Towards efficient and equitable taxation

Whoever likes to pay taxes? There must be an alternative world ? a nirvana ? without taxes. Common sense tells us that in this paradise there will not be any public services. It is surely possible to conceive of a world that needs no regulation, no enforcement, no common services? every person lives perhaps on pure ideas and no material sustenance. Unfortu-nately, just as we have to live out our lives in a world where the laws of physics rule unbounded, so too are public services a necessity of civilised existence. Hence, there is a need for taxes that go to pay for such public services. However, having said that, it remains wholly true that taxes should be reasonable, ought to be efficient in collection and should be equitably borne by the citizens of a nation.

Which brings us to the current furore over value added tax, also known as Vat. Taxes levied on goods have been the common fare of the state since the emergence of urban centres and trade, way back in hoary antiquity. The sales tax that preceded Vat is a tax on consumption and is, thus, collected by the authorities at the point of consumption. The central sales tax was a departure insofar as it is levied on the producer, but this tax is slated to be phased out. All goods we know travel a long distance from being raw material to the final consumption or investment good. At each point of the transaction chain ? that is, wherever a sale was recorded ? a sales tax was levied. No provision existed for providing credits on sales tax levied at earlier stages of the chain. As a result, there was a cascading of taxes.

Over the years, procedural changes have been made. These sought to address the problem by way of permitting shipment against some kind of a credit form to multi-point taxation. However, these were piecemeal initiatives, varying widely across states and even within a state. Worse, the prevalent system of sales tax, while imposing a considerable burden of bookkeeping on business, failed to provide a framework to keep track of the flow of goods. And to check whether the taxes actually collected bore a systematic relation- ship with the volume of underlying economic activity. The problem was compounded by a multiplicity of rates and a maze of exemptions. Over the past few years, in the run-up to adoption of Vat, the number of rates has been reduced and a moratorium placed on the granting of sales tax exemptions. The tax exemptions were, of course, a wonderful policy of beggaring-thy- neighbour, part and parcel of the delusion that generous dollops of fiscal incentives were integral to attract investments.

Vat scores over the pre-existing system of sales taxes in several ways. By its very nature, it eliminates the likelihood of cascading taxes, by ensuring that credits are received on taxes paid on inputs in computing the amount of tax payable on the output. This is of particular importance in manufacturing. Vat, unlike sales tax, brings under the purview of taxation the distribution margins on a product and, thus, enhances the value of goods assessable to tax. It is, thereby, likely to boost the exchequer?s take. The provision of self-assessment and selective scrutiny should make the task of the assessed businesses less of an onerous affair.

Finally, Vat comes inseparable from computerised monitoring and accounting systems in the states? capitals. That should enable administration to look for consistency in the level of collections at different points in the chain of production and distribution and, thus, help facilitate superior compliance. As a result, it is hoped and with some justification, that a net gain to states? revenues should result. If used responsibly, this can go a long distance in improving the condition of public services in education, health care and non-commercial physical infrastructure.

While it may well be true that the level of preparation in some states may not be what it ought to have been, the fact remains that (a) if we wait for perfect preparedness, we will wait forever; (b) procedural glitches can be sorted out along the way. As long as the system remains open to the idea that design problems can be rectified in the process of operations, the existence of some procedural problems and inconsistencies did not constitute a sufficient reason for further delaying Vat. Therefore, the fact that most states have decided to go ahead with Vat, notwithstanding the reluctance of some to come aboard, is a very welcome development.

Compliance is an important ingredient of equity in the matter of taxation. To the extent there is under-recovery of taxes, the burden is transferred either to the tax-compliant citizen, or to society at large through lower provision of public services, or a combination of both. Improved tax compliance should result in either lower tax rates across the board, or improvement in public services. Thus, to the extent that Vat is likely to result in improved compliance, it also serves the end of equity. It is desirable to have the least number of rates, and the least number is one. However, we are a people who tend to wear their morality on their sleeves. Two widely disparate rates (4% and 12.5%) were perhaps inevitable. More rates will introduce a serious haze into the system and eliminate some part of the efficiency benefits.

Worse, our public persona is prone to readily export its public morality to economics. So if there can be three rates, then why not many more, all fine-tuned for a grand social project. Exemptions, no matter how they are articulated, work by legally injecting the same effect as poor compliance ? it makes the burden on the rest of us higher. If we ward off these two creeping dangers, then we could move on, somewhat more solvent towards doing something about improving the efficiency of our public expenditure.

The writer is economic advisor to Icra