Thu, Nov 11, 2004 - Page 9 News List

Higher taxes can help fuel growth

Everyone focuses on bringing down tax rates in order to help business and achieve economic growth. But tax rates that are too low lead to a different set of problems

By Amar Bhide

Excessive taxation can dull incentives and hinder growth. But too little taxation can do the same. Governments with meager tax revenues can't provide basic public goods. Worse yet, low tax revenues in poor countries often result from defects in tax collection systems (rather than low tax rates) that also promote unproductive enterprise.

India illustrates the importance of a well-designed tax system. In Bangalore, high-tech companies have built world-class campuses replete with manicured lawns and high-speed data communication networks. Outside these campuses, however, lie open sewers, uncollected garbage, and roads in acute disrepair. Whereas technology companies instantaneously transmit terabytes of data to remote continents, local transport proceeds at an almost medieval pace.

As a result, businesses in Bangalore run their own bus services, contract with private suppliers for drinking water, and install generators to protect themselves from interruptions in electricity supply. The state can't fix the shambles because it is broke. India's government debt exceeds 70 percent of GDP, so more than half its tax receipts go to paying interest.

But the debt isn't because of excessive spending in the past. India's government expenditures amount to about 15 percent of GDP, compared to an average of around 40 percent of GDP in the OECD. Rather, India's financial difficulties stem from a badly designed and administered tax system. Rates and rules for personal and corporate income taxes appear reasonable by international standards. Nonetheless, India's government collects income taxes amounting to only about 3.7 percent of GDP, about half that in South Korea and the other Asian tigers.

Agriculture in India accounts for about a quarter of GDP, but even wealthy farmers don't pay taxes. Export-oriented companies in the software and other industries enjoy tax holidays on their profits, although their employees do pay taxes on their personal incomes. Despite reasonable rates, tax evasion is widespread.

Cheating occurs because the government hasn't invested in personnel or in the systems to detect tax evaders, who rarely face jail time and can often bribe their way out of trouble when they do get caught. More subtly, the evasion of "direct" taxes on incomes and profits reflects the mess in the system of "indirect" taxes levied on production and consumption.

Excise taxes account for over 60 percent of India's indirect taxes, which in turn represent the same proportion of its total tax receipts. The basic excise tax has been fixed at 16 percent of the value of a firm's output. Then there are a variety of concessions, exemptions, and surcharges. For instance a "concessionary duty rate" of 8 percent is levied on categories like food products, matches, cotton yarn, and computers.

An additional "special excise duty" (SED) of 8 percent is levied on products that include polyester filament, cars, air conditioners and tires. An "additional excise duty" (AED, not to be confused with the SED) is levied on "goods of special importance."

Exemptions from excise taxes are numerous and complex, including businesses with total annual revenues of less than 10 million rupees and firms located in certain troubled or backward areas. Overall, the exemptions fall under 70 broad categories, subdivided into 259 entries, 52 conditions, and 7 lists, each containing numerous items.

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