Thursday, August 13, 2009

Diary: Reactions to India's New Tax Code

The Finance Minister of India, Pranab Mukherjee, released yesterday a draft tax code, which is expected to replace India's Income Tax code by the next fiscal year. India's Income Tax code was indeed dated, written in 1960s, and confusing, with too many amendments and exemptions earned by pressure groups riddled all over. The new tax code, Mr. Mukherjee stated, will 'simplify' the matters. Besides, it is expected that this will modernise the India's tax system, and rationalise it for the new Indian economy.

It is a revolution in waiting, indeed. Consider the changes it proposes in personal income tax. Today, a tax payer pays tax of 10% once he [there is a different slab for women] crosses Rs. 160,000 in income. This applies up to Rs. 300,000, above which, and up to Rs. 500,000, one has to pay 20%. They have to pay 30% on anything above Rs. 500,000. Besides, there are a number of surcharges, completely irrational levies that the government puts in ad hoc, on top for the top bracket of income. Recently, there was an Education surcharge, as if the government is not supposed to cover education investments from its usual tax proceeds. Now, the following changes are proposed: One pays no tax up to Rs. 160,000, pays 10% for amounts above Rs. 160,000 and up to Rs. 1,000,000, 20% for amounts between Rs. 1,000,000 and Rs. 2,500,000 and 30% for amounts over that.

This will greatly benefit India's knowledge workers. A typical starting salary of a graduate engineer in India is anywhere between Rs. 300,000 to Rs. 600,000. Today, someone with a salary of Rs. 600,000 a year will be required to pay Rs. 84,000 in taxes, which will be reduced to Rs. 44,000 after these changes are affected. I know this isn't as straightforward - people are already grumbling that lot of exemptions will go - but these should go, because many companies built various perks and allowances to circumvent the dated, unrealistic tax code anyway. It will indeed mean less work for the tax collection agencies, less work for the company payroll and HR, and also possibly less for Chartered Accountants.

The corporation tax will also come down from 30% to 25%, though the company asset base will now be counted and taxed. The first hand feel is that it will reduce the taxes on service sector companies, who do not necessarily build an asset base, but work against companies, particularly in manufacturing, who needs to invest in capital assets. Though this seems a bit harsh at the outset, we don't know the details yet. But, essentially, this tax code has a new economy bias and that goes well with where the country wants to go and where it holds maximum competitive advantage.

As with any political talk, there is already talk about whether this is an Anti-poor tax code. Few things on that. First, the poor is poor, and usually they do not have income over Rs. 160,000 a year. Second, if less tax for rich means more burden on the poor, the people who hold the view need to wake up. They have been sleeping for a few decades too long. India is fast becoming a modern economy and this tax code will encourage knowledge workers and talented individuals to stay and work in India. This will mean more wealth and opportunity for the country, which should benefit everyone in a sense.

Besides, this tax code has a number of measures which discourage rentier behaviour. Like treating capital gains, long term or short term, as income. Like taxing interest from savings, which will now be extended to cover most kinds of savings instruments. This is also in line with the structural shifts in the economy, when the wealth and employment creation is happening faster and bigger in the new sectors than the old ones.

I do think the deeper structural reform of India has started now. I am sure there will be many changes in this tax code before it gets operationalised and integrated in the system. But, overall, this shows the intent and that's a good sign. They will disturb the status quo, indeed, like Kapil Sibal's proposals in education has, but it seems that the new Congress government has understood the nature of the country better than others. India today is an aspiring, forward looking and positive country, and it is no longer enough to manage individual seats through pork-barrel spending and unreasonable handouts; to stay in power, the government must act and help the country move forward. Unfortunately, this understanding needs to get passed on to the state governments as well, who play an important role in India's federal system. Most of the state governments are in still in the rip-van-winkle stage, in denial and believe that pork-barrel seat management is the way to cling onto power.

I am celebrating the tax code more for the intent than for its content. The commitment to change is needed in India, and there has been ample evidence that we are finally showing the courage to change. Manmohan Singh's gentle leadership is proving to be more effective than his charming predecessor; things have indeed started moving. Even in the middle of this deep recession [though, with the good news coming from France and Germany, it seems that the worst is now over], the hope about India is hope, the forward looking attitude and the belief in the future that is being displayed by the Indian government, businesses and public. History shows that every nation reaches such inflection points, and if they can take advantage, they transform themselves. So far, the story of India is running uninterrupted - and there is reason that we should remain hopeful.



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