Pranab-'da', listen to taxpayers, not economists

When Pranab Mukherjee gets up to present his second Budget in this stint as finance minister, he is going to be nobody’s hero. Till last year, overflowing coffers, freebie politics and a recession threat ensured that finance ministers only had to give things away: loan writeoffs, tax reliefs, stimulus packages, et al.

This year, Pranab’s cupboard is empty. He has nothing to give. He will first have to withdraw the fiscal stimulus — perhaps in stages, but withdraw he must — and then find ways to end free lunches in several places: petroleum products, fertiliser, and food, among others. He will have to end the accounting fudges under which subsidies for oil are not paid from revenues but out of borrowings — and this stupidity is not even acknowledged as a bad practice.

He will have to unveil a roadmap to combine excise
and service taxes into one common goods & service tax (GST) regime. He has multiple challenges on multiple fronts, and the only high card he holds in this game is public sector assets.

Given political backing, he can sell a part of the family silver and raise resources to plug the black hole in finances (over Rs 4,00,000 crore according to Pranab-da’s last Budget).

This is, unfortunately, a terrible way to raise money. It’s literally like eating your seedcorn. No sensible farmer would ever do this. You may satiate your current hunger, but you won’t have enough seeds planted for the next crop. It’s self-defeating.

Pranab Mukherjee surely understands this, but while planning any new taxes — apart from GST — he needs to take note of our experience with taxes before introducing new ones. He should ignore the advice of economists and just consider what is feasible in the Indian context. Economists will fret about the tax-GDP ratio, and want more direct taxes (income and corporation taxes, capital gains tax, et al) rather than indirect ones (excise and customs, and now VAT and GST).

In the Indian scenario, however, it should be the
other way around: we should have more indirect taxes,
and fewer direct taxes, unless you make it impossible
to evade it.

For example, the dividend distribution tax
is a direct tax on dividend incomes captured entirely at
the corporate end. There is no scope for evading it, and
the receiver is also happy since he doesn’t pay further
tax on it. It should remain on the statute books because it has worked well for us.

Economists will also tell you that it is not a great idea to tax transactions; one should tax incomes instead. But economists live in the world of make-believe. What
they suggest does not work in India. Like all sensible
human beings, Indians don’t like paying any tax on income, and the taxes that work best for us are those that
are integrated with transactions.

This way, the taxes are subsumed in the price and no one notices. One example is the securities transaction tax
(STT), which the new direct taxes code seeks to abolish
and replace with taxes on capital gains. The STT is collected centrally on all stock and futures transactions.

The tax gets added to the price of a stock and investors have learned to live with it. There’s also no scope for evading it, since all transactions are now electronic
and there is  an audit trail.

The main reason why investors like STT  is that they pay no capital gains tax on long-term share gains, and very little (15%) on short-term gains. Pranab should not change the status quo in the name of reforming the system. STT should stay, and long-term capital gains should not be taxed. It can only lead to more evasion and heartburn.

Another tax that has worked well is the cess on petrol and diesel to fund road development. Once again, the customer is only aware of the final price of his fuel, and makes little effort to evade them. Money is collected easily and efficiently through a handful of petroleum companies. The tax works like a dream.

The central and state value-added taxes (VAT) also pass the test of efficiency. VAT ensures that the buyer of a product gets a tax credit on any tax paid by the supplier, and this serves as an inbuilt check against tax evasion. If the supplier hasn’t paid excise (VAT, that is) on his inputs, the buyer higher up in the food chain doesn’t get a tax credit, which in turn pushes up his tax.

Every subsequent buyer thus ensures that VAT is paid by his suppliers. It’s delivered brilliantly, and the GST — which is essentially a VAT on goods and services — should also work fine. Pranab should not delay its implementation.