Budget 2012: Adopt sound parts of DTC & frame policies for smooth transition to GST this Budget

What should be the direction of tax policy in the coming budget,” Finance Minister Pranab Mukherjee quizzed the country’s two top tax officers three months ago. One of them said it would make sense to implement proposals in the Direct Taxes Code (DTC) that will replace the cumbersome income tax law. The other suggested policy changes to ensure a smooth transition to the Goods and Services Tax (GST), which would be independent India’s most significant tax reform.

Mukherjee should adopt sound policy proposals in the DTC rather than wait for the parliamentary panel to vet the Bill. Their suggestions can always be considered in the 2013 Budget. Also, the government can revisit some of the radical suggestions in the original code that were abandoned on the grounds that they would be difficult to administer. This would signal the government’s commitment to the principle of the code — low rates of tax on the broadest possible base.

Two proposals worth taking a re-look: the tax treatment of savings and an overhaul of the capital gains tax regime. It makes eminent sense to introduce the exempt exempt tax (EET) method of tax treatment on savings, wherein contributions and accumulations to savings schemes would be tax free, but withdrawals would be charged to tax. Simply put, only income from an asset would be charged to tax.

The country has the information technology prowess to tackle logistical challenges of a big change in the tax treatment of savings. It would bring in a market-based self-fiancing old age security system.

Similarly, the capital gains tax regime should be revamped to allow investors to switch assets without any tax liability. So, if a person sells a house and re-invests the money, say, in shares, her gains from the house sale will not be charged to tax. A course correction would enable the government to raise money that it needs to spend. The Supreme Court, too, has given cues on policy changes to ensure that the exchequer does not lose revenues when companies resort to ingenious tax planning. It has said the government should write a general anti-avoidance rule that would empower tax officers to combat tax frauds. The rule features in the DTC and must be enforced through the Budget. It should also re-write law to bring indirect transfers of capital assets situated in India under the tax net. And that would be a revenue goldmine.

Another bold initiative would be to abolish corporate surcharge and prepare the ground for a cut in the corporate tax rate to 25%, at least from 2013. Since 1991, corporate and income tax rates have been cut to well below US or European levels, although they are higher than Asean levels. Wealth tax and long-term capital gains tax on shares have been abolished, making balance sheets of companies more honest. And the credit for this goes to tax reform.

But taxmen must make sure that the language of the law is clear when policy changes are made. Any ambiguity will only spell trouble, leading to disputes. Simple, clear and stable tax laws will make the country an attractive destination for investors. Indirect tax reforms should be pursued as well to make our industry more competitive. Peak Customs duty must be lowered to a uniform 5%, without unduly worrying about safeguarding interests of domestic industry. They are, in any case, enjoying more protection with a fall in the rupee. Both excise and service tax rates should be restored to the pre-crisis levels to bring government finances to a better shape.

Of course, there would be pressure for sectoral sops to kick-start investment activity. But selective excise duty concessions would only spell patronage and the government should desist such pressures. Multiple rates distort the tax structure and that’s anti-reform. Two policy initiatives are crucial for a smooth transition to GST. One, the Centre should also tax all services except for those specifically excluded through a negative list. Two, it should abolish the central sales tax (CST) that distorts production location and scale economies, though it gives huge revenues to states. A phase out of CST is a must for a fully integrated GST and only then can the economy become globally competitive.

Instituting a countrywide GST also needs initiatives beyond the Budget and can happen only with bi-partisan cooperation. The point is to introduce GST this year as the design can always be fine-tuned later. The scope for evasion will vanish once all production comes under the tax net. GST will improve compliance in direct taxes and raise collections. This is the last chance for Mukherjee to make meaningful tax reforms before the general elections. The country should not miss the bus.