Tax reforms for sustaining growth

Gone are the days when the external world debated India's attainment of double digit economic growth rate. Today, while being sure on the growth aspect, world leaders are concerned about the sustainability of such a growth rate.

The Organisation for Economic Co-operation and Development (OECD), an elite of 30 nations, is amongst the latest to join the bandwagon endorsing that India's annual economic growth could reach a sustainable 10 per cent and be spread more evenly across the country if it pursues ambitious and wide-ranging reforms.

In its first economic review of India interestingly, the OECD has treaded a euphemistic path given India's increasing dominance in world trade. Further, India achieving an observer status in 2006 coupled with its graduation to 'transition economies group' along with Brazil, China, Indonesia and South Africa is suggestive of the OECD's desire to admit India as a member.

Other than pointing out the need to improve general business environment and labour sector reforms, the OECD delves into evolution of India's tax system over the years. OECD's repute in tax related advocacy and commitment to share best practices across the world raises expectations out of its report though it seems it has concentrated more on painting a macro picture rather than recommending solutions impacting the average taxpayer in the country.

At this juncture it would be prudent to revisit some of the significant issues addressed in the report on India's tax system.

The OECD report starts by lauding India for fundamentally reforming its tax system. In doing so, the report traces the historical evolution of the fiscal reform process in India and acknowledges efforts made in fiscal consolidation by enacting the Fiscal Responsibility and Budget Management Act (FRBMA) at federal and select state levels.

Simultaneously, the report notes India's low tax-to-GDP ratio (TGR) as amongst the biggest obstacles to India's sustainable growth. Absence of a system for social transfers encompassing the entire population and increased reliance on borrowings are identified as the major reasons for India's low TGR.

In this regard, the OECD has isolated India from rest of the BRIC economies by recommending widening of its tax base and improvement in tax efficiency to match-up with the TGRs exhibited by Brazil, Russia and China. Achievement of TGR would enable complete adherence to the FRBMA targets, a task which constitutes an important element of fiscal consolidation.

The OECD unequivocally recommends reduction of corporate tax rates. Further, India should aim at allowing companies to unify tax treatment of depreciation with the accounting treatment; a task which is presently underway given that the focus of past few budgets has been reduction of tax amortisation rates. Though this step runs counter to the objective of encouraging greater investment in capital assets using the tax incentives route.

The OECD has stressed on the need to assess the cost of concessions provided through tax-breaks without offering any concrete steps to deal with it effectively, taking into consideration the need for wide spread development, particularly across underdeveloped states and catering to the need of augmenting infrastructure. Hence, we will see consecutive budgets juggling with this age-old issue of tax holidays balancing demands of the industry and political compulsions.

On the personal tax front, India's first priority should be to move the taxation of saving schemes to a base where only the income accumulated during saving is exempt from tax. Further, due consideration should be given in reducing the age and gender related allowances or replacing them with tax credit. The principle is similar to corporate tax rationalisation steps.

The OECD has walked the IMF path in recommending taxation of agricultural income, which I am sure, will not find favour across the entire political spectrum. However, it is creative in a sense that, the income tax generated by taxing agriculture should be entirely transferred to the states.

On the indirect tax front, it recommends creation of a common market within India facilitating free movement of goods across border state. Specifically, it has stressed on the need to adhere to the target of moving to a nationwide goods and services tax by 2010.

Surprisingly, none of the above stated in the report are new to the ears. Undoubtedly, reiterating the facts by a premier institution like the OECD does carry a lot of significance, but policymakers and taxpayer's alike expect suggestions beyond the obvious basics.

To illustrate, the report is silent on the need to improve tax administration to enhance tax buoyancy. Where honest taxpayers are grappling with stringent requirements the key to improve TGR probably lies in improving the tax administration.

Undertaking methods to improve smooth compliance is devoid of any political considerations or lobbying and thus ensuring the same should be the first step by any Government reforming the tax system. The report has not suggested ways and means to ensure better compliance. Recommending the best practices in ensuring proper compliance norms would certainly have made the OECD's review of India stand out amongst other economic reviews undertaken by international organisations.

Currently, prompted by high economic growth, the government is proposing to wipe out the revenue deficit and reduce fiscal deficit to 3 per cent of GDP in 2008-09. However, the current figures on mid-term economic performance released by the Reserve Bank of India still show a revenue deficit figure of 1.5 per cent. A 0.5 per cent decrease as stipulated by the FRBMA would require more than what has already been achieved.

Resource mobilisation at a much faster pace is the key. Thus, India can celebrate its resurgence but it cannot rest on its past laurels. The OECD report should not make us complacent as we look ahead at the next budget.

The author is a Partner with BMR & Associates and these are his personal views