There has been a lot of comment in the media—both print and visual— on the draft direct tax code, which was unveiled last week. The comments have been largely positive, recognizing the departure that this code seeks to make from the past, and, barring a few exceptions, generally applauding the direction of the proposed legislation.

There are several reasons why this exercise is quite unique.

First, in naming it the direct tax code and not the Income-tax (I-T) Act, perhaps the government is attempting to send a signal. The I-T Act is one law that finance ministers love to carve up every budget—keeping the public and corporate houses in suspense about their culinary skills until it is unveiled on budget day. Unlike in India, I-T laws do not change annually in other mature democracies, and predictability and continuity of tax structures is a mature signal to investors about the stability of tariff regimes in the country. By naming the new legislation a “code" rather than an Act, the government appears to be giving a signal that in the future, there will be greater stability of the tax structures—if one just thinks about the other codes, such as the Indian Penal Code or the Code of Criminal Procedure, these are not changed every year. If this has been intended, it is a very good signal.

Second, there has been a conscious effort to do away with exemptions—so that effective rates of taxation reflect the charges on incomes that are transparently defined. This is a major shift away from area-based exemptions, from choosing winners and losers in industry and, indeed, in removing distortions that have crept in the way of “development initiatives". What the code seems to be saying is that while particular classes of individuals—such as women and senior citizens—deserve differential treatment, there is no room for distortion on the basis of geographical region or industry segment. This is again a sign of a maturing economy that believes in market forces rather than on state-sponsored growth initiatives.

Third, there is considerable relief for individuals, while less so for business entities—these would, perhaps, be tested a little more than now and, in most cases, have to pay more tax. By calling it the direct tax code rather than the I-T legislation, there is an attempt to bring some of the newer tariffs such as the fringe benefit tax and the securities transaction tax into the legislation—they were unhappy appendages to the earlier I-T Act, for they are not direct “incomes" by definition. There is, thus, a clear demarcation between direct and indirect taxes. It is to be hoped that with the introduction of the goods and services tax (GST), and lowering of customs duties to international standards, there will be only two pieces of legislation left—one related to direct taxes and the other related to GST.

There have also been some concerns that have been expressed. At the top is the worry about revenues. If personal income tax is to be reduced substantially, and the top rate of corporate tax brought down to 25%, then surely there would be an impact on revenue buoyancy. With a high level of public expenditure envisaged over the next decade, revenues may fall short of expectations, leading to ever-increasing fiscal borrowing programmes. With a huge lag in infrastructure, especially power, there would be a stress on public investment programmes.

Second, there appears to be a curious lack of vision and long-term strategy in the document. If the purpose is to reduce taxes, it could have been achieved in the annual budgets, and the exemptions could have been removed based on the Kelkar committee recommendations. There is little evidence of simplification of procedures, of administration or governance of laws. In fact, interpretational ambiguities persist, most so in areas of taxation of international firms operating in India—one would have expected that this would be one area where transparency and simplification was needed most. There is little that is being attempted in the way of simplification of assessments—in the US, assessment acceptances take only a couple of months— even in the present draft, the appellate and dispute resolution processes are quite long drawn out. In short, there is no effort to reduce the administrative costs of tax collection.

Third, it does not deal with the most important problem of Indian income taxation—avoidance and coverage. With higher exemptions in personal taxation, there will be several lakhs more that will drop out of the tax net. All these years, the attempt has been to bring more people into the taxpayers’ category—the attempt now seems to be to leave them out. This approach is curious, given that since 1991, the attempt has been to increase the tax base, and now, suddenly, there is an attempt to reduce it. Why? Given that there is a serious problem in our economy of cash incomes that are not taxed, as well as rural incomes that are not directly from agriculture, this new code may actually be a bonanza for those who are not in the tax net—again, quite surprising.

In short, while thinking through the process of removing exemptions and reducing tax rates, little thought seems to have been given to some of the long-term implications.

S. Narayan is a former finance secretary and economic adviser to the prime minister. We welcome your comments at