The Next Union Budget Presents A Unique Opportunity To Go Full Throttle On Taxation Reforms

The Union Budget 2019-20 was an interim one and had restrictions given that elections were due in a few months. The post-election budget too had its own share of limitations given the time one had to work on it.

However, the upcoming budget is a unique opportunity to undertake taxation reforms, which may become difficult as we get closer to the year 2024.

There is hope that taxation reforms are underway as the direct tax report was submitted to the government over the last few months. The recent corporate tax cut has further led to the expectation of simplification of our taxation norms along with rationalisation of tax rates in the upcoming budget.

While several economists have argued against a reduction in the personal income tax rates over the last couple of weeks, in my opinion a structured tax reform is warranted as far as direct taxes are concerned.

For starters, the current peak tax rate is over 17 per cent compared to the corporate tax rate, after the tax cut. This gap is perhaps one of the highest in the world.

Therefore, there is a definite need for tax rationalisation and the current slowdown further creates an urgency for such a cut as it will leave more money in the hands of people.

A welcome change occurred with the corporate tax cut as Central Board of Direct Taxes (CBDT) started to talk about increased revenue mobilisation through greater compliance. Therefore, over a period, a tax cut may be revenue positive.

But tax rate is just one part of the story as it is just one part of a tax reform. The other more important aspect for direct taxes is our tax code, which is archaic and insufficient to cater to the needs of a dynamic and emerging economy.

It is precisely here that we should put enough focus — simplification of processes, improving compliance through a modern tax structure and looking at the tax structure as an important determinant of growth.

For instance, Young Lee and Robert Gordon find evidence to support the hypothesis of how tax structure is a key determinant of economic growth. They further highlight how growth increases by 0.1 per cent point for every 1 per cent point reduction in tax rates.

These findings are consistent with a joint exercise performed with Dr Surjit S Bhalla in August of 2019.

Tax structure does matter and therefore, dividends should be taxed at the recipient’s tax rate while submission of their return. This would do away with the problem of triple taxation — however, we may still be taxing the same income twice. Taxing dividends as recipient’s income is a good idea provided there is rationalisation of income tax rates and that dividend income is not added to the overall income while arriving at the appropriate tax rate.

Similarly, there is also a need to discuss whether a capital deficient country like India should tax capital, and if so, then at what rate.

Another important issue is the form of such a tax and when is it supposed to be paid. The low yields in developed economies have resulted in investors looking for fresh opportunities to invest and therefore, taxation policies can be critical in bringing them here.

It is important to view the tax structure with this backdrop and bring it aligned with our growth objectives.

We have made serious errors when it comes to taxation of capital. One such error is the securities transaction tax (STT), which was introduced as an alternative to long-term capital gains tax (LTCG). While India introduced LTCG on securities, it retained the STT, puzzling many investors.

Indeed, credibility of our tax policy was affected because of this move just as it did during the Vodafone retrospective tax case. Perhaps, STT should be removed while government should have a uniform rate or duration of LTCG.

The idea that capital gains arising from equity trading should be higher or lower than capital gains from real estate speculation is fundamentally a discriminatory one.

The government has already taken a step in the right direction by reducing the corporate tax rates to 22 per cent while offering a lower tax rate for new firms.

However, the new corporate tax rates are not applicable for limited liability partnerships (LLP) which continue to be taxed at 30 per cent. The structure of the company should be irrelevant for the purpose of taxation and therefore, even LLPs should benefit from the lower tax rate.

This will bring with it a uniformity of tax rates which will be instrumental in simplification of the tax structure.

Many have advocated against tax cuts — and indeed, there should not be any unstructured tax cuts which will only add to uncertainty.

However, a structured tax reform involving rationalisation of tax rates for personal income taxes is a need of the hour. That is, any tax cut must be a part of the overall direct tax reform. This is critical for addressing the recent economic slowdown but more importantly, it will increase India’s potential growth rate over time.

There is simultaneously a need to further simplify the goods and service tax (GST), however, since that is under the purview of the GST Council, there is not much that the budget can do. But a statement re-emphasising commitment towards such an exercise would go a long way in giving everyone the confidence that further indirect taxation reforms are likely soon.

A simple taxation regime that reduces confusion will result in unshackling of unnecessary compliance requirements and reduce tax related litigation. Both will allow companies to focus on wealth creation, which is critical to achieving the $5 trillion economy by 2024 or 2025.