The next Union Budget is to be unveiled on July 10. One hopes that it is not too late for the government to consider a few suggestions.
Introduce a flat tax
There are reports that there could be a steep hike in the general exemption limit to Rs 5 lakh. This proposal should be taken advantage of to introduce a flat tax. The concept implies the imposition of only one tax rate for personal incomes above the exemption limit. It already prevails in some countries. Even in our country there is a flat tax rate for companies. And when the personal income tax was introduced, it was a flat rate. A committee on direct taxes made a pro forma and cursory examination of the suggestion, and rejected it for no solid reason.
It is often rejected on the ground that it is not progressive. This is not so. For example, if the threshold for taxation is Rs 5 lakh and the tax rate is 25 per cent, the tax on incomes of Rs 10 lakh, Rs 15 lakh and Rs 20 lakh will be Rs 1.25 lakh, Rs 2.5 lakh and Rs 3.75 lakh, respectively. Thus the average tax rate will constitute 12.5 per cent, 16.6 per cent and 18.75 per cent, respectively - so the flat tax could indeed be progressive.
For the common man, the tax burden is represented by the average rather than the marginal tax. To simplify the system all exemptions, rebates and deductions should be eliminated. Such a system will be welcome to everyone except tax consultants!
Objections will be raised on the ground that tax incentives will not be available for promoting saving. It is time that the authorities realised that saving is a function of incomes and not of returns. The latter, by way of interest or yield, determines only the avenues of investment and not the total quantum of savings. Did not people save in the past, burying their money under their pillows, before the advent of institutions like banks? They did not get any returns from savings, which they accumulated for various reasons like providing for the future, exigencies, leaving inheritances for their descendants, and so on. Let us not be misguided by theories of saving prevalent in the West, which does not have the type of joint-family set-up that we have.
The threshold for taxation and the flat rate may be so fixed that they are optimal, to satisfy taxpayers. Future increases in savings should come from a rise in incomes.
Restore dividend and capital gains taxes
These are two areas where there is immense scope for raising revenue. Dividends and long-term capital gains in shares are exempt from taxation now. Under the flat tax system, these exemptions will be removed.
There are reported to be around 20 million retail investors in shares. Most of them belong to the middle classes. If the general tax exemption limit is Rs 5 lakh it will take care of their interests. At the most, if the government still wants to protect them, it can prescribe a reasonable specific limit for exemption from dividend and capital gains taxes.
Certainly, the current tax rules are not acceptable when huge amounts are earned by promoters by way of tax-free dividends and capital gains. The promoters' share in dividends in big companies ranges between 16 per cent and 80 per cent.
Expand the wealth tax
Wealth tax payable is one per cent of the net value of taxable wealth if it exceeds Rs 30 lakh on the valuation date for the financial year. It is payable only on non-productive assets - jewellery, vacant land, farm houses, etc. A citizen may own an unlimited amount of financial assets like bank deposits, shares, and so on, without being liable to pay wealth tax. According to Forbes magazine the country has 56 billionaires in all, with a collective net worth of $191.5 billion. A one-per cent tax will fetch more than Rs 11,000 crore, against a paltry amount of Rs 1,233 crore in 2012-13 (Revised Estimates) and Budget Estimates of Rs 866 crore in 2013-14.
The exemption of financial assets from Wealth Tax was understandable when banking and markets were still evolving. Now we have a sophisticated financial sector comparable to that in OECD countries. It is time to bring financial assets within the ambit of the wealth tax. The government may consider raising the exemption limit to Rs 1 crore, keeping in view the erosion in the purchasing power of the rupee.
Link fiscal deficit to revenue receipts
Considerable concern is expressed on the high level of the fiscal deficit. Road maps have been laid out to reduce it from time to time, without much success. The objective of a reduction can be achieved through a rise in revenue and/or a cut in expenditure. The measures outlined above should help in raising revenue.
Also, there is a need to review the linkage of the fiscal deficit to gross domestic product, or GDP. The final GDP for a year is available with a considerable time-lag, and is hence not helpful in monitoring the fiscal deficit. Instead it could be linked to revenue receipts. Due to computerisation, the government can easily monitor their flow. The advantage is that there will be an incentive to improve performance.
Sierra Leone, where I worked as adviser to the governor of the central bank under an IMF assignment, had its fiscal deficit target linked to revenue receipts.
The writer was officer in charge of the Department of Economic Analysis and Policy at the Reserve Bank of India
Disclaimer: These are personal views of the writer. They do not necessarily reflect the opinion of www.business-standard.com or the Business Standard newspaper
