The Telegraph
Since 1st March, 1999
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- A selective acceptance of Kelkar’s recommendations would be useful

The author is former governor, the Reserve Bank of India

No tax reform proposals of past years have received the flood of comments and critiques equal to what the Kelkar task force has been receiving in the last few weeks. While there have been many critical comments, some have been complimentary, especially with reference to the task force’s few proposals friendly to the tax-payer and, above all, to its comments on the need to revitalize tax administration. The basic attack has been upon the task force’s recommendations to remove exemptions. For obvious reasons, some of which have been spelt out in the revised report, the task force has not accepted many of the suggestions for the dilution of its recommendations. It is another matter that influential voices in the ruling party have trashed the report. With his true reforming zeal, Vijay Kelkar has not changed the broad thrust of his report, which he still believes is the solution for India’s fiscal problems.

One of the highlights of the revised report, which was evident in the original version too, is the declared preference of the task force for an upfront subsidy to meet developmental goals rather than adopt tax exemptions. Thus, the task force argues that it is preferable from the point of view of transparency and control to have an upfront subsidy as a percentage of capital expenditure to be spent on outlays in backward areas rather than through income tax exemptions.

The task force’s recommendation preferring that the government offers straight subsidies instead of exemptions, ignores the fact that such subsidies are also capable of being abused — as for instance shown by the subsidies for the integrated rural development programme. Further, the calculation of such subsidies involves the government in the assessment of the costs of the capital project — with all its loopholes. There may also be allegations that procurement of equipment is subject to abuse. It might mean resorting to government procurement rules, whose infirmity is well known. The task force’s preference for subsidies over exemptions is only a choice between two evils. Subsidies have also a habit of growing over time and being subject to many pressures. The task force may have needlessly thrown open a window for fiscal profligacy in its pursuit of transparency.

The task force’s stance in favour of subsidy is reflected in its recommendation of a 2 per cent interest subsidy to be given to all recipients of housing loans. This amounts to offering a lower interest rate. If this alone had worked as an incentive for housing activity, the housing financiers would have resorted to it long ago. The psychology of housing activity is complex. The built-in attractiveness of income-tax concessions as an inducement to housing is partly the result of a perceived gain in net income — an effect, which does not get translated when interest rates are reduced, although the two may be theoretically equivalent. The suggested subsidy option by the Kelkar task force is unlikely to be received enthusiastically by the affected parties. Particularly, the problem persists in respect of those who have already entered into loan commitments in the expectation of continuing tax concessions. The task force does not seem to be clear as to what treatment such investors would be entitled to.

It is in the same spirit that the task force has to approach the problem of denial of tax concessions with regard to various infrastructural investments. It is obvious that the credibility of government promises is at stake here. When corporate bodies have embarked on costly investment projects in the expectation that certain tax write-offs will be available, it is unfair to remove them. The task force discusses at great length the doctrine and practice of promissory estoppel, which lies behind the argument in favour of continuing the concessions to the concerned entities. The task force enters into a legalistic argument, citing various judgments, that the doctrine of promissory estoppel does not apply. Promises, says the task force, are made only to individuals, not to corporate entities, and therefore there is no justification for citing the continuance of the concessions. It is obvious that corporate entities have every right to expect continuing enforcement of promises made by governments. What is at stake is the sustainability of government decisions over time. Corporate entities no less than individuals are entitled to expect that a government stands by its promise.

It is a rather weak argument to say that corporate bodies, which invest in infrastructure, have nothing much to lose as in any event they have an assured rate of return and the costs are passed through. It is surprising that Kelkar, who presided over the dismantlement of the administered price mechanism of petroleum, oil and lubricants, should have cited assured returns as an argument in favour of the removal of exemptions. Exemptions offered by the government in respect of infrastructural investments concern mainly the garnering of cash flows that accrue for investment. “Assured returns” are also very fragile in the case of many investments, including roads and waterways, not to mention independent power producers, vide the case of the CESC and Dabhol. The task force is carrying its pursuit of the so-called equity to an extreme when it tries to deny the legitimate concessions offered by the government for encouraging essential investment in infrastructure.

The task force has continued its regressive stance in favour of removal of exemptions for investments in research and development. To argue, as the task force does, that the corporate entities and individuals can claim depreciation on the R&D investment is to ignore the special nature of such expenditure. It is regrettable that in an age in which R&D is the lifeblood of progress, the task force has removed or diluted the few life-supports that the existing tax structure has seen it fit to give. One would have expected an enlightened group, like the Kelkar task force, to have really spelt out more encouragement instead of less for outlays on R&D.

The task force has continued with its stance in favour of removal of exemptions on exports. It justifies the proposed removal by citing various anomalies in respect of offsite outlays by software companies. The task force has put one more hurdle in the way of one bright sector of India’s new economy. When will reformers’ enthusiasm avoid the danger of overkill'

The task force goes overboard in its recommendations on the category of assessors called “residents, but not ordinarily residents” who stay mostly abroad. This recommendation to bring under the tax net most non-residents’ incomes can have a deleterious impact, especially in as much as the flood of remittances from our non-resident compatriots will start slowing down for fear of being caught in the tax net. Leave alone the question of how to enforce compliance on assessees abroad, whose incomes cannot be monitored, the task force has missed the main objective of encouragement of invisibles, significant from the balance of payments point of view. The task force recommendations in this regard may have a serious impact, especially on the economy of states like Kerala, if the remittance senders seek other destinations than India for fear of the taxman.

Granted that exemptions do contribute to complexity. But, the pursuit of simplicity cannot be an end in itself. The substitute device of subsidies will also have complexity because it has to be tailored to indicate different outlays. Complexity arises from the diversity of development goals and is not an attribute of exemptions alone. Complexity alone cannot condemn a tax system. The pursuit of simplicity can be at the expense of fairness and equity.

It is a pity that the efforts of the Kelkar task force seem destined to be love’s labour lost — if the current indications of the political reactions are to be any guide to the finance minister’s decisions on budget day. One hopes that it will be a selective acceptance of the recommendations, rather than a total rejection that the finance minister decides on. Much as Kelkar would wish it, a big-bang approach to his recommendations seems unlikely. One only hopes that it would not be an en bloc rejection.

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