“Why should I pay so much tax to the state since most of it goes into private pockets?” becomes a common refrain for the affluent middle class. Tax cuts, therefore, become the order of the day along with expenditure cuts by the state, which is exactly what successive Republican administrations did in the United States. Since the tax cuts are for the rich and the affluent middle class, while the expenditure cuts are for the poor, this has a directly regressive effect on income distribution”—Prabhat Patnaik, professor emeritus at the Centre for Economic Studies and Planning, Jawaharlal Nehru University

Union Budget 2013-14 is an opportunity for the government to address key concerns related to tax policies in the country which have wide socio-political ramifications. With the Planning Commission in 2011 having noted that the top 5 per cent of India’s households possess around 38 per cent of total assets and with Forbes 2012 finding of India being home to 55 dollar billionaires worth $240 billion, it is imperative that the forthcoming Budget’s tax policies considers these inequality levels to address distributive justice.

Addressing India’s low tax-GDP ratio

In order for the government to be able to provide more resources for crucial development sectors, such as health, education and nutrition, it is important for clear measures to be in place to increase India’s low tax-GDP ratio. India’s total tax revenue (collected by the Union and state governments) at 16.6 per cent of GDP (for 2011-12 ) remains significantly lower than not just that of the developed countries but also of some of the developing countries like Brazil (25.4 per cent), Russia (22.9 per cent), China (18.9 per cent), South Africa (26.5 per cent), Argentina (24.7 per cent) and Turkey (21.1 per cent). With direct tax share of 37.7 per cent in total taxes, India’s tax structure is perceived to be regressive. Even developing countries like South Africa (57.5 per cent), Indonesia (55.85 per cent) and Russia (41.3 per cent) have a more progressive tax structure in terms of the contribution of direct taxes to the total tax revenue. Unlike indirect taxes, direct taxes are linked to the tax-payer’s ability to pay and hence is considered to be progressive. Therefore, any measure to increase tax-GDP ratio, should be with a clear focus towards increasing progressiveness in our tax structure—through direct taxes.

Revenue potential from wealth and inheritance tax

These taxes have been in the news recently with many opinions on the pros/cons of introducing or strengthening these taxes. It is pertinent to note that the purpose of wealth and inheritance tax was never revenue mobilization only, but to check concentration of wealth in the hands of a few as enshrined in the Constitution of India. Property taxes, which include wealth and inheritance tax, contribute only around 0.44 per cent to total taxes compared with 15.1 per cent in the US, 5.8 per cent in South Africa, 5.1 per cent in China, 4.87 per cent in Russia and 4.25 per cent in Brazil over the period 2000 to 2007-08. A conservative estimate by Centre for Budget and Governance Accountability (CBGA) shows the revenue potential of inheritance tax and wealth tax to be Rs 63,539 crore per annum—around 0.8 per cent of GDP (for 2011-12). This is almost the total expenditure on health care in India which is currently 0.9 per cent of GDP. Though the revenue generated from wealth and inheritance tax vis-a-vis the cost of collecting the same should be one of the concerns of our policymakers, it should not be the only concern. The main arguments in favour of wealth and inheritance tax should be seen in terms of distributive justice as well.

Rationalise tax exemptions

With 6 per cent of GDP representing revenue foregone in 2010-11, there is a need to reduce and rationalise the existing gamut of tax exemptions and review the rationale for most of the exemptions. A white paper on tax exemptions should be released, providing detailed sectoral break-up of revenue foregone for different industries with a comparative assessment regarding objectives of exemptions fulfilled vis-a-vis magnitude of exemptions. It has been observed that companies with the largest profits (greater than 500 crore) pay the lowest effective tax rate (22.59 per cent) while companies with profits between 0-1 crore pay the highest effective tax rate of 26.77 per cent. The statutory tax rate is 33 per cent. An in-depth industry-level study needs to be conducted to review the extent of anticipated benefits of tax exemptions extended for certain industries, specifically those that have low effective tax rates (ETRs), such as software development agencies, power and energy, petroleum and petrochemicals, and drugs and pharmaceuticals, as reflected in the Union Budget documents. A thorough examination is also required of the justifications for the tax exemptions/concessions given in the special economic zones (SEZs). The Parliamentary Standing Committee on Commerce has criticized the government for not establishing industries in almost half the SEZs set up since 2006 and giving the land to realtors, diverting fertile land of farmers.

Loopholes in international taxation

Against the backdrop of revenue losses with regard to capital gains, specifically in the India-Mauritius treaty, which accounts for almost 40 per cent of all foreign investments in India, even though talks are on-going to amend the Mauritius treaty, a comprehensive review of all double taxation avoidance agreements (DTAAs) is needed to understand the revenue implications and extent of treaty shopping currently taking place. Relevant data detailing transactions that avail of treaty benefits (which are currently unavailable) should be recorded and made available publicly. Such a review, with the relevant data, will help establish the need for DTAAs and explore more efficient alternatives. Recent back-stepping of the government in addressing tax avoidance, by postponing and diluting provisions of General Anti-Avoidance Rules (GAAR) meant to tackle tax avoidance, due to fear of the impact on FDI is of concern. The fear of the impact on FDI with introduction of such measures is unproven, especially considering that China had introduced strict anti-avoidance rules in 2008/2009 and the UNCTAD World Investment Report 2012 stated that FDI flows to China reached a “record level” of $124 billion in 2011.

It is imperative that the Union Budget 2013-14 addresses these issues recognising that fair taxation policies are at the core of addressing inequality in the country and have a direct impact on the scope of social services that the government can provide.

Pooja Rangaprasad can be reached at rpooja@cbgaindia.org