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Taxes: All that's foregone

Mar 2, 2007

The main objective of any tax system is to raise revenues to fund government expenditure. The amount of revenue raised is determined to a large extent by tax bases and tax rates. It is also a function of a range of measures - special tax rates, exemptions, deductions, rebates, deferrals and credits - that affect the level and distribution of tax. In an earlier article we had highlighted how the entire tax burden of the country (net tax 11.4% of GDP in FY06) befalls on a mere 1.5% of the country's population. The rest enjoy what we call deductions and exemptions that are nothing but 'tax expenditures' sponsored by the 'tax payers'. In this article, we dwell on this aspect of the budget that often becomes the bone of contention for the 20 m-odd taxpayers and a prospective vote garnering mechanism for the ruling party at the Centre.

When it comes to individual taxpayers, the basic exemptions offered to women, senior citizens and lower income groups are looked upon as social welfare measures and therefore attract very little opposition.

Tax expenditure on individual tax payers
Nature of incentive Amount foregone (Rs bn) Change
FY06 FY07  
Higher exemption limit for senior citizens 30 33 10.0%
Higher exemption limit for women 16 17 6.3%
Deduction on account of certain investments & payments 90 105 16.7%

Tax exemptions on corporate profits, however, draw much flak due to the inequity of the same amongst sectors. While profits of export oriented units (EOUs) and expenditure on research activities have received considerable fiscal support in recent years, given their relevance in economic development, the exemptions (by way of tax holiday) offered to special economic zones (SEZs) were seen as a device for enabling large corporations and developers acquire fertile land. It is also very disappointing to note that exemption towards donations (including donations to political parties) has multiplied two-fold in the last fiscal, adding very little output to the economy in the meanwhile!

Tax expenditure on corporate tax payers
Nature of incentive Amount foregone (Rs bn) Change
FY06 FY07  
Profits of EOUs 87 125 43.7%
Weighted deduction for scientific research 28 41 46.4%
Donations 38 87 128.9%
Profits of undertakings in SEZs 109 158 45.0%
Others 84 90 7.1%
Total 346 501 44.8%

The tax foregone on each tax concession claimed by the companies has been calculated by applying the corporate tax rate of 33.66% on the amount of each deduction.

Exemptions - 'Inclusive' enough?
A look at the broader picture leads us to comprehend that while the exemptions by way of social security measures for a meager 3% of the total tax collected, benefits to the corporate sector account for an astounding 47% proportion. In other words, the removal of such exemptions and deduction would automatically multiply the gross tax revenues by 1.5 times.

Quantum of total tax revenue foregone
Nature of incentive Amount foregone (Rs bn) Change % to gross tax collection
FY06 FY07 FY06 FY07
Corporate Income tax 346 501 45% 9.5 10.7
Personal Income tax 136 155 14% 3.7 3.3
Cooperative sector tax 16 - -100% 0.5 -
Excise duty 667 997 49% 18.2 21.3
Customs duty 1,277 1,237 -3% 34.8 26.4
Total 2,442 2,890 18% 66.7 61.7
Less: Export credit related 376 538 43% 10.3 11.5
Grand total 2,066 2,352 14% 56.4 50.2

While we do not wish to advocate any reformist views with regard to discarding of exemptions, what we wish to emphasise on is the viability and relevance of such tax expenditures in the current fiscal planning. This is to say that when dominance of agriculture and related activities in the FM's planned budget expenditure are seen as promoting 'inclusiveness' of the under-privileged, do the wealthy agriculturists not deserve 'inclusion' in the breed of taxpayers? The examples given in this direction could be myriad. But what deserves a detailed introspection is whether the wealthy are sponsoring the needy or vice versa?

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