment convenience: A tax should be due at a time or in a manner that is most likely to be convenient for the taxpayer. These guidelines definitely indicate retreat from the current policy of imposing a cash transactions tax and the Fringe Benefit Tax. They also call for the reintroduction of estate duty, which was withdrawn for no reason whatsoever. Advanced countries such as the UK and the US still swear by inheritance taxes, which can be collected painlessly.
The abolition is a luxury that we can ill afford. And, finally, the Government will have to decide whether the present income-tax code should be completely replaced or reformed. There is much to be said for reforming the existing system on the lines suggested by experts.
(The author is a former Chief Commissioner of Income-Tax.)
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