Don’t Wait For The Budget: These Tax Reforms Can Be Announced Right Away 

Over the last couple of months, we’re witnessing a renewed discussion on taxation policies. This discussion is motivated largely by the interest in the report of the Direct Tax Code which has been submitted to the government.

To be fair, India’s tax policies have been criticised for a prolonged period, yet we didn’t witness bold tax reforms that were pending for decades. A good example of this is the Goods and Service Tax which was implemented only during the previous government.

Of course, the current Goods and Service Tax is in no way an ideal GST and we need several tweaks to move towards a more robust indirect taxation system.

But it is important to acknowledge that we’ve got a GST which was itself viewed to be impossible in India nearly a decade ago. But, despite changes in indirect taxes, there have been few reforms of the direct taxes in India over a fairly long period.

This makes it important to put in context the broad changes that are urgently needed in India’s taxation policies.

It is important to recognise the significance of India’s corporate tax cuts which have moved our tax rates closer to the optimal tax rates. This means that at these rates we will witness better compliance.

More importantly, the current tax rates bring us a lot closer to the tax structure of several of our competitors which will have a positive impact on Indian manufacturers.

The move was bold, it was significant and will have spillover benefits over a long period of time.

The question is, if it is enough and the answer to that has been a resounding no.

Luckily, very likely we will see more such tax reforms over the near future.

It is important to recognise that the objective of tax system is not just to raise revenues but to also reduce rent-seeking, improve compliance and boost economic growth.

These three objectives aren’t mutually independent, and they can be easily achieved through efficient tax reforms.

Now the question is what some of these reforms are?

Over the last few days we’ve heard reports of removal of Long-Term Capital Gains tax and the Dividend Distribution Tax.

One doesn’t know whether the two taxes would be removed or not and it may well be a rumour now. However, there are economic reasons for the removal of the dividend distribution tax.

The dividend distribution tax was introduced in the mid-1990s and successive governments have made changes to it over the years.

Since 2007, the dividend distribution tax has been at 15 per cent and firms are supposed to pay it while issuing dividends. This actively discourages dividend distribution and violates the principles of any progressive taxation.

A modest dividend, say for someone who is virtually at a tax-exempt income level is taxed at 15 per cent which is equal to someone who is at a higher income tax level.

Moreover, there’s a case of triple taxation here as the moment we’ve got income from dividend above 10 lakhs then there’s an additional tax of 10 per cent. The additional tax was levied in 2016 and therefore, there’s an urgent need to reimagine our direct taxation policy.

While the Direct Tax Committee report is yet to be released, there are reports that it suggests dividends to be taxed at the level of recipient of the dividend instead of the firm. This is very important as it will simplify the taxation system and will have a big impact on revival of sentiments.

Tax reforms should not be linked to just the dividend distribution tax or the LTCG as there’s a genuine need to rationalise our personal income tax rates.

For starters, at present there’s a gap of peak corporate tax rates and personal income tax rates of approximately 17 per cent. This is very likely going to result in compliance problems and some amount of it will be visible once we’ve the detailed data of tax collections for FY2019-20 sometime next year in September or October.

The arguments presented for corporate tax cuts resulting in improved compliance at lower rates are extremely valid even for personal income taxes. Moreover, a cut in taxes at this moment will very likely result in a further boost to consumption which seems to be showing signs of picking up.

While there’s another budget just three months away, there are economic reasons for undertaking some of these measures now.

For starters, a major tax rejig is not expected now. The government can simply remove the super-rich surcharge with effect from the current financial year and convert the tax exemptions announced during the interim budget presented in February into tax slabs.

This will ensure that everyone benefits from a lower tax rate for the FY2019-20.

The bold changes in personal tax rates can wait till February, however making these two changes will be critical in revival of the sentiment and they will bring our rates closer to the proposed taxation structure in the DTC.