T N Pandey: Tax reform is a long-term duty

Ad hoc reform committees have achieved little

The Congress Party's election manifesto endorses the Vijay Kelkar panel's vision of a simple tax structure with low rates and few exemptions.

The task force on the Fiscal Responsibility and Budget Management Act is reported to have made a presentation to the finance minister on changes in the income tax law.

Tax history since independence shows that there have been nearly 15 piecemeal attempts through commissions and committees to simplify the tax laws. Yet the laws continue to be complex and cumbersome, leading to increased costs for taxpayers and a disinclination for voluntary compliance.

In his earlier stint as finance minister, P Chidambaram had also appointed a tax expert group in August 1996. This proved futile because of the short time of seven months the group was given to come up with a report. This group's report and its draft of the Income Tax Act are now part of the finance ministry's archives.

Effective, meaningful and long-lasting tax reforms have not been possible principally because of the lack of strong political will. The rumblings of ministers and others on Kelkar's consultation paper showed that a number of the panel's recommendations were not politically welcome.

But tax reform cannot be a short-term exercise. Appointing ad hoc commissions and committees "" without drawing up proper terms of reference or allotting adequate time to study the problems and make recommendations "" has not served the objective of rationalising tax laws.

To start with, deciding the purpose of tax reforms is important. There should be clarity on the expected outcomes of direct tax reforms.

In this context, it is crucial to think about the process and the period through which the reforms are to be carried out. The procedure best suited for this is to draw up a Long Term Fiscal Policy (LTFP) for at least five years as was done in 1985 before appointing a tax review body.

How can the efficacy of tax reforms be judged? It would be relevant and of interest to refer to four efficacy-testing rules for reforms mentioned by Richard M Bird in a paper on Tax Reforms and Tax Design in Developing Countries.

These rules are:

• Rules of results;
  
• Rule of relevance;
  
• Rule of robustness; and
  
• Rule of resilience.

In the context of tax reforms, I would like to suggest the following:

• Drafting the tax reform plans and implementation aspects should be done simultaneously.
• The suggestions should be classified under two broad heads, namely:

(a) Amendments of a technical nature
(b) Amendments of a strategic of a nature requiring policy decisions

A "technical amendment" is a change in the tax law that reflects no substantial re-examination of tax policy. The existing tax structure is not changed, but the wording of particular provisions is altered somewhat, the better to implement the underlying policy of the provisions.

A technical amendment may be necessary because:

• The original law opened an unintended loophole;
• A judicial or administrative interpretation of the law has yielded an undesirable result;
• The original law is unintentionally harsh on a particular taxpayer or group of taxpayers;
• A change in the procedure for reporting information is desired;
• The law contains a drafting error; and
• The changes can only be introduced through the annual finance Acts.

The second category of changes "" "special changes" "" could be where the government wants to:
]

• Make a strategic change in the Act "" for example, increase or reduce the taxpayer entities;
• Change the system of assessment in search cases;
• Introduce concepts that until now were not embodied in the Act, like the provisions to tackle the problem of transfer pricing;
• Meet emerging situations caused by external factors like globalisation and liberalisation;
• Introduce provisions that deviate from generally accepted notions of tax equity, such as proposals concerning deemed concealment as suggested by the Tax Expert Group of 1996;
• Introduce provisions that deviate from the accepted principles of commercial accounting, like Section 43B (f) proposals, which lead to sacrifice of tax revenue to achieve a non-tax objective like development of backward areas and infrastructure facilities.

Special amendments should not be routed through finance Acts. For these amendments, Bills should be introduced.

A tax reforms body with permanent and part-time members needs to be constituted with adequate secretarial assistance to make recommendations for comprehensive tax reforms and re-write the direct tax laws.

Given that many legal issues arise in the implementation of direct tax laws, the commission should preferably be headed by a sitting or retired Supreme Court judge with members from various other disciplines. This commission should be given a minimum period of one or two years to complete its assignment.

A still better alternative would be to set up a permanent Economic Laws Commission on the lines of the Law Commission to periodically offer suggestions concerning tax changes.

And, finally, it would be excellent if the finance minister refrained from announcing amnesty schemes. That not only indicates the government's helplessness in dealing with tax evaders, but also greatly demoralises honest taxpayers and, thus, seriously affects voluntary compliance. The gain in terms of revenue does not compensate for these problems.

(The writer is former chairman, Central Board of Direct Taxes)