Column : Opportunity forgone

Written by Bibek Debroy | Updated: Mar 13 2011, 02:14am hrs
Those who earn income above a threshold must pay income taxes. Taxes are not fees. Fees involve quid pro quo. They are paid for specific services. There is no such quid pro quo for taxes. They sink into the Consolidated Fund and notwithstanding the parliamentary scrutiny about expenditure out of this Consolidated Fund, there is tax-payer fatigue and apathy about payment of taxes, since no such benefits are seen to flow. These benefits can be in the form of either public goods or collective private goods. Alternatively, these benefits can be equitable considerations of cross-subsidisation. Taxes collected from the relatively rich are used to subsidise the relatively poor. Unfortunately, tax and expenditure policy have been cluttered up and made non-transparent, with confusion about what is being done and for whom. Consider this business of subsidising the poor. Apart from the problem about not being able to identify BPL unambiguously and refusing to accept participatory and decentralised identification, is the current system of subsidising through administered prices most efficient This is relevant not just for central subsidies such as petroleum, food and fertilisers, but also for state-level ones like roads and power. Under-graduate economics texts have demonstrations that direct taxes are superior to indirect taxes, because welfare gains are greater.

By the same token, direct income transfers are superior. By this, one means direct cash transfers, assuming financial inclusion proceeds, not this business of messing around with coupons and conditional cash transfers. The recent Budget has apparently promised this, though one should remember food coupons were first promised in the Budget for 2004-05 and nothing came of that promise. There is still reluctance to accept that we are effectively talking about a negative income tax system. It will be useful to separate out ostensible subsidisation into private flows (BPL households through negative income taxes) and the provision of public goods or collective private goods in the backward regions (decentralised appropriately, weeding out high administrative costs of delivery). This is on the expenditure side. On the tax revenue side, the system is cluttered up through exemptions, both on direct and indirect taxes. Sticking to direct taxes, is there any reason why farmers who are above threshold levels should not pay income taxes Not only is agricultural income of farmers not taxed, neither is non-agricultural income. After all, two-thirds of sales of consumer products occur in rural India and contrary to perceptions, two-thirds of extremely rich households (NCAER data) are also there. Farmers who are in dire straits will, in any event, be below threshold levels.

Direct tax exemptions also extend elsewhere. For instance, since 2005-06, Budget papers have included a tax forgone statement, divided into corporate exemptions, exemptions from unincorporated enterprises and individuals. This explains why effective tax rates for all three categories are lower than what they should be. The sums involved are not insubstantial, 5.5% of GDP. It is correct to presume that these exemptions only benefit the fat cats of the system. First, exemptions are granted for exports and backward regions, too, and these lead to positive multiplier benefits (including direct and indirect employment) and it cant be anyones case that these dont benefit the poor. Second, unincorporated enterprises and individuals may not necessarily be the fat cats, too. Having said this, three points are unexceptionable. First, tax exemptions are not the best method to drive resource allocation. They lead to distortions. For instance, how does one know exemptions to create physical infrastructure are superior to creation of social infrastructure Second, fiscal incentives dont matter in developing backward regions. They can matter at the margin, but primary determinants are elsewhere. Rare is the case where everything else is constant, so that fiscal incentives matter at the margin. Stated differently, lack of physical and social infrastructure is much more important.

Third, exemptions clutter up the system and make the objective of tax policy non-transparent. The tax forgone statement should, therefore, be interpreted differently. 5.5% of GDP is being lost and this has opportunity costs. Lets clean it up, obviating the necessity for MAT. DTC was meant to do this, but has been diluted. And continuance of MAT suggests we arent yet ready to clean up the system. Assuming we obtained that additional 5.5% of GDP, without getting into receipts through spectrum and disinvestment, there would be 22.5% of GDP to spend on individual subsidies (negative income taxes) and collective private or public goods. One can then prioritise and decide on efficient expenditure of these public resources, including zero-based budgeting exercises on ministries and government departments and decentralised transfers. Unfortunately, no Budget since 1991 has been couched in terms of such prioritisation. Had that been done, there would have been clarity about resources available and their competing uses. This is one of the first principles of economics and also figures in definitions of the subject. That such an obvious idea is not implemented, suggests the system wants opaqueness and lack of transparency.

The author is a noted economist