The Hindu Business Line : Reforming personal tax can be taxing

The tax department does not just collect revenues; it administers social policy. All changes in tax law cannot be called `reform'. True reform should be based on principles. Many changes in the past decade have made the tax laws permanently more complex. So, why not a separate tax code for individuals?

The income-tax has made more liars out of the American people than Golf has: Even when you make one out on the level, you don't know when it's through if you are a Crook or a Martyr.

— Will Rogers, The Illiterate Digest

NO AREA of policy-making `taxes' the brain more than taxation. Though the nuances of tax reporting and accounting are mind-boggling, they reflect the implementation of a much wider, sometimes disenchanting, but ever-engaging, policy process.

Sound tax policy and administration — like a trustworthy judiciary and reliable financial accounting system — is one of the pillars of modern governance.

In examining those nations that aspire to be republics but have not yet firmed up this pillar, one would find a crumbling or barely viable government. That is what Eugene Steuerle, senior fellow at The Urban Institute and co-director of the Urban-Brookings Tax Policy Centre, observed while writing on contemporary American tax policy. When policy-makers decide to change the economy or society's behaviour, the tax code is usually their tool of choice.

Cumbersome exercise

A survey by the World Bank and the International Finance Corporation reported that paying taxes is not an easy job in India. A businessman has to make 59 payments to discharge his tax liability. The US Internal Revenue Service has estimated that the typical taxpayer spends about 21 hours filing a tax return, with interest and itemised deductions. Tax complexity itself is a kind of tax, bemoaned US Senator Max Baucus.

Despite the Saral forms in India, without professional help it is not easy to file a tax return. Several committees have been talking of reducing the cost of compliance, the latest being the Kelkar Task Force. Every time, the finance minister talk of simplifying the tax code, he sends a shiver down the spine of the honest taxpayer.

A pink paper wondered, "May the FM save us from the temptation to make simplicity the prime virtue in taxation". The common man cannot be faulted if he feels that the simplest course is not to file any return. No wonder, despite the booming conditions of the stock, the bullion and the real-estate markets, the number of people with the declared annual income of over Rs 10,00,000 is just 85,000, even according to the Income-Tax Department.

Amaresh Bagchi, Emeritus Professor, National Institute of Public Finance and Policy, points out that collections of income-tax fell after the tax cuts of 1997, and the personal income-to-GDP ratio rose later despite the surcharges that followed, thereby disproving the belief that lower taxes always mean higher tax collections.

What the tax administration should do is to make the cost of evasion higher than that of compliance. This is not so today. Prosecutions are rare and successful ones almost nil.

The deterrence effect has almost waned. What is collected today is more by way of tax deductions at source (about two-third of the total collections) and advance tax than by way of detection on raising of additional demand through intelligent assessments.

From EEE to EET

A vociferous complaint about the Indian tax code is that it gives room for large revenue losses due to fiscal concessions. Several committees have been targeting the incentives given for savings.

The truth is that we have been able to obtain a savings rate of the 25 per cent of GDP mainly because of the tax incentives given for such savings by way of rebates and relief for contribution to the LIC, NSC, PPF, and so on.

Despite the reduction in interest rates, these instruments have been fetching large savings for the Central and State Governments, as can be seen from the following data as on March 31, 2005:

Post-office monthly income scheme: Rs 1.5 lakh crore.

Kisan Vikas Patras: Rs 1.36 crore

NSC VIII Issue (six years): Rs 55,128 crore

Post-Office Recurring Bank Account: Rs 41,102 crore

Post-Office Time Deposit Account: Rs 31,994 crore

Public Provident Fund (15 years): Rs 14,273 crore

Senior Citizen 9 per cent scheme: Rs 5,436 crore

Interest rates and maturity time on these instruments vary. Last year, the Finance Minister abolished Section 88 of the Income-Tax Act 1961 and introduced Section 80C under which investments up to Rs 1,00,000 in specified instruments, including equity-linked saving schemes of mutual funds, will be eligible for a straight deduction from income.

Much confusion was caused by recent circulars and notifications laying down that the mutual fund schemes should be open- and not close-ended to get the benefit of tax deductions.

It is now provided that the equity-linked savings scheme (ELSS) plans shall be open for a minimum period of one month during the financial year 2005-06 and for three months during the subsequent years.

The latest clarification on the subject is that contributions to schemes which were in operation on April 1, 2005, will be eligible, despite the shift to the exempt exempt tax (EET) scheme from April 1, 2006, onwards.

The shift to the EET system may benefit Government revenues but it will definitely bea disadvantage to the lower tax-paying public compared to those in the higher tax bracket.

Taxing the lumpsum at the time of maturity will bring those in the lower tax benefits to the higher slabs.

Second, not many taxpayers will be able to take advantage of the deduction of Rs 1,00,000.

Nothing prevents the cash-rich individuals with large tax-free dividends in their pocket from ploughing back the tax-free incomes into savings instruments to earn tax relief and tax rebate.

Armchair economists may argue that there is no clear nexus between the level of taxation and other factors affecting the rate of return and the level of savings, and that EET system is a much better internationally recognised practice relating to taxation of financial savings.

The shift to the EET will tax the middle-class and lower middle-class by way of higher tax incidence at the time of maturity.

It should be remembered that the tax department does not just collect revenues; it administers social policy. All changes for the tax law cannot be called `reform'. True reform should be based on principles.

Many changes in the past decade have also made the tax laws permanently more complex, increasing the time and transaction costs of dealing with tax-preparers and tax professionals, filling out tax forms, and adjusting portfolios and other parts of our lives to minimise taxes.

Why not a separate tax code for individuals? A committee has been formed for suggesting and drafting a new Income-Tax Bill to be placed in Parliament in 2006. It may not be a bad idea to consider the separation of the tax law for individuals from the tax code for companies.

All the complexities in the tax code can be attributed mainly to the difficulties in interpreting the provisions relating to corporate taxation and quite often these provisions intermingle with sections relating to non-corporate taxpayers.

A separate tax law for individuals may simplify the taxpaying exercise and make the Act simpler and readable. True, no country has thought on these lines but India can be an innovator and prepare a separate tax law for non-corporate taxpayers.

(The author is former Chief Commissioner of Income-Tax.)