Tax consumption, not income

BHARAT JHUNJHUNWALA

Finance Minister Yashwant Sinha believes in increasing income tax because that is more equitable. Such equality, however, would have been secured in incomes, not consumption. Inequity in incomes is bad only if used for consumption. It is good if it is used for investment. Sinha must tax luxury consumption, instead of incomes. It does not matter to the poor if the rich have huge bank balances with which they put up factories. They are hurt by vulgar consumption. Sinha should lower income tax and raise excise and customs duties. That will be both equitous as well as pro-growth.

The country has to increase investment while maintaining equity. Investment depends upon the simplicity with which the government collects its taxes. A complicated tax collection system leads to the generation of more black money and more consumption. The choice of tax, therefore, should be made on the three criteria of equity, investment and simplicity.

Income tax hits investment in may ways. One, the upper and middle classes who pay income tax are also the ones who save and make most investments. Less income means less investments. Two, it encourages consumption. A tax payer prefers to make a foreign vacation and claim it as a business expenditure because he saves tax on the money spent. He pays only Rs 70,000 for an expenditure of Rs 1 lakh. Three, it encourages No 2 production. Any Delhi shopper will know that shopkeepers ask for payment of sales tax ‘‘if you want a bill’’. No 2 production leads to further evasion of income tax, excise duty and sales tax. Four, the process of collection of income tax is complicated with individual assessments being necessary. Income tax is one easy route to the transfer of money into the hands of corrupt bureaucracy who largely invest in real estate and gold. It is investment unfriendly.

Excise and customs are iniquitous. They are collected from every consumer, including the poor. The little stamp affixed on the match box is a proof of payment of excise duty. But these taxes are investment friendly. Their incidence falls on those who buy the cars and chocolates. A Sethji who lives frugally pays little in the form of these taxes. They are also simple. If the government wanted to collect, say, a tax of Rs 1 lakh each from the buyers of cars it would have to make two lakh individual assessments if it chose the route of income tax. It would collect the same from about 10 producers and 10 parts if it imposed excise or customs duties for the same.

The problem with Sinha’s approach is that though equitable, income tax is consumption-friendly and complicated. The share of income tax in total tax revenues has increased from 28.4 per cent in 1997-98 to 35.8 per cent in 2000-01 under Singh’s leadership.

It is possible to impose high duties on cars and chocolates while maintaining them at low levels on match boxes and inexpensive paper used for copy books. Such excise duties would be equitous. Those rich who buy cars and chocolates will pay the taxes. The difference is that this equity would be at the point of consumption, not income. The rich who earn and consume will pay more taxes, those who earn and invest will pay less.

We need to celebrate wealth while decrying consumption. Less consumption is socially cohesive as well. The wealth of the Sethji does not hurt the poor if there is no vulgar display. In fact, if Sethji puts up more factories, it leads to more jobs. Iniquitous incomes in the hands of the investor is actually poor-friendly.

Individual income tax contributes only Rs 12,000 crore to the revenues, the bulk Rs 40,000 crore comes from corporation tax. Excise and customs contribute Rs 94,000 crore. Of this, let us say, one-half is imposed on ‘luxury’ goods. In the first instance, individual income tax must be scrapped. The loss of Rs 12,000 crore in revenue can be easily made up by a 25 per cent increase in excise and customs duties on the luxury goods.

One objection to this suggestion would be that high customs duties would provide undue protection to the Indian manufacturers. This is a false argument. What matters from the standpoint of promoting competition is the difference between the customs and excise duties, not their level. The competition between imports and domestic production remains the same as long as the rates of customs and excise duties are similar. Sinha thinks only of equity in incomes. He should think of equity in consumption, instead. Let us chart a different path of our own.