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Thursday, Jan 09, 2003

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Kelkar proposals: The missing objectives

M. Y. Khan

The recommendations of the Kelkar panel do not lead to high growth of investment. The final report has failed to understand the dynamics of savings and investment in the economy. The need today is a saving rate of 30 per cent and an investment rate of 34-35 per cent, says M. Y. Khan.

Dr Vijay Kelkar's revised proposals too may only spur consumption and affect savings — not the ideal recipe for economic growth.

THE Kelkar Task Force has made several recommendations to bring efficiency and efficacy in tax system with multiple methods such as reduction in transaction cost, economy in the cost of administration, elimination of tax incentives and tax subsidies and readjustments of indirect taxes. An ideal tax design, according to the theory of taxation, should take into account equity, efficiency, administrative feasibility, promotion of savings and investment and, finally, economic growth. Economic efficiency for our purpose means that taxation should not impose avoidable real cost on the community and it should not unnecessarily interfere with the attainment of prime economic objectives of growth, stability, equitable distribution and independence, and if feasible should promote them. Administrative feasibility implies that the revenue should be collected without excessive cost for the government or for the tax-payers.

The first impression about Kelkar's overall recommendations is that, if accepted, it would result in shifting financial resources of Rs 10,762 crore from the non-government corporate sector to the government sector. Though individuals will have to pay less tax of Rs 7,284 crore, there will be a net loss of more than Rs 3,000 crore on these two accounts for the non-government sector. Mutual funds will have to pay 20 per cent tax on short-term gains. The Government will utilise such resources for its revenue expenditure and nothing will be used for economic growth.

On direct taxes, the panel has proposed to raise the exemption limit to Rs 1 lakh for individuals and up to Rs 1.5 lakh for senior citizens. This will narrow not only the tax base itself but lead to non-accountability of income earners in the unorganised sector. The Kelkar Committee proposal on withdrawal of tax incentives on various savings schemes would directly and adversely impact the saving rate — an essential variable for economic growth. Withdrawal of tax incentives, by and large, would lead to dis-savings and higher consumption. The households with more income, due to not investing in small saving instruments and due to raising exemption limit, would consume a larger part of this disposable income rather than saving it.

It is a common experience that individuals do forced savings to earn more income in future or to get exemption from tax. A number of times they borrow and invest in such schemes. It may be noted that a saving ratio of 23 per cent and investment rate of 24 per cent is inadequate to generate 8-9 per cent GDP growth.

In a country such as the US, low savings rate can be considered adequate because large capital inflows occur on account of strong dollar and strong US economy.

This feature is not reflected by the Indian economy. India still has to liberalise capital account transactions so that more capital can flow into the Indian economy.

There is another recommendation which curbs investment incentives. Deduction of interest costs from corporate income to arrive at taxable income has been disallowed by the committee. This is an anti-investment recommendation.

The salaried employees will further suffer due to withdrawal of tax break in respect of interest on housing loans and the withdrawal of rebate under Section 88 and standard deductions. On the one hand, the Committee, in its final report, has recommended exemption under Section 80CCC on pension plans up to Rs 20,000 and, on the other, it has levied 20 per cent tax on short-term gains of mutual funds.

It may be noted that the mutual funds earn income by way of capital gains and this is the main source of distribution of dividend or income to mutual fund investors. This taxation will directly hit the investors in its final impact and, in turn, affect the investment in primary capital market and government bonds, leading to reduction in saving potentials. Thus, the recommendations of the Kelkar panel do not lead to high growth of investment. The final report has failed to understand the dynamics of savings and investment in the economy. The need today is a saving rate of 30 per cent and an investment rate of 34-35 per cent.

The subsidies have become an integral part of growth without any evidence of their contribution to growth, particularly in the farm sector. These subsidies create unequal distribution of resources, as they are captured only by the rich farmers. The subsidies generally benefit the rich and the privileged persons far more than the poor whose purchases are limited. As a matter of fact, they penalise the farmers who get lower prices for their produce and whose incentive to work efficiently and to produce more is killed. The existence of large subsidies has brought a criminal waste of scarce resources. The panel has rightly recommended the termination of subsidies.

The Committee has made several recommendations on indirect taxes with the objectives of reducing transaction cost and introducing better compliance and efficiency in the economy. There is a need for economising in the cost of raising resources. It requires simplification of excise duty rates, Custom duties and unification of certain taxes at the State- and Central level. For instance, value-added tax on state- and central-level should be unified. Only the Centre should levy value-added tax and its receipts be divided between the Centre and the States. The Government should introduce international accounting standards to be mandatorily followed by the business world so that the accounts become transparent and understandable. Moreover, indirect taxes should be pro-production and neutral to tax incidence on the consumers. The tax reforms have to be directed to address the interests of all stakeholders such as consumers (rich and poor), investors, dealers, revenue receipts of the Central and State governments and other entities.

The prime goal of the Kelkar Committee was to reduce the Centre's revenue deficit, which has risen from 11.6 per cent in 1996-97 to 13.5 per cent in 2000-2001.The limiting factor discouraging the growth of tax revenue is the exclusion of several services from tax net. While the share of the services sector in the GDP is more than 50 per cent, service tax collections form insignificant portion of tax revenue. On the other hand government has not been able to contain revenue expenditure which has been made difficult by rigidities in expenditure pattern, and weak fiscal consolidation by introducing stringent controls on non productive government expenditures. The government should tide over its expenditure by cutting subsidies, unnecessary spending on its own functioning, and by widening the tax base.

(The author is Economic Adviser to SEBI. The views expressed are personal.)

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