Let's Talk Tax Collection and Spending!!

  

Tax collection and spending are two of the most fundamental tasks for any State and is as old as civilization. It represents one of the most direct forms of coercive power of the State. From ancient monarchs to modern democracies, every citizen has accepted the fact that taxes are the only constants after life and death! In a well-meaning State apparatus, expectation is that the state would establish systems to collect and spend the Tax that would give a sense of justice/equality for majority of citizens. If the state is not efficient in either or both fronts, it ends up creating resentment in everyone.

 As we move towards more modern form of governance, there are certain parameters to evaluate a tax collection system -

• Tax Type - There are two broad categories - Direct (tax on income) and Indirect (tax on Spending).  Income Tax and corporate Tax falls under Direct Tax Umbrella while GST, Customs duty etc. would fall under later.

• Tax Input Base - How much of your population you are covering under tax. Ideally, a broader tax base is considered fair.

• Tax Rates - What are the rates you are charging. Golden rule being rates should be lower and uncomplicated to encourage voluntary tax payment by citizens and also to encourage them to work on prosperity.

• Tax Ease - The idea is to keep least complex rule structure so that Taxman does not get power to interpret the rules at will and harasses citizens for personal or state gains.

• Tax to GDP - This is a controversial topic, and your answer may depend on your school of economics. While one school gives a rather misplaced importance to Tax to GDP ratio, other one (and rightly so) believes that GDP growth should be the aim and Tax growth follows without targeting a specific Tax-GDP ratio.

•  Tax Spending - Like we should have a broader tax input base; we need to also have a broad tax output base. The State should spend majority of tax money on public goods that impact broader citizens including taxpayers. There should not be concentrated expenditure on a particular stratum.  

• Tax Layering - What's the layer at the Tax is charged and spent - Centre, State and local government. 

Expectation from every ideal system is that it takes above parameters in consideration and do setup in a way that would encourage a citizen to participate in wealth creation with minimum roadblocks in terms of ease of doing business.

Now, before moving further, let's take a look at below details which give a broad level income and expenditure allocation in India at Centre (Union), state and local body level per latest data.

Income and Spending Data of Indian State

Key Problem Areas 

While we have certainly made gradual reforms in these systems, we can still observe some key problem areas - 

• Unnecessarily complex tax systems both in Direct and Indirect taxes.
• Very low participation in Direct Income tax resulting very high burden on very few.
• Very concentrated direct spending on small strata of citizens.
• Very high "Run the Government" spending - Salaries and pensions of government employees.
• Very high briberies/kickbacks though government contracting systems resulting in lack of service and quality (It's a fact and not backed by data for obvious reasons).
• Very high number of population dependent on subsidies and other government facilities.
• Overall, major portion of government spending is to simply keep the lights on for majority of citizens while either pushing a small subset to pay taxes or borrowing for future. 
• This is resulting into lack of incentive for anyone in the ecosystem to do honest effort in contributing future GDP growth.

Premise for Solution

People are honest. People respond to incentives.  We need systems that would provide incentives to people to do right things.

There is a lack of incentive/motivation for a person to pay direct taxes as India's public goods system is weak at best and broken at worst. On the contrary, if a person can, she may prefer migrating out of India where she may be able to keep a better chunk of earnings for herself and may also get a better bang for her buck in taxes. We need to create a better incentive system for a citizen paying Direct tax.

There is a lack of incentive for a corporation to pay more to pay corporate tax. 

There is a lack of incentive for an honest merchant/corporation paying GST. We need to create an incentive system in GST and should try to make this as primary source of Income for government.

Finally, there is lack of incentive for a government official to be honest. Here, honesty simply means doing her job without taking a kickback on a transaction. At the same time, there is a lack of incentive for a government contractor to execute a contract in good faith as she has to set aside money for bribes/kickbacks. We need an incentive system for Government employees and contractors given India is spending a major part of its budget on Salaries and Capital expenditure.

Western countries had a runway of 200+ years to create these systems, and China shortened the runway to 30 years by primarily taking away human liberties (with other additional steps). India does not have a 200-year runway, neither can she follow the undemocratic model of China. The models followed by other Asian tigers simply don't fit here due to sheer size. So, India needs to think out of the box to shorten the runway.

