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| Combat slowdown with tax reforms |
| Mukesh Butani / New Delhi Jan 26, 2009, 00:31 IST |
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Governments around the world are jostling to devise new strategies to battle the current economic downturn, dubbed as unprecedented at least for the past several decades. The solutions being promulgated typically advocate enhancing government spending, boosting liquidity, reducing interest rates and offering tax breaks. I have summarised an overview of key measures being pursued by governments, particularly those in the area of tax and examined the merits behind some of them which India could embrace.
Is slashing corporate tax rate an option?
Past few months has witnessed a host of countries slashing corporate tax rates in G-8 and BRIC’s economies; particularly Russia, Vietnam, Canada. Luxembourg has enacted a comprehensive corporate tax reform package, aimed at bolstering the economy. Perhaps, the most radical measure was announced by the UK’s Gordon Brown government, wherein taxpayers’ difficulties were addressed by allowing them to spread business tax payments over a timetable they can afford. Though, this is music to Indian tax payers’ ears, I doubt if India can afford to implement such radical measures.
Given that the transition to new administration is less than a week old, the United States is yet to announce measures on tax rates, though, the Obama stimulus plan does encapsulate tax cuts for individual taxpayers. The only meaningful tax reform we have pursued is an across the board reduction in Cenvat rates, with a view to bolster demand. Clearly, that has not had the desired impact. The December sales figures for automobiles demonstrate the inefficacy of Cenvat rate cut.
Demand & supply dynamics
While attempts are being made to bolster demand by improving liquidity by lowering of cash reserve ratios, greater access to funds by way of special purpose vehicles including NBFC’s and increasing governmental spending, it is clear that they are not by themselves enough to propel growth. Unless measures are taken to bolster supply, attempts to spur growth would not be efficacious.
Initiatives to broaden access to external commercial borrowings (ECB) may fail at the moment as access to global funding is scarce. Indian businesses who had ready access to easy foreign capital feel trapped due to extraneous circumstances. Improved ECB limit for infrastructure, real estate and NBFC’s assume that foreign debt is available! Lower marginal tax rates in India would encourage businesses to invest, take risks and seize opportunities, particularly where rates of business tax are highest. My economist friends in the North Block would agree that lower cost of money with lower rates of tax would spur consumer demand.
Increased government spending — not a perfect solution
History bears testament that during recessionary times, government’s “urge to splurge” has been counter productive. In economic depression of 30’s, governmental spending in US tripled in a costly effort to revive the collapsing economy. However, the US GDP fell 27 per cent through that decade. In the early 90’s, Japan’s attempt to emerge from the crisis by adopting a “spend” approach failed.
Tax policy changes — some suggestions
Admittedly, as a developing nation, governmental spending in critical areas such as infrastructure is inevitable, though we would do well by not ignoring the lessons history has taught. Reduction of tax rates, introduction of time bound incentive schemes, incentivising savings and extension of tax holidays nearing their sunset is much needed. Besides, a fillip to manufacturing and services sector needs implementation of stalled reforms. There is lot on government’s agenda to enhance competitiveness of our exporters.
A starting point would be for the government to rethink its policy for phasing out tax incentives. Sectors such as information technology can ill afford to lose their competitive edge at a time when margins are falling. We should re-examine the benefit of “pass through” taxation for venture capital funds investing in all sectors of the economy as they are growth catalysts.
Manufacturing companies would benefit with reintroduction of rebate for maintaining “investment allowance reserve” to incentivise investment in capital goods. This was an effective incentive in the 80’s and enabled manufacturers to pull out of stagnant growth rates in two decades; in my view, a tried and tested avenue.
Reducing tax rate by removing surcharge on tax has been long on the agenda, though not activated. While experts are quick to quantify the loss to the exchequer, such studies do not encapsulate the impact of growth in jobs and output, besides boost to indirect tax revenues.
On the individual front, limits to tax-free investments, particularly in infrastructure bonds needs to be revisited. Every instance of enhancement of taxable limit has resulted in better compliance besides increased collections. A case in point is the current year; tax collection figures which have increased by over 15 per cent. Finally, the much-awaited new income tax code should be introduced soon, since at the very least, it should help simplify complex tax administration and compliance.
Act with Urgency
We ought to speed up the process of GST introduction; an area we are lagging behind. We should bring down the tariff levels to Asean levels to promote competitive pricing of raw materials and capital goods. Our service tax law is mired with several hundred notifications; complex enough for experts to grasp.
There is scope to weed out uncertainties in this complicated arm of taxation. In summary, effective government action can only help catalyse the process of economic recovery and not supplant it altogether. The focus should be towards improving incentives that promote economic activity. Finally, a myth that changes in tax policy is an annual exercise undertaken by the way of Finance Act, needs to dispelled.
Why can’t we bring legislative amendments to the law? And finally, if we have accepted that adherence to Fiscal responsibility and Budget Management targets will be given a pass for the current fiscal, why not take a calculated risk by offering tax sops? It is time to act and we needn’t wait for the newgovernment. Also, an opportune time to demonstrate ‘Singh is King’.
The author is a Partner with BMR & Associates and views expressed are personal
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