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P.V. Indiresan

ECONOMISTS themselves concede that economics is a dismal science. Paying taxes is the gloomiest part of this dismal activity. It need not be so. Paying taxes could be made a rewarding experience.

A heavy weight tied to the ankles will make walking difficult. The same weight tied as a backpack will not hamper movement. If that weight were your own baby, carrying the burden will even be pleasurable. Therefore, it is not the weight of taxes but the way it is imposed, the way it is utilised that make it an unbearable burden.

Three cardinal principles are in order in the levying of taxes. One, the certainty of compliance is more critical than the quantum of taxation. Two, fiscal deficit is more due to political thuggery than due to poor or inefficient tax collections. Three, it pays to reward taxpayers as social benefactors instead of treating them as potential criminals and harass them the way tax collectors do.

With his practical wisdom, Chanakya postulated that it is futile to raise tax rates above 15 per cent. In his view, any higher tax will be evaded and lead to criminality. We need not fear that such a modest rate will impoverish the state. Hong Kong suffers little or no tax evasion by keeping taxes within that limit, and has, at the same time, prospered as few countries have.

Simple taxes are easy to enforce. Complex ones inevitably lead to proliferation of tax experts — in evasion, that is. Hence, taxes should be made as simple as possible with next to no exceptions, stipulations, and other complications. A tax bill longer than a page or two will generate not more taxes but more trouble.

For these reasons, income-tax can be set at a flat rate of 15 per cent but with no deductions. That will horrify the proponents of `progressive' taxation. They are mistaken. In the past, progressive taxation has not helped the poor the way it was expected to do; it is unlikely to do so in the future. How far the poor benefit, and how well the disparities are minimised, depend more on the way taxes are spent than on how progressive they are.

India being a poor country, it is worth taxing only that part of the incomes that are above the average, currently above Rs 40,000 a year. Typically, such excess incomes gross 20 per cent of the GNP. At a 15 per cent tax rate and no deductions, income tax will then fetch 3 per cent of GNP.

Corporate taxes are levied on declared profits. The concept of profit overlooks a fundamental feature in the distribution of business profits. Take the case of an IT company that declares a profit of Rs 1 crore and pays its engineers Rs 10 lakh a year. The profit is modest but the salaries are extravagant. Ha d the salaries been on a par with the rest of the economy, the profit would have been several times more. In other words, many businesses distribute most of their operating surplus in the form of extravagant wages. Hence, instead of taxing profits alone, it would be fairer to tax also expenditure on the proportion of wages in excess of the national average. As a thumb rule, that too will amount to about 20 per cent of GNP. At a 15 per cent tax rate, corporate taxes too will fetch 3 per cent of GNP.

Effectively, this is double taxation with the same income taxed both in the hands of the earner and the employer. However, human psychology being what it is, it is better to split the tax into two rather than tax excess incomes at one point at double the rate. Companies may circumvent the tax by paying their staff in kind. Hence, it is important to tax also any expenditure incurred by businesses in the purchase of consumption goods and services at the same rate as excess wages.

Incidentally, this form of taxation imposes a relatively low burden on small businesses, and a high one on large ones. That way, small businesses secure a significant financial advantage. Hence, with this levy, no tax exemptions need be given to small businesses. That too will eliminate a major source of corruption and tax evasion.

Excise duties are a maze and a major source of black income. They may be simplified if they are confined to a few major and expensive items of final consumption, and not on a plethora of intermediate goods. For this purpose, any consumption item that costs more than Rs 100 per kg may be treated as a luxury item. A 15 per cent tax on such items ought to fetch 1.5 per cent of GNP.

Under/over invoicing is the problem with Customs collection. This disease will be checked if foreign exchange is expensive to buy but cheap to sell. That kind of differential will be obtained if a levy is imposed on the forex purchased, and the same levy is transferred to those who bring in forex. For instance, those who purchase forex may be asked to deposit a similar amount for one year, and those who bring in forex may be offered free credit for the same period. Then, exporters will get free credit worth over Rs 200,000 crore. Then, it will be advantageous to hold assets in rupees instead of parking them abroad — particularly when the income tax is limited to 15 per cent. That will benefit the economy more than amounts collected as customs taxes. After all, some of the richest nations do not levy customs duties at all.

Taxes levied in this manner will add up to more than what we collect presently because we can expect better compliance, lower black money, and less criminality. Resultant good governance is more valuable than attempting to fine-tune the tax regime the way we do at present.

The way the Indian polity operates, politicians see greater personal advantage in keeping the people poor and milking the economy than in promoting economic growth. Many of them are forcing governments to misuse public funds and to drain the economy for short-term gains. That myopism will be remedied only when politicians get a direct share in the profits of the economy, more from long-term gains than from short-term ones.

Prof Olson has explained that politicians and bandits belong to the same breed — both use their power to rob people. Such misuse of power is mitigated if they are induced to settle down permanently in one place, and made to become a fixture in one single community. Then, it would be a good rule if no candidate were allowed to change the constituency, ever. In that case, politicians will be forced to look far ahead, to invest for long-term returns, and not rob one constituency after another. In India, bureaucrats are not allowed to change their hometowns (except once). Then, why should politicians be allowed to change their constituency (even once)? This simple reform (a timely one now that the Constitution Reform Committee is in operation) is bound to curtail politicians' predatory habits in a significant manner.

Taxpayers too should be given inducements to pay in full. Low tax rates will no doubt improve compliance. Even then, it is desirable to reward taxpayers in such a way that they too see a private benefit in being good taxpayers. Evidently, they cannot be repaid in cash but only in terms of prestige. In India, taxpayers are so few that they have little influence in elections. Hence, in spite of democratic elections, the principle that there should be no taxation without representation is not realised in practice in India. To remedy this situation, let us treat taxpayers as a selectorate, a group that determines which candidates will be eligible to state funding of elections and which ones will not be. Then, suppose only those candidates that get, say, 2 per cent of the votes cast by that selectorate are made eligible to get government funding to contest elections. Two per cent is such a small fraction that it is not an onerous stipulation. Nor will it be unfair if others too are free to contest but without government support. This small gesture of empowering taxpayers to have a small say in the electoral process will give them a feeling of participation in the democratic process, which they lack at present.

Apart from empowering taxpayers, this selectorate system will remove one of the great evils of our political system.

As matters stand, only hangers-on of powerful politicians — many of whom are criminals — can get ticket for contesting elections from the larger political parties. The selectorate system will provide a better chance for honest and professionally competent persons to contest elections. To that extent, this process will curb the increasing criminalisation of politics. Our economy is dismal because tax evaders have all the political clout, and honest taxpayers have none. The remedy is to empower honest taxpayers and to let politicians become rich legitimately without their having to resort to extortion.

(The author is former Director, IIT Madras. Response may be sent to Indiresan@bol.net.in)

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