View: Go for nuanced tweaking of taxes, not outright tax holiday

What’s the difference between a taxidermist and a tax collector? ‘The taxidermist takes only your skin,’ quipped Mark Twain, the great American writer and humourist. As the toll, both human and economic, from the country’s desperate fight against the biggest pandemic of the century begins to bite, many more Indians are going to feel like Mark Twain.

With jobs and incomes dwindling, the demand for some tax relief acquires a new urgency. Never mind that India has one of the lowest tax/GDP ratios in the world and even among emerging markets. Or that the rescue package being sought from the government is hamstrung by rapidly falling tax revenues, thanks to economic activity being at a virtual standstill for close to two months. Worse, is likely to remain patchy for a while to come.

So where does one draw the line between the government’s need for revenue and the ordinary citizen’s need for tax relief? The answer, unfortunately, is not easy. The problem is compounded by the fact that we are one of the most unequal societies in the world. There are Indians and Indians, there is India and there is Bharat, there is Maharashtra and there is UP. And though for the first time, the greater loss of activity in India may bring income levels there closer to those in Bharat, likewise Maharashtra closer to UP, this does not take away from the fact that India is home to both the largest number of poor in the world as well as to the 3rd largest number of billionaires, next to US and China and way ahead of Germany.

In such a scenario, any tax holiday, however temporary, must be carefully structured to give relief where it is most needed without hurting tax collections unduly. Fortunately, the same income inequalities that otherwise make our society one of the most unequal in the world also make it possible to structure a tax break that benefits the maximum number while hurting revenue the least.

Take direct taxes, corporate and personal. The bulk of both corporate and personal income taxes comes from a relatively small section of the overall cohort of taxpayers with large corporates and high net worth individuals paying a larger share of total tax revenues. This is as it should be. One of the cardinal principles of taxation, though never quite couched this way, is ‘from each according to his ability to each according to his need’. Consequently, direct taxes have always been progressive, i.e. those at higher income levels pay more, both proportionately and in absolute terms.

But these are not normal times. In the words of noted economist, Dr C Rangarajan, the first principle of war finance is that nothing should be decided on the principle of finance. And this is war, no less, even if against an unseen enemy. To the extent that some sectors, notably civil aviation, hospitality, tourism etc have suffered more than others, the government should definitely extend tax relief, if not an outright waiver. For the rest, the case is less strong, particularly now that corporate tax rates have been substantially reduced. So, while keeping the broad principle of progressivity in mind, the government must extend tax holidays to sectors that have been most impacted by Covid-19.

As far as personal income tax is concerned, the skew in incomes is no less pronounced. Unbelievable as it may sound, especially to readers of this column, only 2.5% of Indians pay income tax and of this just four percent account for as much as 60% of the total personal tax revenue, with salaried taxpayers for whom tax is deducted at source accounting for the bulk of tax paid. A tax break at lower slabs, say for incomes in the Rs 5 – 10 lakh per annum bracket would, therefore, not cost the government much by way of revenue loss while benefitting large numbers. Remember, the propensity to consume is also more at lower income levels so such a tax break will also help support demand in the economy.

On the indirect tax front, the main sources of revenue are GST, customs and excise duty on items not yet included in GST. Customs duties are bound to get hit, thanks to dwindling global trade. Also, there’s not much to be gained by tinkering with the rates. In any case, successive budgets have seen the government raise customs duty across a wide variety of items.

As far as GST is concerned, revenues will, inevitably, take a big hit given the dramatic fall in economic activity. Nonetheless, it is not enough to look at taxes only through the prism of revenue. At times like these, the government must also look at the impact of taxes on people’s ability to consume/protect living standards. Indeed, the Covid-19 compulsion provides just the trigger needed to rationalise GST structure, collapse the existing five rates and confine the maximum rate of 28% to only a few sin goods, like tobacco/pan etc. If, as may be expected, this leads to increased demand, higher volumes will make up for some of the revenue loss.

‘We’re all going on a summer holiday, no more working for a week or two’, sang evergreen pop singer, Cliff Richards. Well, the country shut down for more than a week or two, but not for a summer holiday. It’s now back to a slow and painful grind to make up for lost time. The hope is that when it comes to tax holidays, the government will tread a fine line; give tax breaks where it impacts the maximum number without hurting revenue collections. The rest of us will have to grit our teeth and bear it. For now!

* This is part of a multi-article series written by economists and sectoral experts on the path India must take to survive the Covid crisis.