The Hindu Business Line : Broad-basing tax reform

In 1955 the late Milton Friedman was invited by the then government to comment on India’s industrialisation strategy. Among other things, he held the small scope of direct income taxes to be a major defect; a more broad-based tax system with lower exemptions and more effective administration could raise revenues considerably and distribute the tax burden more equitably. Had the Nobel laureate been alive today, he would have nodded in appreciation at the revenue grow th made possible through an ongoing rationalisation of tax levies and administration.

The data on direct tax revenues for April to November 2007 show a growth of over 42.9 per cent against the same period last year, with net collections rising from Rs 98,126 crore to Rs 1,40,373 crore. This growth is part of a trend and also amounts to more than half the budgeted direct tax target for the entire year. This is no flash-in-the-pan growth but expresses a dramatic shift in the relative importance of direct taxes over a decade. In 1995-96, indirect taxes contributed nearly 70 per cent to total gross Central collections. Five years later, the balance began to tilt in favour of direct taxes; the 2007-08 Budget estimated indirect tax collections at 51 per cent. While the tax-GDP ratio of the Centre (indirect and direct taxes) has increased from 9.4 per cent in 1995-96 to 11 per cent in 2007-08 (Budget estimates), what really reflects the gains from overall tax reform is the direct tax-GDP ratio that has increased over the same period from 2 per cent to 5 per cent, while the ratio of indirect tax to GDP has remained the same, at 6 per cent. Thus there is room for further changes; reforms in Central Sales Tax and VAT with excise duty harmonisation at lower levels across the States may reduce the indirect tax collections but the benefits from lower costs and reductions in inter-State freight movements should boost economic growth, make it more equitable and thereby more than compensate the exchequer through direct tax collections.

But economic growth is not enough. For better revenues, tax administration has to be compliance-friendly too. Simplified and electronic tax filings have paid dividends; while corporate and personal tax revenues have grown 45 per cent and 40 per cent respectively, self-assessment tax revenues increased 90 per cent over April-November 2006. Alongside, there has been a growth of 47 per cent in tax refunds in the first seven months this year over the last. Fiscal reforms still have a long way to go, and broadening the tax base to include hitherto untaxed segments without affecting growth appears as necessary as minimising tax concessions. Both may be easier said than done.

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