Over the next two years, India will have equipped itself with a spanking new tax regime that sheds much of the baggage it had acquired over half a century. A common goods and services tax next year and a simpler tax on income and wealth the year after should take the stress out of paying the sovereign its due. The new code for direct taxes, authored by P. Chidambaram and tabled by Pranab Mukherjee, has gone back to first principles to make the system more equitable, transparent and competitive. Those despairing of seeing a reformist streak in the United Progressive Alliance will take heart from the mature decision-making on display in the very act of seeking views from taxpayers on what they will have to cough up.
Which, it appears, is far less than what they are paying now. By widening the slabs, income tax will be more progressive in 2011 than it is today. Lower tax incidence permits the government to take the axe to a jungle of exemptions that has grown around the Income Tax Act, 1961, with the passage of budgets every year. Giveaways have crazily distorted the way India taxes alternative streams of income; phasing them out is a return to horizontal equity. The withdrawal of exemptions will not be painless, but is well worth the effort if tax revenue afterwards is less leaky and, therefore, not exerting a continuous upward pressure on rates. The taxpayer can be made to realise that the tax benefits he loses on savings schemes are more than offset by the lower income tax he pays overall.
Critically, 2011 will mark a turning point in our journey to a rule-based tax system. Although we are far from the tax apparatus in the West, where rates change rarely, if at all, India needs to get there if it is serious about being a “well-regulated free market”. Discretionary distinctions like that between short- and long-term capital gains and easy-to-collect revenue like the securities transaction tax have wisely yielded to a more formulaic approach to taxation. The assumption behind lower rates and fewer exemptions is more people pay taxes if they are reasonable, and stable. The lower peak rate of tax on corporate profits brings us on a par with China. High time too if we hope to catch up with a country where a Han dynasty emperor first imposed a tax on income 10 years after Jesus Christ was crucified.