T N Pandey: Kelkar panel's mandate was not tax reform

TAXING MATTERS

The main purpose of constituting the Kelkar Task Force-II in February this year was to "draw up the medium-term framework for fiscal policies to achieve FRBM objective."

The panel submitted its report in July. Though the basic objective of the panel was to make recommendations relating to the implementation of the Fiscal Responsibility and Budget Management (FRBM) Act, it also made recommendations on income-tax reforms, which were classified under two categories: personal income-tax and corporate income-tax.

In the context of personal income-tax, the suggestions are: (i) All exemptions, barring those available for housing finance, senior citizens and woman taxpayers, should be removed; (ii) Standard deduction available to salaried employees should be eliminated; (iii) Savings incentives be rationalised through ETT, namely savings up to Rs 1 lakh in a year should be tax exempt and withdrawals be made taxable as ordinary income; (iv) Existing investment schemes, like PPF, should be grand-fathered i.e., the interest under the existing scheme should continue to be exempt and new investments would become part of EET; (v) A shift to a two-rate schedule should be made, namely income up to Rs 1 lakh should be tax exempt, that between Rs 100,001 to Rs 4,00,000 to be taxed at the rate of 20 per cent and at 30 per cent for incomes above Rs 400,000.

Recommendations have also been made on the treatment of fund management, zero coupon bonds and speculative transactions on financial derivatives. For corporate taxation, two alternatives have been suggested.

The first alternative envisages: (i) Grand-fathering of existing tax incentives, and removal of the same for new ones; (ii) reduction in the general depreciation rate from 25 per cent to 15 per cent; (iii) reduction in the corporate tax rate from the present 35.875 per cent to 3 per cent.

The second package differs from the first in two major respects (i) it proposes to eliminate tax on distribution of dividends while preserving exemption for the dividend from income-tax; (ii) phasing out incentives in two years instead of grand-fathering them.

Such recommendations cannot be called 'tax reforms'. The panel's work related to drawing up of a medium-term framework to achieve the FRBM's objective of eliminating fiscal and revenue deficits by March 2008 and building up of a revenue surplus thereafter. It was in this context that the panel has looked into income tax collections.

Certainly, it was not required to make suggestions regarding 'reform' of income-tax laws. Its views concerning income tax can, at best, be regarded as indicative of 'adjustments' or 'corrections' to the existing law to boost revenue collections "" certainly not working out reforms agenda. Tax reforms cannot be suggested in such a 'by the way manner' while examining its working primarily for some other objective.

Before a successful exercise can commence for tax reforms, the appointing authority needs to solid homework. It has to issue an explicit statement of policy objectives sought to be achieved through tax reforms.

Obviously, no such mandate was given to the Kelkar Panel-II. Its views concerning income tax are merely 'incidental' to achieve the objectives of the FRBM Act. Hence, to call its recommendations on income tax as suggestions for tax reforms is a misconception.

An idea about the work involved in tax reforms can be had from the Canadian experience. The Carter Commission in Canada was appointed in 1962 for suggesting major reforms in the tax system. This exercise passed through 3 stages.

In the first stage, the Canadian tax system was studied in detail by a group of tax experts and public finance specialists, resulting in a six-volume report with 27 supporting staff studies. These were presented to Parliament in 1967.

The report provided a blueprint for tax revisions that would have fundamentally altered the existing system by systematically defining income as mentioned by Henary Simons.

The second stage began with a national debate on the Carter report and ended with the publication of a white paper in 1969, containing the government's proposals for tax legislation. The final stage began with a parliamentary debate on the white paper and ended with the enactment of Bill C-259 at the end of 1971.

Obviously, such a long time may not be possible in the Indian context, but surely tax reforms cannot be formulated by a body of six bureaucrats in five months, when all the members of the task Force are simultaneously busy with the exercises for the Budget, to be presented in July 2004.

Tax reforms imply carrying out an empirically grounded assessment of all existing provisions and future requirements to decide about the changes to be made in the existing law. It has to keep in view four rules mentioned by Carl Shoup in 1976 in framing its recommendations.

The rules are (I) Rule of results ; (ii) Rule of relevance, (iii) Rule of robustness ; and (iv) Rule of resiliency. No worthwhile tax reforms can be made on the basis of truncated recommendations merely on some aspects as made by the Shome and the two Kelkar panels.