Kelkar Task Force?s Agenda And Growth

The Kelkar panel?s tax recommendations need to be disseminated widely. If not seen in its totality, the package is likely to be misunderstood. While the panel is justifiably concerned with the impact the proposed reforms would have on the viability and sustainability of government finances, the key test of the package lies in whether it would place India?s economy on a higher growth path by promoting investment in all sectors.

As and when implemented, the Kelkar package would surely alter the fiscal landscape of the country. The panel seeks to make a break from the mindset that dominates prevailing tax policy that gives preference to immediate revenue needs of the system ignoring the growth needs of the economy. In contrast, the panel?s report makes a gratifying read, as in a number of places it tries to mould the tax system to meet growth aspirations of economic actors in the country.

The panel?s emphasis on bringing about a tax system that is simple, easy to understand and implement is unexceptionable. The diversion of energy from tax management to productive activity is a plus for the economic system as a whole. So is the emphasis on low and minimal number of tax rates that promote equity and compliance. The reduction in tax evasion and fiscal deficits and hence lower government borrowing envisaged by the panel, would help investment through lower interest rates in the system as supply of credit would increase. The widening of the indirect tax net by bringing untaxed sectors such as services into the net would correct a longstanding bias against the manufacturing sector. This sector would also gain from the proposed reduction in incidence of all indirect taxes (inclusive of all central and state levies) on goods to 20 per cent.

Considering that on most manufactured products, the impact of all central and state taxes works out to more than 30 per cent, even up to over 40 per cent on some cases, the panel?s recommendations would bring about a surge in demand for the manufacturing sector as a whole. The investment boom of the mid-90s in manufacturing petered out as a number of segments ran into a demand constraint.

Restraining the tax impact on prices to 20 per cent would create a demand-pull that would stimulate both consumption and investment and also employment. (Given the high consumer response to any price cut, the panel may consider reducing the final indirect tax incidence number to 16 per cent, even if at a later stage). What would aid this process is the recommendation to abolish numerous layers of taxation such as octroi, stamp duties, entry taxes, electricity duties etc. All this is a huge simplification that would not only reduce the price of goods but also transaction costs incurred by producers.

The panel has also taken a step forward by recognising that globalisation is redefining production. Thus it has recommended that only the value added locally, when production is part of a global value chain, should be taxed. Another investment-friendly reform is the proposed change to full set-offs to be made available to producers against indirect taxes paid on capital goods. This too would reduce costs of production and would enhance India?s competitiveness as a destination for investors. All these initiatives would surely aid investment, promote productivity and create a new multiplier in the economy. The exchequer would gain too as more demand means more revenues that enhance the state?s capacity to pump in more public investment.

The panel?s proposal to remove all direct tax exemptions needs to be viewed against this backdrop. For, if those who gain from these exemptions do not take a balanced view of how this loss is being offset by other benefits that the panel brings to them, they may unfairly judge the package and end up opposing it even when it may not be in their interest.

In this context, the most important from an investor and producer?s point of view is the proposed reduction in corporate tax and depreciation rates. To sweeten the bitter pill of no exemptions, the panel has suggested a reduction in corporate tax rate to 30 per cent and in depreciation rate to 15 per cent. It is clear that the reduction in the corporate tax rate is being neutralised by the reduction in the rate of depreciation. This is buttressed by the panel?s conclusion on page 120: ?the proposed corporate tax regime will not adversely affect the economics of investment in plant and equipment.?

This is a negative and defensive statement and not in keeping with the panel?s own thrust on seeking investment-led growth. The panel?s conclusion should be that economics of investment should improve rather than remain the same. This outcome is particularly important for those sectors where this economics is turning negative following withdrawal of exemptions. Therefore, it?s desirable that the depreciation rate should be retained at 25 per cent. To achieve GDP growth rate of 8 to 10 per cent would require a massive jump in investment, and this calls for an improvement in the economics of investment.

The author is an advisor to Ficci. Views expressed herein are personal