Taxation becomes cluttered because too much is sought to be done through tax policy. Sector A needs incentives, let’s give it a lower tax rate. Segment B needs encouragement, let’s grant exemptions. Commodity C is a luxury item. Let’s tax it at higher rates.
A Rolls Royce Phantom must be taxed at a high rate. Will Jaguar XJ be taxed at the same rate as Rolls Royce? Will Mahindra Scorpio be taxed at the same rate as Jaguar XJ? Will Maruti Dzire be taxed at the same rate as Mahindra Scorpio? Will Maruti Alto be taxed at the same rate as Maruti Dzire? How do I fit in various motor cycles, scooters, fancy and less fancy bicycles?
Finer and finer distinctions are created. They distort resource allocation, artificially incentivising a sector/ segment/ commodity and creating disincentives against others. They increase litigation.
If there is an incentive for physical capital formation, what’s wrong with human capital formation? Is green coconut a fruit or a vegetable? Is Parachute oil, occasionally used for hair too, ‘coconut oil’ or ‘hair oil’? Is Lal Dant Manjan a toothpowder or a medicinal product?
Is McDonalds’ McSwirl an ice cream or a dairy product? Is Scrabble a game or a puzzle? These, and there are more examples, are matters on which courts have adjudicated because of rate differences.
Before proceeding to adjudication, they increase scrutiny by the tax department, making it difficult to reduce compliance costs. They blur the dividing line between tax evasion (not paying taxes) and tax avoidance (using exemptions to reduce taxes).
Exemptions reduce revenue received by government, constraining required public expenditure. India’s tax/GDP ratio varies between 16% and 17%. Without exemptions it would have exceeded 21%.
Standardisation, simplification, reduction of human interface between tax department and payees, and stability (no annual variations) – these are building blocks of tax reforms. We don’t want to repeat Narayan Dutt Tiwari’s infamous “sindoor” Budget of 1988-89.
Such principles apply to all three components of taxes – import duties, indirect taxes and direct taxes, the last two recently in the news. Indirect tax reform and inclusion of all items in a simple GST framework are prerogatives of the GST Council.
After the Task Force on Direct Taxes submitted its report in August, exemption removal was imminent. Lower corporate tax rates were linked with exemption removal in a Budget speech of the first Narendra Modi government. We now have a corporate tax rate of 22% (coming to just over 25% with cess/ surcharge), provided the company does not use any exemptions. The choice is left to the company, which will compare 22% with whatever its present effective rate is.
With corporate India’s tendency to support exemption removal for others, while retaining its own exemptions, this choice is superior to general exemption removal thrust down from above. For new companies, the tax rate is 15% (17.01% with cess/ surcharge).
This is comparable to East Asia and is a trigger to attract investments (though tax rates aren’t the only consideration here). For unincorporated enterprise, applicable rates are personal income tax ones. After revenue stabilises, that should be the next frontier.
DISCLAIMER : Views expressed above are the author’s own.