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Two-Slab Income Tax

Should India take Kelkar's advice on the simplification of income-tax?

By Ashish Gupta

V. Kelkar: Questions galore

Even before the ink could dry on the Kelkar Committee's report on direct taxes, there have been howls of protest from various quarters. The report, it seems, has managed to offend two of the most vociferous sections of Indian society -- the farming community as well as the urban middle-class.

Vijay L. Kelkar, Advisor to the Finance Minister Jaswant Singh, has set off the alarm bells by recommending that farm income be taxed, and that we do away with the assortment of 'deductions' (tax incentives) that go into the calculation of a salaried person's personal income tax.

Farmers have been on a tax holiday for decades and decades, and they're bound to protest. Who likes to be taxed? The point is: in an ideal world, everyone should be treated alike, including farmers.

That's also why the battle against the other reform proposals (for salaried individuals) comes across as a case of knee-jerk resistance to change. Take a closer look at the proposals, and you'll find that the Committee has operated on the basis of economic first principles -- something all reformists have been demanding for so long.

What Kelkar wants to do is simplify taxation to the point of common sense. As commonly understood -- on the street. And what could be simpler than a two-slab taxation rate (20 per cent for income of Rs 1-4 lakh and 30 per cent for anything above) without any deductions?

After all, equity and simplicity are the two basic canons of taxation... and they're inter-related, since it is tax complications that typically make space for the sort of arbitrary taxation measures that could be seen as unfair from some angle or the other.

The Committee's practical objective is to raise the tax-GDP ratio. And the macroeconomic idea is to make the allocation of resources more efficient -- understood nowadays to mean letting markets do most of the job, with minimal interference.

That, again, would mean ensuring that tax laws do not distort the way money is saved or invested by society (as most tax incentives tend to do). The logic: what gets funded, and what not, should not be dictated by tax codes, but by the actual market forces of demand and supply -- to the extent possible.

From the tax-payer's perspective, the idea is to stop penalising people who choose not to take a home loan, or not to use their insurance policy as a savings instrument.

Yet, simplicity is finding itself up against established interests (anyone who's already invested in a tax-saving scheme or taken a home loan would qualify as such). This also explains why North Block seems so reluctant to embrace the proposals. Says a senior finance ministry official: "It would be wrong to think that all the recommendations will be accepted in the Union Budget.''

The simplification is not the only issue, since the recommendations cover a whole lot more. The committee wants individual taxes on dividend income and long-term capital gains to be scrapped, as also wealth tax. This also fits in with the general principles outlined above -- and are to be welcomed.

The corporate taxation proposals are also quite attractive -- and seem to be guided by the same sort of thinking. The only fair tax, they say, is a tax understood by a 10-year-old.

But will the government accept these proposals? That's the question. Don't forget that the government needs to gain from it, too.

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