The Hindu Business Line : Dangers of excessive taxation

It is time we realised that the upper critical limit of indirect taxes has been reached. Apart from high rates of excise duty, most of the organised sector pays a huge amount by way of sales tax, octroi and various other indirect levies.

NEWSPAPER reports indicate a possible rise in service tax to 12 per cent and elimination of several excise duty exemptions. While the elimination of excise duty exemptions on several products may be justified, there is absolutely no justification for any further increase in service tax.

It is also said that service tax will be extended to several other areas. At present, more than 50 service sectors are included and hardly any service in the organised sector is left out. The only major professions that have not been taxed are law and medicine.

Most important, the transport sector remains untaxed. The earlier attempts to tax this sector resulted in a nation-wide strike that completely paralysed normal life.

The focus seems to be to reduce direct taxes and increase indirect taxes. With no sign of any fiscal discipline or reduction in Government expenditure, the Finance Minister can only increase the burden of the common man. Any rise in indirect taxes will compound the hardship caused by the recent increase in the prices of petrol, diesel and LPG. It is time we realised that the upper critical limit of indirect taxes has been reached. Apart from high rates of excise duty, most of the organised sector pays a huge amount by way of sales tax, octroi and various other indirect levies. Unfortunately, no attempt is made to find out the approximate total burden on account of all indirect taxes on most goods. Unilateral, ad hoc increases in the rates of different kinds of indirect levies not only cripples the organised sector but forces several businessmen to resort to unaccounted clearances.

The paper industry is one example. Before 2003, there was no excise duty on the first clearances of paper up to 2,500 tonnes. Thereafter, the rate of duty was 16 per cent. The sales tax levied on paper was about 10 per cent in Tamil Nadu.

If you add the incidence of additional sales tax and surcharge, the total burden of indirect taxes on paper was almost 30 per cent. Consequently, several paper mills simply did not report clearances of paper after crossing the limit of 2,500 tonnes.

No paper mill has a profit margin of 30 per cent. Therefore, there is a big incentive for paper factories to remove goods clandestinely resulting in a huge and illegal profit margin. In several cases, the buyer is unconcerned about Cenvat. He will manufacture paper products which are also unaccounted.

Take the petroleum sector as well. If one examines the break-up of current petrol and diesel prices, it will be seen that more than 50 per cent consists of various indirect taxes and levies. In one case, the ex-refinery price of a petroleum product was Rs 12,000. This price not only suffered excise duty but also a gulf surcharge which was imposed in 1990 on account of the Gulf War due to the invasion of Kuwait. (Ironically, the Gulf surcharge continues).

In 1991, an additional Budget surcharge was also levied which continues till date. After adding sales tax and other levies, the ultimate selling price was Rs 24,000. In other words, 50 per cent of the price consisted of indirect taxes. The price of similar imported products, even after the payment of Customs duty, was just Rs 17,000. This example shows how indirect taxes destroy the competitiveness of Indian products.

In large establishments, such as refineries, evasion of tax may be difficult regardless of the quantum of levy. Even if 100 per cent excise duty is levied on petrol, the refinery will still pay tax. But most middle and small business will immediately clear goods clandestinely. In the case of controlled commodities such as petroleum, the huge price creates a flourishing black market in stolen and adulterated fuels.

In the case of service tax, it will be impossible to expect people to pay 12 per cent. In the case of marriage halls, tourist taxis and several other services owned by individuals and small assessees, most services will be either unreported or there will be severe underreporting of charges.

The unfortunate effect will be substantial evasion of service tax and a huge black market in goods and services. As a corollary, there will be substantial evasion of income tax as well.

There is a naive feeling that increase in the tax rate will result in corresponding increase in collection.

One bureaucrat thought that increasing parking charges on the roads at Chennai from Rs 2 to Rs 10 would triple or quadruple the revenue. This move resulted in predictable consequences. The revenue collected actually came down and several parking attendants started earning illegal income. Similarly, most States levy absurdly high rate of sales tax and this results in rampant evasion. In several States, goods are purchased without any bill.

Apart from the generation of black money, a higher rate of tax will increase corruption and only exacerbate the existing unholy nexus between the tax evader and the Department. High rates of tax have always, without exception, been counter-productive.

The collection of income-tax at 97 per cent was far less than when the tax was reduced to 77 per cent and then to 60 per cent. Similar examples can be given from various countries. It is sincerely hoped that the lessons of history are not forgotten.

In this background, there is no doubt that a 12 per cent levy of service tax will prove counterproductive. Even the current 8 per cent is very high and it is better to fix it at a flat rate of 5 per cent for all items. Unfortunately, the policy of the Government seems to be to increase the levy without effective implementation. The proper course should be to lower the rates of tax but strictly enforce collection.

(The author is a Senior Advocate of the Madras High Court.)