The Centre estimates it lost 6.5 per cent of the national income last year in taxes foregone through exemptions. If it can plug this hole, India's tax to GDP ratio could rank alongside those economies that take fiscal rectitude seriously. Which is why it is a pity the UPA has diluted a code for direct taxes that held out the promise of a rules-based system. The politically acceptable version of former finance minister P. Chidambaram's brainchild is a throwback to decades of discretionary taxes so riddled with exemptions that it becomes nearly impossible to lower rates or widen the net. India's tax revenue has never exceeded 13 per cent of its national income. Meagre pickings for a country that must take a third of its people out of poverty, provide them rudimentary healthcare and equip them with the basic skills needed to survive in a modern economy. Lower taxes, spread across a bigger chunk of the population, have demonstrably yielded higher revenue. Unfortunately, lobbying claimed a principle-driven approach that could have delivered.
Individually, though, the revised provisions are not without merit. The absence of a social security net sets a premium on precautionary savings, which can be incentivised by preferential tax treatment. Likewise, the original proposal to tax assets, and not profits, of companies paying the minimum alternate tax would be a drag on investment decisions. The securities transaction tax and the wealth tax in their present form are policing measures to keep funny money out of asset classes, these needed to morph into effective taxation of capital gains. The clarification on a sunset clause for tax giveaways in special economic zones remains true to the spirit of the code to do away with the jungle of exemptions that has grown around the Income Tax Act, 1961. The direct tax code, even in its watered down form, tries to limit giveaways and, therefore, is a return to horizontal equity.
The withdrawal of exemptions is not a painless process, as the UPA has discovered, but is well worth the effort if tax revenue afterwards is less leaky and thus not exerting a continuous upward pressure on rates. This does not mean there is less to pass around by a Robin Hood government. It is borrowing heavily to fund its welfare programme and this imposes a hidden tax on savings, as also on income and consumption, through inflation. The macroeconomic rationale for an easy tax regime on savings in a capital-scarce economy has been the received wisdom in India's policy establishment. Looks like the fashion won't change in a hurry.