To appreciate the true importance of the draft direct tax code that the government announced on Wednesday, one needs to trudge back to the dark years of Indira Gandhi’s tryst with socialism.
There were 11 income-tax rates ranging from 10% to 85% depending on a person’s income. Then there was also a 15% surcharge, which meant that effectively the top marginal tax rate was 97.75%. So an individual liable to pay the maximum tax rate had to give Rs97.75 of every extra Rs100 he earned to the government. The only two rational responses to this would be to stop working or evade taxes. In short, we had a tax system designed to kill initiative and promote black money.
Illustration: Jayachandran / Mint
Now look at what finance minister Pranab Mukherjee has proposed, based on a lot of hard work done by his predecessor P. Chidambaram: There will be only three tax rates. The marginal tax rate for incomes between Rs1.6 lakh and Rs10 lakh will be 10%. That means a vast majority of Indians will either not pay taxes or will have to pay a modest tenth of every extra rupee they earn. It would not be an exaggeration to say that India will almost have a flat tax regime.
The gradual dismantling of the pernicious tax system began in 1975, continued 10 years later with finance minister V.P. Singh and his long-term fiscal policy and picked up speed after the economic reforms of 1991. Similar changes were also made in indirect taxes and import tariffs, with lower ad fewer rates.
We hope the new system of income and corporation taxes widens the tax base, minimizes distortions and increases tax revenues. The latter is especially important since higher direct tax collections will help the government further reduce its dependence on indirect taxes; the former are usually progressive and the latter tend to be regressive.
The new direct tax system should be in place by 2011 and the goods and services tax (GST) should be introduced a year before that. What this means is that a globalized and private sector-driven Indian economy will have a modern and efficient tax regime, helping the process of economic growth.
That eventually will be the litmus test: Will this last burst of tax reforms help the Indian economy? We believe it will. Poet Kalidas wrote of a king in Raghuvamsha: “It was only for the good of his subjects that he collected taxes from them, just as the sun draws moisture from the earth to give it back a thousand times.”
Does India need further tax reforms? Tell us at firstname.lastname@example.org