Opinion - Editorials

Towards simplification

A SIMPLIFICATION OF the tax regime is the rationale of the proposals contained in the Consultation Papers of the two task forces on direct and indirect taxes headed by Vijay Kelkar, Adviser to the Union Finance Minister, Jaswant Singh. To the extent the cause of simplification is aided by simultaneously lowering tax rates and removing exemptions, there is much to commend in both papers. But in the race to simplify the tax regime, some suggestions, especially on direct taxes, need a closer study in terms of their long term impact. If the final report on direct taxes makes the same recommendations as contained in the Consultation Paper and they are included in the Union Budget for 2003-04, it will be a godsend for the NDA Government to recover its popularity among the middle and upper-income classes a year before the next general elections. But what might be good politics for the BJP-led Government may well be bad economics.

The task force on indirect taxes has made the more far-reaching recommendations. The most radical suggestion is to do away with all tax incentive schemes for exporters, except for the duty drawback scheme. This is required since a proliferation of schemes has not contributed to the export effort even as it has led to an annual revenue loss of almost Rs. 20,000 crores. In customs, the major proposal — though not a new one — to have just two rates of customs duty (10 and 20 per cent on finished goods and intermediates, respectively) by 2004-05 will change the face of the existing duty structure. The addition of a 150 per cent rate on agricultural products and a zero rate on certain products such as life-saving drugs will not distort the structure, though it does speak of the power of the agriculture lobby. The philosophy of low tax rates and zero exemptions has been taken much further in the Consultation Paper on direct taxes. Exemptions for personal income and corporate taxes have proved to be the bane of the Indian tax effort. They are also iniquitous since they favour those with the resources to take advantage of the exemptions. It is therefore correct that the proposals are for sweeping cuts in income and corporate tax rates alongside the removal of almost all exemptions. The task force has also been bold enough to tackle the sacred cow of taxation of agricultural income, by suggesting a tax rental agreement between the Centre and the States. But a number of questions are in order. Is it correct to kick in income tax at Rs. 1 lakh which is over five times the per capita income? This will please the urban middle class but, according to initial estimates, it will also remove three-fourths of the present tax assessees from the tax net. Is it correct to suggest yet another flip-flop on taxation of dividends, the third such change in policy in five years?

For the salaried classes, the carrot of lower tax rates and higher exemption limits will come with the bitter flavour of a removal of all exemptions on savings. Again the broad approach is correct, but the task force is guilty of not making a distinction between short and long-term savings. Incentives for long-term savings are necessary not just to prepare for retirement, they are also needed to channel funds into infrastructure. By heeding Mr. Jaswant Singh's promise to "put more money into people's pockets", the task force is giving tax payers a short-term benefit which will hurt them badly later. When the two task forces finalise their recommendations, the lessons of tax reform in the 1990s are worth keeping in mind. Two bursts of rushed tax reform were attempted in 1992-93 and 1997-98. A rush to overhaul the system resulted neither in a more transparent system nor in a higher tax-GDP ratio. The Centre still collects a smaller amount of tax revenue as a proportion of the GDP than it did in 1990-91.

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