India’s economy needs a boost: A reform wish list

Despite the slowdown in China, the fall in commodity prices, and the continuing economic stagnation in most of the Western world, the Indian economy has managed to stay on a growth path of around 7 per cent. To maintain and even accelerate growth further, some bold steps are needed. The forthcoming budget could be a good occasion to modify the tax rates. The package of measures announced under the ‘Start-up India’ scheme is a welcome step. But much more needs to be done on reforms.

Advantage India

India offers many attractions for foreign and domestic business. These include a large expanding domestic market, a large pool of labour and professionals, and a good location across international trade routes. However, the business process environment, the infrastructure, logistics, and the complicated taxation and legal framework pose challenges for business. The government has focused on improving the ease of doing business ranking (already improved from 134 in 2014 to 130 in 2015), which is to be welcomed. However, other problem areas need to be tackled vigorously if the true potential of India’s economy is to be realized. This is particularly true in manufacturing and trade in goods in which India is lagging behind China, and the “Make in India” effort.

Reforming Taxation System

The taxation system needs to be streamlined and simplified. The direct taxes code should result in a simplified, transparent, predictable and rational framework for taxation. Taxation should be seen as an instrument for economic growth, not merely a means of raising revenue for the government. India’s taxation system is a maze that makes compliance difficult, provides unnecessary avenues for disputes, and creates opportunities for corrupt practices. The menace of arbitrary and retrospective taxation has discouraged investors and business. The burden of tax compliance is especially heavy on small businesses and start-ups.

Corporate tax rates for Indian and foreign companies are far too high compared to rival economies in the Asian region. When the competition for business and investment is becoming more intense, our tax rates must be competitive. Most Asian economies have reduced or are reducing corporate income tax rates to around 20%. India should also reduce corporate income tax rates from the present 30%.for Indian and 40 % for foreign companies. The potential loss in revenue would be covered by the resulting expansion in business activity.

The capital gains tax system also needs reforms. The present provision that exempts capital gains from sales of listed shares traded via the stock exchanges and held for over one year needs to be extended to sales of any equity shares. This will stimulate investment and FDI in the economy, and give a boost to start ups. It will make it unnecessary to structure investments through countries such as Mauritius and be a big attraction for investment. The provisions for capital gains on sale of immovable property need to be liberalized. For example, the Section 54 EC on exemptions from capital gains tax should be liberalized to allow exemption of investment in equity markets for at least three years rather than only in some designated bonds, with the limit raised to Rs 1 crores as against the present limit of Rs 50 lakhs. This will reduce the generation of unaccounted money, and stimulate the property markets and the equity markets.

On indirect taxes, the GST should be rolled out at the earliest. The customs duties should be rationalized, with only three levels of tariffs, for raw materials, intermediate goods, and finished goods. Customs facilitation and electronic processing should be promoted further to bring down transaction costs and improve efficiency. The norms, standards and systems followed by APEC countries for customs tariffs and processes provide a good model for India to emulate.

The personal income tax rates are generally reasonable compared to Asian countries. However, the issue of tax on agricultural income which accounts for a large part of GDP needs to be addressed fairly. While small and marginal farmers need relief, agricultural income beyond a certain limit should be subject to income tax.

Subsidy Issues

There are major issues related to subsidies on food, fertilizers and kerosene that need to be addressed. The government has so far managed to bring down the subsidy burden from 2.5 % of GDP in 2012-13 to 1.6 % of GDP in 2015-16. Instead of interfering with market prices of subsidized products, the direct benefit system may be more effective in providing relief to poor farmers and consumers, and avoiding leakages and diversion of benefits. This will also remove the difficulty that India is facing in the WTO on the question of agricultural subsidies. It is true that small farmers across the country are unable to make a living. This should be addressed through encouraging them to go in for production contracts with product buying entities, which could help boost productivity by providing better practices, inputs, and technology. If necessary, a direct benefits scheme could help marginal farmers, together with debt restructuring linked to production contracts.

In the energy sector, there is a temporary relief due to the fall in oil prices. But this will not last long and there is no room for complacency. India needs to move away from fossil fuels including coal, oil and gas to renewables such as hydro, wind and solar energy. This should be encouraged by incentives such as accelerated depreciation, tax deductions, and preferential energy tariffs. If the true cost of carbon emissions and power distribution networks is included, energy from coal and gas fired plants would go up. The present system gives coal an unfair advantage and a free pass from the costs of environmental damage.

(Dr Bhaskar Balakrishnan is a former ambassador of India and writes on foreign policy and economic issues)

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