The Hindu Business Line : Raising taxes least painfully

BRITISH economist Francis Ysidro Edgeworth (1925) had said taxes should impose minimum total sacrifice. He called for, not equal, but equi-marginal sacrifice among individuals. In the tax regime, this proposition is reflected in slabs applicable to different income segments. Indirect taxes impact society according to the size of consumption. But total tax collections indicate the overall tax impact on society. An ideal taxation policy should, therefore, minimise the burden on taxpayers and maximise tax revenue.

The tax impact is generally calculated as a ratio of tax collections to GDP. In India, the tax-GDP ratio over the past 20 years has shown a decline — from 15.4 per cent in 1980-81 to 13.8 per cent in 2001-02. Subsequently, however, it has improved to 15 per cent, but it is still lower than what was achieved in 1980-81 and what prevails in many Asian countries.

The lower tax ratio has to be seen in the context of low per capita income. In India, 60 per cent of population living in the rural areas may not be contributing to the direct taxes kitty owing to its low taxable income. The same holds true for indirect taxes, as the taxed goods are basically consumed more in the urban sector.

Another fact is that even as the direct tax to GDP ratio increased from 2.5 per cent in 1990-91 to 4.4 per cent in 2003-04, the indirect taxes to GDP ratio decreased from 12.9 per cent to 10.6 per cent.

The overall tax ratio is on the lower side as agriculture is exempted from tax. If agricultural income is excluded from total GDP, the tax ratio works out to 16.3 per cent (rather than 15.4 per cent) in 1980-81 and 15.6 per cent (15 per cent) in 2003-04. This implies that there is a case for improving the tax ratio by bringing agricultural income into the tax net, especially by targeting the rich farmers.

Turning to the stock market, the short-term capital gains exemption on sale of shares must be reviewed. This exemption, while resulting in a revenue loss for the government, has fuelled a stock market boom. The Government seems keen on pampering the investor class, at the expense of the salaried and the retired.

The Government should target the big fish, sitting on heaps of accumulated wealth and assets. It should put in place a mechanism to monitor unaccounted wealth. For instance, any individual with assets of more than, say, Rs 50 lakh, should be required to pay wealth tax. Also, those owning both car and telephone may be asked to pay wealth tax.

In the current set-up, tax-evaders can default without fearing penalty. The names of big defaulters should be publicised through newspapers and so on. Tax defaulters should be monitored on a quarterly basis. But the experience in this regards has not been happy, with small defaulters being pursued more vigorously that the bigger ones. The tax collection machinery can play an important role in catching the big fist provided there is no political intervention.

On the industrial front, the small-scale sector enjoys major tax benefits. Medium-scale entrepreneurs, therefore, resort to hiving off their business set-ups into a number of smaller units so as to minimise the excise duty burden. Such entrepreneurs are not small in number. If an entrepreneur has more than one unit, the output of all his units should be aggregated and normal duties applied on them.

The other important tax source is the services sector, which contributes around 54 per cent of GDP but whose share in total taxes is abysmally low. The Government has to widen the net to cover all important services. The Finance Ministry can constitute a body to evaluate and collect tax from this sector.

States have many unexploited sources of tax revenue. The RBI, in its Report on Currency and Finance, 2000-01, observed that sales tax in States is not progressive enough. A value-added system would unify the tax rates in States and eliminate competitive reductions in the rates.

There are a number of alternatives other than hiking personal income-tax rates for raising tax revenue. Personal incomes, particularly those of the salaried, need to be spared. The Government has already withdrawn all incentives for household savings.

An ideal taxation system should result in higher domestic savings, investments, income, production and additional incentives to work.

Whatever the outcome of the tax effort, the Government's deficit can be contained only if the revenue expenditure of the Centre and States is reduced.

(The author is a former Economic Advisor to SEBI.)

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