S S Tarapore

Any ideas for the Budget? Speak now

S S TARAPORE | Updated on January 23, 2018 Published on October 29, 2015

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There’s plenty that could do with revamping, such as Direct Taxes, the Inheritance Tax and G-secs, for starters

Work on the Union Budget is in full swing and this is the time to put forth suggestions to the authorities. Invariably, commentators put forth pertinent suggestions a few days before the presentation of the Budget. This is futile, as the key ingredients of the Budget are settled within the ministry of finance well ahead of the actual presentation of the Budget.

The standard indicator of the deficit is the gross fiscal deficit (GFD)-GDP ratio. According to the Budget Estimates for 2015-16 this ratio is 3.9 per cent of GDP. This indicator is fraught with difficulties as small changes in the denominator can substantially alter this ratio. A better indicator is the Gross Fiscal Deficit-Total Expenditure ratio which, for Budget 2015-16, is estimated at 31.2 per cent. It is this ratio that needs to be closely monitored as it clearly shows that a very large part of the total expenditure is financed by the deficit.

Iniquity in Direct Taxes

India had a history of confiscatory direct taxes that, over time, became counterproductive. In the past 25 years, there has been a perceptible swing the other way round. As a result, there are islands of very low direct taxes along with vast tracts of iniquity. These anomalies cannot be fully corrected in a single Budget though there is merit in initiating corrective steps.

The government has an in-principle commitment to gradually reducing the present rate of 30 per cent on corporation tax to 25 per cent over a period of time and simultaneously reducing the large number of exemptions. This is a commendable objective. A reduction in the corporation tax from 30 per cent to 29 per cent would reduce receipts by about ₹16,000 crore. The fisc cannot afford to lose such a large amount of revenue and hence the government would need to use great finesse in reducing the corporation tax and simultaneously reducing/abolishing certain exemptions so that there is no net loss to the exchequer.

After a prolonged regime of confiscatory taxes, the swing in India, and for that matter in a large number of other countries, has been the glaring increase in concentration of wealth. Sound political economy considerations point to the urgent need to address this issue. In this context, reorienting fiscal expenditure to job creation with productivity increases is an overriding priority.

The case for Inheritance Tax

In recent years many influential thought leaders have stressed the need to moderate the tilt of income to the tiny and exclusive upper income groups. The argument powerfully set out against this is that any correction would be uncontrollable and revert to the confiscatory regime of the 1960s and 1970s.This is a bogey that must be confronted.

A couple of years ago there was some tentative discussion on the reintroduction of an Inheritance Tax (there was an Estate Duty from the 1950s but this was abolished in 1985). The problem with Estate Duty was that the threshold level was very low and on an estate of as low as, say, ₹2 lakh, the duty was as high as ₹15,000.

There is a case for introducing an Inheritance Tax. The threshold level could be ₹20 crore and the exemption should be strictly limited to one family home.

To keep things simple there could be a flat rate tax of 20 per cent. It is appreciated that top corporate honchos and high net worth individuals would take threatening postures that activity would move overseas. There should be a high-powered committee to study the issue of Inheritance Tax; there should also be a comparative study of the working of the Inheritance Tax in other major countries.

At present, there is a token Gift Tax but the net of exemptions for relatives is so wide that for all practical purposes the Gift Tax is as good as abolished. The system should allow only very few exemptions such as a gift on marriage (subject to a ceiling).

The rate of tax could be a flat 10 per cent, provided there is also a 20 per cent Inheritance Tax. Thus, there would be a trade-off between a lower tax today rather than a higher tax on the demise of the individual.

Bigger market for G-secs

For decades, an avowed objective of policy has been to develop a deep and liquid market for government securities. A basic requirement is that investors must have different perceptions and different needs that would help develop a wider market with depth and liquidity. It is in this context that individual holdings of government securities should be encouraged.

In a number of major markets individual holdings of government paper are channelled through mutual funds. It is in this context that dedicated gilt funds were allowed to be set up in India. Unfortunately, gilt funds are subscribed to by both individuals and institutions. When institutions exit from a gilt mutual fund it is the individual holders who suffer. Fifteen years ago there was a recommendation that mutual funds should be required to have separate dedicated schemes for individuals and institutions, and schemes for individuals should be exempt from the Dividend Distribution Tax. Investments by individuals in dedicated mutual funds would take off.

Such a tax concession is not a new idea — it was recommended over 20 years ago but shot down by the revenue department.

The government is willing to give tax-free status to bonds of public sector units and, more glaringly, exempt dividends from companies from taxation at the individual level. In this context, the government, by taxing its own instrument, namely, gilts, is resorting to self-flagellation.

The writer is a Mumbai-based economist

Published on October 29, 2015
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