India's tax reformers

Recently I had occasion to review India's [ Images ] 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 [ Images ] 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 [ Images ]
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
[ Images ] 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 [ Images ] 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 [ Images ] 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.
Shankar Acharya
Source: Business Standard