The latest Budget of the Government of India is heavily welfare-oriented. The various schemes of social security, especially for the unorganised sector, and the enhancement of the limits for tax concessions will certainly be beneficial to the common man. There may be a disappointment that there are no changes in the exemption limits for individual income tax or in the tax brackets, though they may be justified by the high level of inflation that has prevailed in the recent years and the bracket creep that has taken place due to increases in nominal, and not real, incomes. It is in this context that the proposal to reduce corporate tax rates from 30 per cent, existing in the last 10 years, to 25 per cent over the next four years, starting April 2016, needs to be taken note of. Finance Minister Arun Jaitley said the process of reduction has to be necessarily accompanied by rationalisation and removal of various tax exemptions and incentives for corporate taxpayers, which incidentally account for a large number of tax disputes. This is a step towards the ideal flat tax rate system, where there is only one rate for all incomes without any provisions for tax rebates, income deductions or exemptions.
Jaitley said that exemptions to individual taxpayers would still continue since they facilitate savings, which get transferred to investment and economic growth. There is enough evidence to show that the level of savings is influenced by income and not yield or return on investment. Once the level of savings is determined, its disposition in various avenues of investment only is influenced by the relative returns. Did not the individual save before there was any institutional arrangement for mobilising savings by paying an interest? People used to keep their savings under mattresses! The theory of savings in India is influenced by Western ideas. Unlike there, we still have a family system where the head desires to leave wealth for posterity.
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Jaitley could have very well envisaged a flat rate system for individual taxation also. An official committee, which went into this issue a few years ago, gave it a cursory examination and did not review the experience in a number of other countries while rejecting the proposal. I have shown in my past articles on the subject how the flat tax is also progressive in as much as the average tax rate goes up with a rise in incomes. The current emphasis in progressive taxation is on marginal tax rates, which gets diluted because of various devices such as exemptions. A flat tax already prevails in about 20 countries, including Russia, where it is reported to have resulted in a significant growth in tax revenues. It will make the tax structure simple and encourage people to file returns. Tax assessment and refunds will be quicker. Fiscal incentives by way of deductions and exemptions distort the flow of investments. I suggest that the finance minister commission a paper on the subject for a wide discussion, so that it could be considered for introduction in the Budget for 2016-17.
Jaitley said the move on the reduction in corporate rates will lead to a higher level of investment, higher growth and more jobs. A higher level of investment will depend on higher level of demand for goods and services. There is a slack in demand due to the high level of prices to which not much attention is paid. Instead, the emphasis is on inflation rate. When the prices of common goods such as shoes are high, a pair of the cheapest variety selling at Rs 1,500, it is no consolation to be told that the price rise over the last year is only 5 per cent. What is needed for corporate growth are incentives for expenditure on research and development and introduction of modern machinery through, say, accelerated depreciation provisions.
To give an example, the textile industry is crying for modernisation that would reduce the cost of production. There is no encouragement for the replacement of the old machinery by new because of the high cost of clothing that is seen in the subdued sales even during the festival season. I remember reading a survey report a few years ago that said that farmers, when they find higher incomes due to a good monsoon, spend the additional incomes first on the repayment of the debt owed to the private agencies and then on clothes. It may be true today also.
The author is an economic consultant and a former officer-in-charge in the department of economic analysis and policy at the Reserve Bank of India