India requires out-of-the box thinking on tax reforms

Trying to eliminate black money through coercive tactics will not work and will only harm businesses. Instead, the government should reform tax policy and remove black money structurally.

It starts with eliminating income tax because it taxes the wrong thing. The income a person earns is either consumed or saved. So a tax on income is essentially also a tax on savings. This discourages savings. And since investment in an economy comes from savings, a tax on income discourages investment. India desperately needs private investment for the economy to grow, and income tax is a huge impediment to savings and investment.

Consider also the corporate tax, which is a tax on a company’s income. This is the biggest hoax in taxation because the corporation is a non-person, and taxes on a corporation are indirect taxes on its employees, customers, and shareholders (read pension plans that buy shares of companies).

The capital gains tax is also another insidious tax. A capital gains tax is charged on the gains from investments, and because of the arbitrary differential treatment between short and long-term capital gains, billions of rupees are stuck in unproductive investments to avoid taxes. Investments should be judged on their risk-adjusted return and not their tax treatment. The wealth tax is another capricious tax that taxes a person’s after-tax savings (wealth).

The government can turn this economy around by abolishing all current taxes: all the 50 or so direct and indirect central and state taxes that currently exist. No income tax, no corporate tax, no capital gains taxes, no service tax, no excise tax. The current tax system is hurting the economy and killing businesses. Government revenue collection is poor, tax evasion and black money are rampant, the amount of time and resources wasted by individuals and corporates in filing tax returns is enormous, the resources expended by the government to ensure compliance is colossal, and tax terrorism by the authorities is eroding private sector’s confidence. A 2016 Word Bank Report shows that India ranks 157 out of 189 countries on how helpful the tax system is towards ease of doing business.

All existing taxes should be replaced by the only thing that should be taxed — consumption. A consumption tax is the same thing as the current GST with a few important differences. Firstly, all products and services sold (and consumed) are taxed at the same rate. Because the rich will consume more (in value terms), they will pay a higher amount in taxes. Secondly, there are no exempt products. Everything, including food items, is taxed when consumed. Currently, almost 50 per cent of the products on the GST list is exempt. Low-income people can be compensated for the tax they pay on food items through a direct deposit equal to the tax rate on a threshold income. So if the government decides on a threshold income of Rs 10,000 per month and a flat GST of 10 per cent, then everyone earning Rs 10,000 or less will get a direct deposit of Rs 1,000 every month to compensate for the GST on food items. A single rate with no exemptions will greatly simplify compliance and administration.

Studies done by the Office of the Economic Advisor show that a flat 10 per cent consumption tax would be revenue neutral. The total value of all goods and services produced in India in 2016, also called the Gross Value Added, was about Rs 170 lakh crore. A 10 per cent GST tax would yield about Rs 17 lakh crore, which is about what the government currently gets in revenue from all the existing taxes.   

Eliminating taxes that penalise investing and saving will increase the supply and movement of capital, unleash productivity gains and business creation, and invigorate economic growth and reduce inflation. And as the pie gets bigger, the government’s share will also increase.

The author is Managing Director, Center for Environmental & Economic Policy. Views expressed are personal.