Shibboleths of the ‘ideal’ tax system

Source: Business Standard   

Relevance: The old idea that direct taxes are “progressive needs a relook as all ideas and principles should be implemented as per a country’s requirements.

Synopsis:

The principle of focusing on direct taxes is worth questioning in the current era. This is an example of the mindless application of “universal” principles that have begun to fail even in the soils in which they were originally nurtured. Therefore, the focus should be on using a strategy that works best as per the country’s society and economy.

Background:
  • All the things that we took for granted in the 20th century have started to crumble under the weight of their own contradictions. 
  • Belief in free trade, globalisation, electoral democracy, capitalism, communism or Keynesian macroeconomics has never been lower. The principles underlying them have proved to be flawed and are not working.
    • As per Hegelian thesis, every proposition contains within it the seeds of its own destruction.
    • Marx’s predictions have failed primarily because they expected human and economic progress to move linearly. However, in reality, they moved in cycles as Hegel’s proposition or karma theory suggest.
Crumbling of traditional outlook and propositions:
  • Capitalism is under attack in Western Europe and America, and communism has collapsed in the regions of its dominance in the last century. 
  • One can be certain that authoritarian capitalism of the Chinese variety will also have a sell-by date.
  • The United States now believes that all companies must pay a minimum amount of tax (currently deemed to be around 15 percent) that most rich nations seem to agree with. 
    • Ideas are portrayed as universal only as long as they work for the US. The country supported capitalism and free markets when they saw benefit in them. However, now it has changed tack and wants to make sure that the capital which had flown out of the US to low-tax jurisdictions comes back.
  • The US preached the virtues of technology when it was the top dog. This enabled technology companies like google and facebook to become market leaders. 
    • Today, the US wants to rein these technology giants at home through antitrust suits. However, the US has no problems with tech colonisation elsewhere, as long as it serves US interests.

Considering this evolving and changing nature of traditional propositions, one can also question the two time-hallowed tax principles. 

Principle one – it is good to raise the tax-GDP ratio in general
  • This ratio is the result of not just tax policies, but levels of compliance and levels of economic activity achieved. It is a derivative number, and should not be a focus area for action. 
  • The focus should be on having a rate where compliance is maximised, and economic activity is least impeded. It is time we stopped obsessing over the wrong goals.
Principle Two – one must not raise too much from indirect taxes
  • The basis of this principle is the regressive nature of indirect taxes. As per the principle, focus should be on direct taxes which are “progressive.
  • The recent provisional data put out by the Office of the Controller General of Accounts showed that the Centre’s collection of indirect taxes exceeded collections from direct taxes in 2020-21. 
    • Due to this, many economists are expressing caution about regressive taxes overtaking progressive ones.
  • This reasoning is flawed in the Indian context for our goods and services tax (GST). It is actually progressive in nature, as less GST is imposed on basic goods and more on luxury goods.
  • Further, focusing purely on direct tax will allow the rural rich to escape the tax net due to a negatively taxed agriculture setup.
  • On the other hand, it is not always true that direct taxes have to be progressive. A state that levies a flat rate of income tax will be regressive. 
    • Therefore, we must understand that whether a tax rate is regressive or progressive depends not on the tax itself, but the rate structure.
Way Ahead:
  • In a diverse country like India, taxpayers and social security beneficiaries may come from different communities. Thus, the willingness to comply will always be low. Hence, a need for tax terrorism arises however this may induce high net worth individuals to move elsewhere. 
  • Therefore, indirect taxes are the right way to make people pay more taxes, without anybody worrying about who is paying them or benefiting from them. Bearable indirect taxes with near zero rates for wage-goods are the way to go for India.
  • With reference to Global Taxation, India should insist that actual tax flows from global companies must be monitored to check if the minimum tax proposal is beneficial to all or not.  
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