As a first step, in principle, we need to acknowledge that we are two financial countries within India -roughly the top 10 % and remaining 90 %. There is no shame in officially acknowledging that we cannot have a uniform financial system which will fit 150 billion people at the same time and still grow at a competitive rate. This problem is very unique to India. We need to acknowledge that we will have a single political system, but our financial system needs to simultaneously cater to the incentives of top 10 % and remaining 90 % in a way that the top 10 % bracket keeps expanding and 90 % bracket keeps shrinking over next 50 years.

Path Forward 

These are high level out of the box ideas. Would need a lot of churning and refining to become a policy.

Create following soft but mutually exclusive categories of citizens -

• Contributor - A person can enter this category if her LTD (Life to date) Direct tax contribution is more than a certain amount (say 50 Lakh). Note the amount is "Life to Date" and so once one enters this category, she will remain here for life. This is category for an individual and not for a family.
• Aspirant - This is every other person whose LTD direct tax contribution is less than 50 lakhs and aspires to go to Contributor category. Every Aspirant may have a choice of paying a lump sum Tax of 50 lakh Rupees any day and moving to Contributor category for life.
• Administrator - Anyone who is a government employee (On payroll or pension).
• Retiree - Every Aspirant who could not enter to a Contributor category and has passed the working age.

       Direct Tax Structure and Incentives 

• Create Direct tax structure with simple base rate. Something like no direct Tax for income up to 20 LPA. A flat 20 % rate for income above this limit. Once a person reaches contributor category, she will get some special privileges in public goods. Some ideas are - Discounted prices or priority seats at hospitals/ Education Institutes/Trains, discounted property tax and so on. Even Markets/private players may want to direct certain schemes towards a Contributor. 

• Administrator category will have zero tax. Also, while allocating government budget, an additional part of that ministry's expenses (say 10%) will be directly allocated as "Annual Bonus" for employees in that department and (say 10%) to contribute to the pension fund.  For Non capex departments like Police, judiciary etc. a separate provision can be made for this bonus amount. Idea is to replace bribery/kickback with an official incentive. This needs to be backed by a transparent and effectible HR system and Contract system within government. Once this comes into effect, bribery of any kind will be a non bailable offence with harsh punishments (Again, this would need a robust infrastructure of judiciary and auditing).

       Corporate Tax 

• Fix Corporate tax rates for a very long duration. Corporations can get a discount on corporate tax when they employ say more than 10 % of their workforce from Contributor category. This will act as additional incentive for contributors as well.

       GST 

• GST should become primary source of income for government in future.
• Keep a single slab for GST which is very low.
• Bring everything including petroleum and so-called sin goods under GST and under single slab. Keep absolutely no exception as exceptions create opportunities for agency to harass taxpayer and get bribes.
• Effective and timely Input Tax Credit without harassment.

In conclusion, India needs to make focused efforts towards broadening its tax base and to create a fair system for collecting and spending of taxes in a way to priorities building the invisible infrastructure for the 'Haves' while trying to keep lights on for the "Have Nots". This will need some out of box thinking to provide right incentive for everyone in ecosystem to increase everyone's stakes in India's growth story. 

Food for Thought:

Cantillon Effect:  In simple terms, this effect states that new money entering in system does not reach in equal proportion to everyone. Certain people and corporations are always the early beneficiaries of new money and by the time it trickles down the pyramid through markets, very small portion reaches there and that too in a devaluated form due to inflation caused by time delay.

It will be interesting to study this trickledown effect of India's GDP purely though market forces in terms of both proportion as well as time delay. In other words, if purely left to markets, if a value of Rs. 100 is created in say, Jan-25, what portion of that particular value will trickle down and by what date? 

Among other things, is the uneven government spending by a so-called socialist state of India is a bad effort at a compensating response for the Cantillon effect?

Further Reads from Experts -  

• Ajay Shah and Amit Varma, How to Fix Our GST Episode 121, Everything is Everything Podcast.
• Ajay Shah and Amit Varma, The Invisible Infrastructure Episode 82, Everything is Everything Podcast.