Less Tax, More Revenue

Surely, it is necessary to rationalise the personal income-tax incentives. The gross savings concept used for providing incentive in the past has not encouraged savings. Surely, most saving incentives should go as they do not add to the savings rate, erode the tax base and distort the choice between different saving instruments. Shouldn’t the tax system just avoid these preferences and have lower tax rates for everyone? But there is a case for increasing the tax relief to cover savings up to Rs 50,000 in long-term savings like pension funds and life insurance.

There is no case for totally exempting dividends from taxation either. The justification offered for exempting dividends is that when corporate tax rates are brought on par with the highest-margin personal tax rates, and when all tax preferences are removed, taxing dividends results in double taxation. The truth is that even if the tax rates are aligned as mentioned above, it would be well-nigh impossible to remove all tax preferences, and a significant difference between statutory and effective tax rates will continue. It’s necessary to tax dividends by including 50 per cent in the total income of the taxpayers, as in Germany.

Depreciation rates is the issue in corporate taxes. But it doesn’t seem advisable to change the depreciation rates nor align income-tax rules to Company Law. The proposal to abolish the exemptions is welcome, along with abolishing MAT. It does not make much sense to provide large avenues for avoidance of the tax through tax exemptions and preferences and then complain that the companies do not pay the tax and distort the system through MAT.

Fortunately, there has not been much political debate on indirect tax recommendations and the finance minister can implement them. Extending the service tax to cover all services could substantially augment the tax revenue besides helping in converting the prevailing CENVAT into MANVAT or a manufacturing-stage value-added tax. Limiting small-scale industry exemption to Rs 50 lakh will be a very positive step but politically the most contentious.

The finance minister has a challenging task of rationalising the tax system when coalition politics pushes him to indulge in populism. It is fervently hoped that in his eagerness to earn accolades from the middle class, the finance minister does not ignore the really poor. Expanding tax relief to appease the middle class will reduce the tax-GDP ratio and, ceteris paribus, an increase in the deficit hurts the poor more than any other sections. Will he rise to the occasion?

What Should Be Done

• All incentives for savings must go except in long-term instruments like pension funds and life insurance. Think of the really poor.
• Dividend must be taxed, but scrap MAT. Don’t tinker with depreciation.
• Extend service tax to all services