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Decoding the tax code
September, 01st 2010

There are many good reasons for the cautious and conservative approach the Union finance ministry has adopted towards direct tax reform. Expectations of a radical reform of tax policy have understandably been belied because of the governments cautious approach. The most important reason for such cautious conservatism would be the likely revenue implications of the changes being proposed.

The Union revenue secretary has let it be known that the government would be giving away as much as '53,000 crore in the first year of implementation of the new direct taxes code (DTC). Clearly, this fact may have also shaped the governments decision to delay the implementation of the new tax code by an year. No finance minister can afford to take chances with revenues and reform when the fiscal deficit and the budgetary deficits of the government are so high.

Fiscal policy and public finance purists may like neat and decisive reform, while taxpayers would like simplicity of procedure and clarity in language, but fiscal authorities worry more about the revenue implications of tax reform. The government cannot afford to risk reduced revenues at a time when there is such uncertainty about growth and deficit management. Further, given the recent decline in the savings rate, the government may have also been wary of reducing the incentives for saving.

As a consequence of such concerns, the final DTC has proved to be less radical in scope and intent than was widely expected. Critics would say the government has missed an opportunity to undertake more wide-ranging reform. But the fact is that tax reform is always a continuing process and no government can afford to put a full stop to policy change unmindful of the revenue and deficit management implications of such change.

Even so, it is necessary to ensure reasonable stability, predictability and transparency in policy. Hence, whatever the change the government now intends to bring should remain in place for a reasonable period of time to enable individuals and firms to plan and manage their incomes, savings and investment decisions.

The governments decision to offer some comfort to lower middle-class families is well taken, especially when inflation continues to hurt them, and so also its decision to end gender preferences, considering that in India the phenomenon of single mother households is still not significant and most women taxpayers belong to double-income families. However, it is not clear why the government wishes to keep in place so many exemptions. The scope of exempt-exempt-exempt ought to have been reduced and that of exempt-exempt-tax widened. Health and education expenditure and retirement benefits are about the only items that ought to benefit from tax exemptions.

There is no reason why any other sort of income or expenditure should attract tax exemption. It is the margin for discretion and the lack of clarity that complicate tax systems and their administration. These considerations must inform policy on general anti-avoidance rules (GAAR) so that the taxpayer is not at the mercy of tax administration and tax consultants. GAAR principles must be clearly defined by the government and not left to tax authorities to decide. At the end of the day, even the simplest of policies can become a nightmare for the honest taxpayer if authorities have the leeway to harass.

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