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THE BIG BANG REFORMER
- Kelkar’s recommendations provide ground for debate and changes

The author is former governor, Reserve Bank of India

Vijay Kelkar’s task force on taxes has made wide-ranging recommendations, which have pleasantly surprised many and shocked quite a few. Rightly, the government has initiated a discussion on these recommendations by placing them on the finance ministry’s website.

At the outset, it must be conceded that Kelkar has been quite ambitious in the list of changes which he has proposed. He has been constrained by the country’s fiscal position to make his recommendations revenue-neutral. This has meant that what he gives by one hand he has to take away with another. He has proposed reduction in tax rates, abolition of tax on dividends in the hands of the shareholder, removal of wealth tax, elimination of capital gains tax on equity — to mention only a few of the goodies in his comprehensive package. He has found it necessary to compensate for the extra cost of these concessions by a sharp reduction in the exemptions.

Kelkar has made it clear that he prefers a “big bang” approach, since his recommendations hang together logically and therefore all of them are to be implemented “at one go” and not in a gradual or phased fashion. His main argument in favour of this “big bang” approach is that given the political situation, time lost is reform denied. Subsequent phases may not get enacted at all. Perhaps, the same political objection should be held against the big bang approach. Removal of all “exemptions”, recommended by Kelkar’s task force “at one go” is also unlikely to have a smooth passage.

Having made these points, I must grant that the main thrust of Kelkar’s recommendations is in the right direction — namely, reduction of tax rates to encourage compliance, removal of exemptions to smooth tax policy simplification of procedures, massive introduction of information technology into the income tax administration together with a number of procedural simplifications. I refer to a few of the details of the proposals below.

On the positive side, Kelkar has advocated, among other things, the removal of tax on dividends in the hands of the shareholder. With regard to removal of exemption, especially on savings, he has built on the recommendations of previous task forces, particularly the Reddy working group and the Parthasarathy Shome task force. Kelkar’s task force reiterates these recommendations for removal of exemptions on small savings.

While Kelkar’s task force has recommended removal of minimum alternate tax, the text of the report still includes a recommendation for taxing corporate organizations on the basis of book profits. The task force also recommends adoption of depreciation rates as prescribed in the Companies Act in preference to those in the Income Tax Act. The adoption of Companies Act depreciation rates, which are more generally defined in place of income tax depreciation rates, seems unreasonable. Many companies and individual proprietorships would have undertaken investments based on estimates of the income tax depreciation rates. The task force recommendation would militate against such enterprises.

One of the recommendations of the task force relates to removal of exemptions, which were designed to encourage investment in infrastructure, particularly in telecommunication services or for the development of industrial parks or for generation, transmission and distribution of power. Removal of such exemptions will strike a severe blow against enterprises which have taken the government’s word at its face value. At a minimum, the exemption should be allowed to continue in respect of these enterprises, which have already undertaken such investments.

Another exemption, which the task force has effectively recommended changing, is that relating to expenditure on scientific research. The task force prefers the alternative route of donations being made to trusts and institutions engaged in scientific research. In a knowledge-based society, which India aspires to become, it is important that research and development is encouraged. Especially in respect of pharmaceutical biotechnology, software and information technology in general, research and development is intimately linked with operations. A separate trust or institutional device for research and development in these enterprises may be less effective than the current provision. The task force’s recommendation will surely set us back in our drive for scientific and technological development.

It is perhaps in the field of housing that the task force’s report has proved most disappointing. It is widely acknowledged that one of the reasons for the recent boom in housing activity in India, which has boosted employment and economic activity in general, has been the increased availability of credit and at low interest rates coupled with tax concessions for those who take loans. The favourable tax treatment of mortgage payment in the recent budgets would be upset by Kelkar’s proposal, which would reduce these concessions substantially. The proposal of the task force is to reduce the permitted deduction from the current level of Rs 1,50,000 to Rs 1,00,000 for the assessment year 2004-05 and subsequently to Rs 50,000 for the assessment year 2005-06 and nil later. Such a retrospective adverse amendment of tax laws is undesirable. Those who had borrowed amounts in the expectation that these concessions would be available would be grievously hurt. They have, therefore, a legitimate case for being spared Kelkar’s axe.

At a time when Bill Gates is visiting India to offer help from the Melinda Gates Foundation, it is appropriate to reflect on the large contribution that corporate donations to public causes can play and have played in other economies, like the United States of America. The Kelkar task force has, however, in its reforming zeal, reduced the attractiveness of donations, particularly by the higher income group. The tax reduction that a donor will get is proposed to be restricted to the minimum marginal rate of 20 per cent of the income and not the higher rate at which he or she pays taxes. In the current fragile stage, in which many voluntary institutions dependent on charity in essential areas, like health and education, are growing, it is unfortunate that the task force has reduced the already meagre inducement offered by tax laws. Donation by corporate organizations and individuals does contribute a great deal to the provision of health services and education in India by the voluntary sector. Kelkar’s recommendation in this regard is retrograde.

One intriguing recommendation of Kelkar’s task force is the removal of Section 36(iii) allowing for interest expenditure on borrowings. This recommendation seems to be illogical. It is not clear if Kelkar’s recommendation is limited only to borrowings for raising capital. Hopefully, the government will not accept it in an extended sense, as applied to all borrowings.

The task force has recommended taxation of agricultural income on a tax rental basis, the Centre levying the tax and the collections being credited to the states concerned. This would require the approval of the state governments — a doubtful outcome in the current state of political alliances and the strength of the agricultural lobby.

Kelkar’s suggestions for improvement of the tax administration are eminently reasonable. In fact, it is this aspect of his report which deserves a big bang approach and concentration of efforts within a specified timeframe by all levels of government.

While the details of the recommendations in regard to tax administration, particularly computerization, have been well-thought out, the dependence on the National Stock Exchange’s information system needs to be rechecked. Whether the model of the NSE will be fully portable to the income tax department is to be fully examined. The task force has also made a number of recommendations for making the administration more friendly and sensitive to the taxpayers’ needs and give up its adversarial posture. This requires a change in mindset at all levels and in particular, greater responsiveness and honesty on the part of the taxpayer. The government must accept the essential thrust of the recommendations of the task force, which is in the desirable direction of improving efficiency, effectiveness and responsiveness of the tax administration. This will improve compliance and enable substantial improvements in fiscal health.

Although I differ in respect of some of the details of policy recommendations, I must state that Kelkar and the members of his task force deserve to be congratulated for their painstaking efforts for the transformation of the tax system. Two cheers to Kelkar and his team!

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