Question

What principles should guide governments taxation policy?. Suggest some measures to improve India’s tax-GDP ratio.

Answer 1

Approach:

• In introduction write about principles that should guide governments taxation policy
• Write reasons and Measures to improve India’s tax-GDP ratio
• Provide a conclusion based on the arguments provided.

Three broad principles that should guide tax policy:

• First, it should be such that it raises the requisite revenue while minimizing evasion and distortion in the economy, thereby eliminating the generation of black expanding the tax base and supporting investments through predictable and stable tax policy.
• Second, it should exhibit horizontal equity in the sense that individuals with equal income are taxed equally.
• Finally, it should exhibit progressivity in the sense that those with higher incomes are taxed at higher rates.

The tax-to-GDP ratio has not been impressive for India. Ideally, with an increase in GDP, the tax collection should also increase. If the economy is growing and business is doing well, naturally, profits will be better and therefore taxes should also be higher.

In India’s case while the overall tax-to-GDP (Centre and State) increased from 17.45 per cent in FY08 to 17.82 per cent in FY17, the GDP and per capita income has doubled during this period. Interestingly, India’s rate of growth of tax revenues was not in sync with its GDP growth in the post-reforms period.
South Africa’s tax-GDP figures are much better despite its lower GDP per capita and GDP in absolute terms compared with India since 1991. However, the overall tax-to-GDP as it stands for India it is 17.82 per cent and South Africa it is 27.11 per cent.

India must aim to double its tax-to-GDP ratio to achieve the OECD average of about 34 per cent. The tax-to-GDP for some of the other emerging market economies like Namibia, Mozambique, and Chile are higher than India . In fact the tax-to-GDP of neighbouring Nepal is also an impressive 21.3 per cent.

Measures to improve India’s tax-GDP ratio:
Direct tax:

Corporate tax.
The corporate tax regime requires rationalisation and simplification. Although the statutory rate of corporate tax is high, the collection rate is low because of an array of tax exemptions.The high marginal tax rate in India, hurts equity investment.The exemptions are not given based on predetermined rules. This creates uncertainty for investors and also creates opportunities for corruption, rent seeking and tax evasion.
Significant sectoral differences: The tax system is not equitable horizontally since the differential in effective tax rate across sectors is very high.In the next three years, we should eliminate various corporate tax exemptions. This should be accompanied by a reduction in the corporate tax rate from 34% to 25% (including surcharges and cesses) for all companies.

Personal income taxes.
A key limitation of personal income tax regime is the small tax base. It is also not desirable in terms of developing a healthy economy since tax payment is an essential aspect of the relationship between the government and its citizens. Therefore, we should endeavour to bring a large number of citizens into the direct tax net even if their tax liabilities are minimal.

The following reforms address the current situation:

• The tax slabs corresponding to the lowest tax rate should be expanded to ensure that the tax liability of lower income individuals does not increase suddenly with the growth in their nominal incomes.
• We should aggressively move the economy towards greater formalisation, which will lead to greater number of individuals filing tax returns.
• This includes moving towards digital payments and away from cash.
• Arresting tax evasion when non-agricultural income is declared as agricultural income. All agricultural income is exempted from income tax. While the provision is meant to protect farmers, non-agricultural entities sometimes use it to evade taxes by declaring agriculture as the source of their income. In order to mitigate the generation of black money, the loopholes need to be plugged.

Indirect Taxes

Goods and Services Tax.
The GST is a substantial reform of the existing indirect tax regime. The steps needed
(i) A well-functioning GST council.
(ii) Advocacy and outreach programme to help the stakeholders (especially new taxpayers) adjust to the new system;
(iii) A robust tax administration system by the Union and the state governments; and
(iv) A well-functioning GSTN system.
(v) we should move gradually towards fewer number and lower level of rates. Since the GST system will expand the tax base, we should be able to lower the tax rates without loss of revenue.

Custom duty

• Rationalise custom duties and tariffs.
• We need to improve procedures for custom clearances. This will reduce transaction costs and improve the ease of doing business.
• Duty exemption should be given to exporter upon declaration with enforcement done through ex post random checks. Under the current system, delays in drawbacks are endemic and administrative procedures so burdensome that many exporters simply forgo the exemption.

Stamp duty on property registrations
State governments levy stamp duties and fees on property registrations at the time of purchase. A high rate creates the incentives for the buyer of property to declare a lower value and pay a part of the payment in black. Black money thus flows massively into real estate. Therefore, the states may consider reducing the stamp duty inclusive of property registration fee.

Improving the Tax Administration System and Minimizing Tax Litigation

Pending tax litigations cost the taxpayers and the government in terms of resources including delays in the collection of revenue.The following steps should be taken

• Reduce the scope for interpretation of tax laws. In this regard, the Easwar Committee has offered detailed recommendations, which should be implemented.
• Dispute resolution strategy, as recommended by the Tax Administration Reform Commission (TARC), need to create a separate disputes management vertical, which is separate from the tax collection functions.
• The dispute resolution mechanisms need to be modernised through alternative dispute resolution mechanisms, including arbitration and conciliation.
• Performance assessment of tax officials.
• We need to enhance the tax boards capabilities to utilise the available information and modern ICT tools to ensure tax compliance.
• A low tax-to-GDP ratio is detrimental to effective governance and delivery of public services. A larger tax base, achieved through tax reforms, can also allow reduced across-the-board tax rates, thereby supporting investment, expanding output and enhancing economic growth.