http://in.rediff.com/money/2005/apr/26guest3.htm
<!--QuoteBegin-->QUOTE<!--QuoteEBegin-->India's tax reformers
April 26, 2005
Recently I had occasion to review India's tax reforms over the past thirty years or so. It's a fascinating story and I thought I would share a few highlights with readers.
Today, as we struggle to roll back patently bad taxes, such as the cash withdrawal tax and the new fringe benefit tax, we may forget how far we have travelled since the 1970s, when our tax system was really messed up. And we may fail to accord due credit to the stalwarts of Indian tax reform.
Back then, customs duties were often above 200 per cent on many products. Excise duties ranged between 2 and 100 per cent spread across 24 different rates, not counting much higher duties on tobacco and petroleum and many specific (that is, per unit) duties.
Inputs were routinely taxed and credit on taxation of inputs was rare. So "cascading" of taxes was the norm. Direct taxes were even more bizarre. In 1973-74, the personal income tax boasted eleven different slabs with rates ranging from 10 to 85 per cent. With a surcharge of 15 per cent the top marginal rate was effectively 97.75.
Thus, for every additional 100 rupees earned you got to keep just over 2 rupees! Actually since all wealth was also taxed at significant rates, the cumulative incidence of income and wealth taxes frequently exceeded 100 per cent. The predictable result was widespread evasion and avoidance.
Many of the investment companies that today figure prominently in battles for corporate control owe their genesis to the confiscatory tax regime of the 1970s. Company taxes were typically around 60 per cent and varied across equity holding patterns. Tax administration was equally complex and arbitrary.
The retreat from these stratospheric (and totally counter-productive) personal income tax rates began in 1974-75, following the Wanchoo Direct Taxes Enquiry Committee report of 1971.
But it was an unsteady descent, with significant reversals during the Janata government years of 1977-80. Indeed, in 1979-80, Charan Singh raised the tax on net wealth to an unprecedented peak of 5 per cent.
Modern tax reform was really launched in India by V P Singh during his brief two years as finance minister in 1985-87. For a start, he and his team took a holistic view of the tax system, both direct and indirect.
Second, tax reform was driven explicitly by the objectives of economic efficiency, policy stability and equity, not just by the thirst for revenue. Third, for the first time, V P Singh articulated a medium- term strategy for tax reform and placed the "Long Term Fiscal Policy" in Parliament.
Fourth, there was a conscious effort to deploy rule-based, fiscal policies in place of discretionary physical controls in the task of economic management. Finally, there was a serious attempt to improve tax administration.
In his first budget, for 1985-86, V P Singh reduced the number of income tax slabs from eight to four, cut the top marginal income tax rate to 50 per cent (from 62 per cent), lowered the basic company tax rate also to 50 per cent and abolished estate duty.
In the following year he took another huge stride forward by introducing Modvat (credit for tax paid on inputs) into much of the excise tariff structure, thus ushering in the age of VAT principles into Indian commodity taxation.
With V P Singh's exit from the finance ministry in early 1987, tax reform went into hibernation. Until another Singh, Manmohan, took the lonely helm in 1991. In his five full budgets between 1991 and 1996, especially the ones for 1992-93 and 1994-95, Manmohan Singh joined the exclusive pantheon of India's tax reformers.
He reduced income tax slabs to three (20, 30 and 40 per cent), lowered the basic corporate tax rate to 40 per cent, virtually abolished the wealth tax (by exempting financial assets from its purview), did a major clean-up of indirect tax exemptions, extended Modvat to almost the entire manufacturing sector, reduced the number of excise rates and introduced services taxation.
Perhaps his greatest contribution was the reduction of peak customs duties from well above 200 per cent when he came in to 50 per cent before he left. Duties on investment goods and key intermediates were cut more sharply. By these measures Singh wrought a sea change in India's hitherto highly restrictive foreign trade policy.
The momentum of Manmohan Singh's tax reforms was largely sustained by Chidambaram and Yashwant Sinha in the remainder of the 1990s, though some might argue that Chidambaram's further reductions in direct tax rates were unjustified in a poor country struggling to raise tax revenues.
To Yashwant Sinha must go the credit for the major break through in reforming excise rates, when he conflated eleven excise rates to three (in 1999-2000) and then, finally, to the single CENVAT rate of 16 per cent in 2000-01 (buttressed by a couple of additional special excises on a few consumer luxuries).
All three finance ministers of the nineties (and Jaswant Singh later) extended central government support to the reform and harmonisation of state sales taxes, culminating in the current transition to state VATs.
If these men (especially V P Singh and Manmohan Singh) were the principal tax reformers among finance ministers, who were the key technocrats in the story of Indian tax reform? Pride of place must go to two men who kept alive the idea of serious tax reform in the difficult decades.
The first was L K Jha, perhaps the most accomplished econocrat of his generation of ICS officials. He chaired the Indirect Taxation Enquiry Committeee, whose report of 1978 laid the foundation of the Modvat reforms implemented in V P Singh's time. A prominent member of that committee was Professor Raja Chelliah, who later came to be widely respected as India's leading public finance authority.
As chairman of the Economic Administration Reforms Commission of the early 1980s, Jha also produced important reports on tax policy and administration, which underpinned V P Singh's direct tax reforms. Not coincidentally, Chelliah also served on this commission.
Chelliah went on to head the famous Tax Reforms Committee of 1991-92. Its three volumes were widely (and rightly) acclaimed as the most comprehensive and analytical treatment of Indian tax policy and reform issues since Independence. The TRC's recommendations guided the policy actions of all three finance ministers (and their senior officials) of the nineties.
An influential member of the TRC was Amaresh Bagchi, who belongs to that rare and vanishing species of income tax official turned public finance scholar. Later, in 1994, he and his team at the National Institute of Public Finance and Policy produced a classic study of domestic trade taxes in India. This became a key report guiding the reform of state sales taxes and exploring the VAT options available under India's Constitution.
There were others, including: Govinda Rao, whose expert group report of 2001 formed the basis for the recent integration of services taxation with goods taxation under Modvat; Partha Shome, whose 2001 report updated the TRC's recommendations; and the various Vijay Kelkar task force reports.
These last contained some controversial recommendations. But the reports did resurrect the TRC's emphasis on reducing exemptions and on reforming tax administration. The most recent report also makes a persuasive case for a nationwide, integrated dual-VAT across the central and state governments.
We have indeed come a very long way from the 1970s' tax jungle. And we owe a deep debt of gratitude to a small band of dedicated tax reformers for guiding us out of those dense, productivity-sapping thickets.
The author is Honorary Professor at ICRIER and former Chief Economic Adviser to the Government of India. The views are personal.<!--QuoteEnd--><!--QuoteEEnd-->
