07 Sep

Budgeting, Fiscal Policy & Taxation (DAMP)

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Contents

• Enumerate the major tax reforms introduced in India in the recent times. Do you think that India should move towards a Direct Tax Code? Examine.
• Do you think that multi-year budgeting is the need of the hour in India? Critically examine the statement.

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07-08-2023

Q: Enumerate the major tax reforms introduced in India in the recent times. Do you think that India should move towards a Direct Tax Code? Examine. (15 Marks, 250 Words)

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Answer :

The Government is committed to providing a hassle-free direct tax environment with moderate tax rates and ease of compliance to the taxpayers and to stimulate growth by reforming the direct taxes system. Such reforms bring clarity and certainty to investors, leading to better economic growth. Investments into the country increase leading to higher GDP levels.

Major tax reforms in recent times:

• Indirect taxes reforms: The integration of State and Central indirect taxes in the GST which replaced various indirect taxes like VAT, service tax, excise duty, abolishing entry tax and Central Sales Tax (CST) in the process.
• Reduction in the corporate tax rate for all existing domestic companies: The government introduced the Taxation Laws (Amendment) Ordinance 2019, offering a reduced tax rate of 22% to existing domestic companies without exemptions or incentives, along with the exemption from Minimum Alternate Tax (MAT).
• The incentive for new manufacturing domestic companies: The Taxation Laws (Amendment) Ordinance 2019 reduced the tax rate to 15% for new manufacturing domestic companies that do not have avail of any specified exemption or incentive, aiming to attract investment.
• Reduction in MAT rate: To provide relief to the companies which continue to avail exemption/deduction and pay tax under MAT, the rate of MAT has also been reduced from 18.5% to 15%.
• New Income Tax slabs: Union Budget 2023, introduced 6 tax slabs by replacing the earlier four tax slabs to give tax relief to income taxpayers and broaden the tax base.

Need for Direct Tax Code:

• The Income Tax Act, with around 700 sections since 1961, is outdated, complex, and finding difficult to align with today’s economic and corporate landscape.
• The Vodafone case, in which the government lost in the Supreme Court, is a classic example of the IT Act’s lack of flexibility.
• The Income-Tax Act, 1961, was drafted more than 50 years ago and it needs to be redrafted to meet new models of business (e.g., international businesses, digital businesses etc.)
• To align taxing regime with evolving methods of income calculation based on the objectives of economic policy.

Rationalization and simplification of Income Tax Structure:

• Consolidate tax brackets: Currently, numerous tax brackets/slabs with varying tax rates. Simplifying this by consolidating brackets can make it easier for taxpayers to understand and comply with the tax system.

• Eliminate or reduce deductions: Consider eliminating or reducing certain deductions as tax deductions can complicate the tax code and create opportunities for tax avoidance.
• Standardize exemptions and thresholds: Exemptions and thresholds can vary across income levels and categories, which adds complexity to the tax system. Standardizing these thresholds and exemptions can simplify calculations and reduce confusion.
• Increase transparency and taxpayer education: Improving the transparency of the tax system and providing educational resources can help taxpayers better understand their obligations and navigate the tax code. This can lead to increased compliance and reduce errors.
• Use technology: Embrace technological solutions to automate tax processes, enhance efficiency, and reduce administrative burdens. Digital tools and online platforms can simplify tax filing and reduce the likelihood of errors.
• Reducing tax litigation: Tendency of tax officials to initiate an action without the necessary justification or assessment is reflected from low success rate of appeals (~30%).
  • Protracted tax litigation in India has not only put a burden on Indian judiciary but has also cost the government exchequer.
• Clarity in cross border transactions: Till now, source rule of taxation for non-residents was linked to physical presence (permanent establishment) which has led to protracted litigation, base erosion and profit shifting.

Taxation plays a vital role in economic and social development beyond revenue generation. While improvements have been made in tax administration, India still faces challenges in mobilizing higher tax revenue. Further reforms, such as the Direct Tax Code, are necessary to address compliance issues.

03-08-2023

Q: Do you think that multi-year budgeting is the need of the hour in India? Critically examine the statement. (15 Marks, 250 Words)

Answer :

Multi-year budgeting is defined as the development and formal adoption of expenditure and revenue document that spans two or more years.

Currently, GoI adopted annual budgets present the revenue and expenditure projections for twelve months only. This approach requires the government to plan, approve, and execute their budgetary plans on a yearly basis, typically aligning with the government’s fiscal year.

Advantages of Multi-Year Budgeting over Single-Year Budgeting:

• Limited long-term planning: Single-year budgeting restricts comprehensive long-term planning, hindering strategic initiatives and infrastructure development.
• Multi-year budgeting allows for a long-term vision and projected expenditure, enabling better long-term planning and development.
• Inefficient resource allocation: Yearly budgeting can lead to suboptimal allocation of resources, focusing on short-term priorities and potentially neglecting critical sectors and long-term investments.
• Multi-year budgets enable efficient allocation of public resources by aligning current and future budgets, ensuring optimal resource distribution.
• Lack of stability: Single-year budgets create instability in government programs and policies, making it challenging to achieve consistent, sustained development and effectively address complex challenges.
• A multi-year budget provides stability and continuity by providing estimates for forthcoming years, allowing for better program planning and execution.
• Limited fiscal discipline: The annual budgeting process may lead to a myopic focus on short-term goals, reducing accountability and hindering efforts towards fiscal discipline and efficient use of public funds.
• Multi-year budget reinforces fiscal discipline by aligning expenditure commitments with available resources and generating fiscal outcomes in different economic conditions.
• Incomplete evaluation of outcomes: Single-year budgeting makes it difficult to assess the long-term impact of policies and programs, hindering the evaluation of their effectiveness and the implementation of necessary adjustments.
• Multi-year budget facilitates a comprehensive analysis of schemes and programs, enabling better evaluation of outcomes and informed decision-making.

However, there are various challenges associated with adopting a multi-year budget such as the difficulty in forecasting revenue and expenditure for multiple years, administrative capacity to monitor and implement, lack of flexibility for unseen expenditures due to certain emergencies etc.

Therefore, it is important to address these challenges before multi-year budgeting is implemented. Also, it can be adopted on a gradual basis starting with a single ministry/department to analyze the changes better.