Tax reform returns

The new report makes two interesting points: one, that the Constitution 88th Amendment Act, 8217;03, makes it possible to extend the CENVAT up to the retail level. Two, that the revenue neutral basic rate of the CENVAT, including both goods and services, is around 12 per cent. The discussion of how the CENVAT should replace the stamp duty and other imposts on real estate and of how to apply the CENVAT to the financial sector is quite illuminating.

The report also recommends three rates 0, 6 and 20 per cent in addition to the standard rate of 12 per cent. The negative list of exempted goods 0 per cent is what I have proposed earlier with one important item missing 8212; namely processed food. There is a strong case for including all processed food in the 0 per cent category instead of in a 6 per cent category, because greater employment in agriculture and agro-processing and reduced wastage of agricultural produce would be added benefits. This would serve the purpose of equity much better than a separate 6 per cent category with a number of 8216;necessities8217;.

I am also against a separate 20 per cent CENVAT rate for luxury goods: polyester is the poor man8217;s fibre not a luxury and it is absurd to classify carbonated drinks as a luxury item in this day and age. Cars, polluting fuels petrol, diesel and tobacco should, however, be subject to an additional special excise/sales tax rate 8 per cent that cannot be set-off. The recommendations on the treatment of small units are sound exemption up to Rs 25 lakh and pragmatic choice of 4 per cent sales tax rate up to Rs 1 crore. Monitoring will be easier in the system proposed by us.

The report also estimates that a revenue neutral standard rate for a state Vat what I have termed as STATVAT, covering goods and services, is 8 per cent and proposes three other rates 0, 4, and 14 per cent at the state level. It rightly notes that such a state VAT should replace all other taxes on goods and services at the state level.

In my view, there is no need for a 4 per cent rate and the list of exempted items can be the same as for the CENVAT. Similarly, instead of another 14 per cent rate category, a sales tax of 6 per cent could be applied at the retail level on hotels, restaurants, entertainment and betting/gambling, in addition to the standard STATVAT rate.

The task force proposes a 5, 8, 10 and 20 per cent customs duty/tariff rate structure. As acknowledged in the first Kelkar report, the Virmani Committee report of the Department of Revenue 8217;01 had demonstrated, one, the negative effect of such a four-tier structure in terms of effective protection and, two, the advantages of a single uniform rate of 10 per cent. In fact, based on a recent Indian Council for Research on International Economic Relations research paper showing the positive effect on exports and productivity, we are now confident that tariff rates can be reduced further to a uniform 5 per cent in the next five years.

Both the Virmani 8217;01 and Kelkar 8217;02 and 8217;04 reports concur that agriculture tariffs have to be dealt with more cautiously. The former, however, proposed that these tariffs should not be more than two or three times the standard peak rate ie, 20/30 per cent and 10/15 per cent while the latter recommends an exorbitant rate of 150 per cent.

Turning, finally, to income tax, the very sound arguments for low marginal tax rates and elimination of exemptions ineffective and inefficient are repeated in this report. I do not, however, agree with the proposal to move to a two-rate 20 and 30 per cent system. The reason why experts have recommended a flat income tax is that such a tax would have the lower marginal rate than a two or three rate system.

If the two-rate system is going to have the same marginal rate of 30 per cent as a three-rate system there is no benefit from the former. At the same time, a gradually rising marginal tax rate of the latter results in a more efficient lower average marginal rate system that provides less disincentives for the honest declaration to both first time tax payers and the 8216;missing middle8217;. Further, India has a much higher exemption limit in PPP terms then other Asian systems but its tax rapidly exceeds all others. I would, therefore, recommend the following structure: 10 per cent above Rs 60,000, 20 per cent above 1.2 1.32/1.44 lakh and 30 per cent above 3.96 or 4.2 lakh.

The proposal to eliminate savings exemptions and replace it with an Individual Saving Amount is a sound one. However, the EET system proposed for pension savings, etc, along with grandfathering, is too complicated. The report has an interesting calculation of the economic depreciation rate, which is calculated as 15 per cent. This needs to be cross-checked. Though the personal and corporate income tax recommendations are consistent, the MAT should be abolished along with exemptions and depreciation rate reduction. Further, in my judgment, a system of corporate tax CIT credit to all shareholders for CIT paid by the company is preferable to abolition of the income tax on dividends and capital gains on equity. This can, in fact, be implemented very easily in the proposed Tax Information System.

The writer is director and CE, ICRIER. The views expressed here are personal