DTC and 2C2E2I: Financial Express Aug 31 2010

We can never have a tax code that satisfies all of us. Individuals want to pay fewer taxes and ask for lower rates and more exemptions. Corporates are lavish with executive pay (yes, this is relevant today) and talk of corporate social responsibility, but are unwilling to pay more taxes. They will always selectively give examples of countries where tax rates are lower, though assuredly there are others that charge higher rates, depending on whether we benchmark with BRICs, Southeast Asia or developed countries. Yet all of us want the government to spend money the way we want (they should not increase their own salaries), balance the budget (how can that be done) and be efficient. How does one strike a balance?

We had DTC1 and DTC2, which evoked strong responses. DTC3 appears to be a diluted version and should please all. Individuals are better off, though not as well off as with DTC1. But they get their EEE on savings and don’t pay more taxes and retain all housing benefits. Corporates will pay less than now, but more than what the earlier DTC versions had promised. They are sulking that MAT has gone up from 18% to 20%, but is this significant?

A dispassionate way of judging a tax approach is to go back to the textbook and examine what Adam Smith had to say. Smith used the 2C2E formula to define a good tax code. Taxes should be ‘convenient’ and easy to pay so that paying does not inconvenience the payer. Has our code thought about such a thing? Prima facie, having a TDS on every transaction with those being exempt filling the requisite form would make life easy for all tax payers, because by the end of the year you cannot have a record of the Rs 100 that came to you as interest income. Our tax reforms address numbers and seldom processes.

The second C pertains to ‘certainty’. One should be able to understand the tax laws easily. The present rounds of DTC create a lot of uncertainty and we need to have a fixed approach that does not change. Hopefully, this DTC will bring an end to the uncertainty. This holds for all investment decisions—individuals would like to be certain that if they go for an EEE scheme today, it would not become taxable later. A corporate would like to have a clear vision of, say, five years to take informed decisions.

The first E stands for ‘equity’. Is the tax code equitable? The answer is yes. The rates are progressive, though the critic will argue that compared to DTC1 the rich are better off than the less rich. By continuing with the EEE schemes and housing benefits, the code does support the middle class too and should be commended. In a country that has no social security system, such benefits are required so that people can fend for themselves in old age.

The second E is ‘efficiency’. The cost of administering the tax collection process should not be disproportionate to the amount collected. If tax collection is simplified, then the cost can be reduced, too. Today, the paperwork that has to be maintained by each individual/company is considerable and easing the system will save a lot of time for tax payers. The government has made life easy with tax returns processes being given online facilities, which should be widened to lower costs for the tax payer.

DTC is in general conformity with the basic 2C2E tenets and only needs to be tweaked in certain places. To these four traditional goals we need to add two more tenets that are germane to all economies: 2Is. DTC should specify the sectors that are to be defined as priority so that ‘incentives’ may be provided—exports, infrastructure and housing could be such sectors for the next 10 years. Accordingly, tax rules could evolve in various forms to provide the necessary incentives along the way so that entrepreneurs or investors looking to the future can benefit through tax breaks and simultaneously contribute to the national cause.

The second ‘I’, which is critical, is ‘inflation’ adjustment. This holds for individuals where all taxable income should be adjusted for annual inflation to arrive at the initial taxable income.

This way, the government can provide an inflation buffer and need not keep tinkering with the tax rates as conditions change in the country.

Drawing a tax code that satisfies payers, critics and economists is a challenge, and the code in its current form is well-balanced. While theoretically one can fi