India's tax story: A success?

All those who have been in favour of India's economic reforms must feel vindicated by the spectacular performance on the tax front -- with a second year of about 40 per cent growth in direct tax collections. The logic of tax reform, especially direct taxes like income tax and corporation tax, was that moderate tax rates and wider coverage would yield more revenue than high rates on a narrow base, as used to exist.

Indeed, those old enough will remember that the worst phase of socialist taxation was in the early 1970s, when the maximum rate of income tax was 97.75 per cent.

That was an open invitation to people to evade taxes -- which they duly did. If you criticised such unrealistic tax rates, the socialists' response was that no one actually paid that rate of tax, so no damage was done. They did not ask why such a rate should be there, if no one paid it.

Reform began slowly till Rajiv Gandhi in 1985 got his finance minister (VP Singh) to slash the peak income tax rate to 50 per cent. The rate then began a slow creep back up, until Manmohan Singh in 1991 piloted more sustained tax reform, though the really drastic action was by P Chidambaram, who slashed the peak rate 10 years ago to 30 per cent.

With surcharges and cesses, it is now 34 per cent. The results are most gratifying. While the tax rates have fallen, collections in relation to GDP have gone up from less than 2 per cent of GDP when the reform began, to about 7 per cent now.

If anyone wants proof that people are more willing to pay taxes if the rates are reasonable, and if the tax collection machinery uses data bases intelligently to bring millions more into the tax net, here it is. All the leftists who have criticised the broad thrust of tax reforms should have the grace to admit that they were wrong, and that the reformers were right.

To be sure, the tax buoyancy of recent years has been helped by the general buoyancy in the economy (another product of reforms, but that is a larger story), and by the fact that corporate profits have been at record levels. Here too, the critics were wrong because they had argued that the "World Bank-IMF inspired" reforms of 1991 would lead to the de-industrialisation of India and the decimation of the corporate sector.

Instead, the delicensing programme, the slashing of import tariffs and the easing of controls have meant that the corporate sector has come into its own; even the manufacturing sector now contributes to the success story.

A progressive tax system (in which the rich pay more than the poor) is one in which direct taxes account for more revenue than indirect taxes (which are on goods and services). In that respect, India's period of supposedly extortionate tax rates produced a most undesirable result because the Centre's next direct tax revenue was barely a fifth of its net indirect tax revenue.

Reforms have changed that, and this year is a watershed in that direct tax revenue has finally caught up with indirect tax revenue; what the reformers have achieved is precisely the progressive tax system that the socialists wanted but failed to deliver.

The success of tax policy has made available the vast resources now being ploughed into the socialists' favourite spending programmes. If only the reformers could have their way here as well, to get the maximum bang for the taxpayer's buck instead of wasting government money on boondoggles, India's poor and uneducated would benefit much more from the government's spending than they do today.