Tax Models

Income tax was a temporary measure introduced during the Napoleonic Wars (1795-1815). The British government raised taxes on business and landowners to arm itself. The temporary measure became permanent.

Since then, income tax regimes have gone in many directions. There is the Scandinavian/West European model. High rates pay for social security. The laid-off get 75 per cent to 80 per cent of last wages, the elderly draw big pensions. Infrastructure is good, as is the business environment.

Another model exists in Singapore/Hong Kong/Korea. There rates are low. There are enforced pension plans for individuals. Pension/provident fund, insurance-driven savings regimes are, in theory, equitable. These funds are low-interest, long-term loans to government. In return, the individual gets security in late-life/emergencies.

The American system is slightly different. The USA has both state and central income taxes, and even US citizens living abroad pay taxes! The rates are in-between Europe and Singapore, social security is less than in Europe.

Efficient state machinery forces compliance. The state enables good infrastructure and a good business environment. The state also extends a security umbrella. The US works proactively to protect business interests and citizens abroad. Whatever a non-US citizen may think of such a doctrine, there is a tangible return to taxpayers.

There is also the chaotic Third World model of India, Sri Lanka, Nigeria etc. These places have high tax rates, and are incapable of forcing compliance. Social security is nil, the infrastructure and business environment is poor, security for citizens is nil.

Russia ditched this model recently. It raised tax-exemption levels and introduced a flat rate of 13 per cent. Compliance rose, IT revenues shot up 500 per cent. This can be explained on rational grounds. Taxpayers work hard at avoidance/evasion. There are costs attached.

These range from the legitimate such as legal/audit fees, to the illegitimate such as bribery and money-laundering expenses. If the tax rate is lower than the cost of tax-avoidance/ evasion, taxes are paid.

It is thus not paradoxical when low-tax regimes earn higher revenues than high-tax regimes.

Indian taxable income starts at very low levels. This is vicious as well as silly since it runs straight into the