Consumption tax

For an equitable tax system

The country has to increase investment while maintaining equity. Investment, in turn, depends, among others, upon the simplicity with which the government collects taxes. A complicated tax collection system leads to generation of more black money and encourages consumption. The choice of tax, therefore, should be made on the three criteria of equity, investment and simplicity.

Income tax hits investment in many ways. One, the upper and middle classes who pay income tax are also the ones who save and make most investments. Less income in the hands of the upper classes, therefore, means less investment. Two, it encourages consumption. A businessman takes a foreign vacation and claims it as business expenditure because he saves tax on the money spent.

The increased expenditure of, say, Rs 1 lakh on the foreign trip, leads to lesser profits in the company and to lesser tax burden. The businessman effectively pays only Rs 70,000 for an expenditure of Rs 1 lakh. Three, it encourages generation of black money. Shopkeepers buy goods in black and sell them in black so that the income does not enter their books of account. Customers will know that shopkeepers ask for payment of sales tax ‘if you want a bill’.

Excise, customs and sales tax, on the other hand, are iniquitous. They are collected from every consumer, including the poor. The little stamp affixed on the match box is a proof of payment of excise duty by the poor. But these taxes are investment-friendly. Their incidence falls on those who consume.

A sethji living frugally pays little in the form of these taxes. These are also relatively simple to collect. If the government wanted to collect, say higher income tax, it would have to make thousands of individual assessments. It would collect the same amount from about 10 producers and 10 ports if it imposed excise or customs duties on expensive cars instead. However, excise and sales tax also lead to the generation of black money.

Manufacturers produce and sell goods without bringing them on to their books of account. They make payments for purchases in cash and get payment for sales in cash and evade paying excise and customs duties.

The government has to collect more taxes to cut the budget deficit. Imposing higher income tax hits investment, while imposing excise duty and sales tax hits equity and social stability. A possible solution to this predicament is to impose a progressive consumption tax.

The country’s population can be divided into three groups on the basis of high, middle and low incomes. Goods sold in the market can be classified according to the bulk of the purchasers. Items like air-conditioned cars, LCD TVs, swimming pool and foreign travel can be considered to be mostly consumed by high-income groups. These items can be taxed at high rates, say 50 per cent, or even more. Items like motorcycles, computers, refrigerators, washing machines and beauty parlours can be considered to be mostly purchased by middle-income group.

Progressive consumption tax
These can be taxed at middle rates, say 25 per cent. Items like match boxes, bicycles, bus travel and bread can be considered to be mostly purchased by the low-income group. These may be tax-free. Such a steeply progressive consumption tax would attain the objectives of investment and social justice.

The rich will be encouraged to invest more because they will pay fewer taxes if they abstain from consumption and invest their incomes. On the other hand, they will have to pay heavy taxes on luxury consumption. This will act as a disincentive to ostentatious consumption. The upper classes will be prodded in the right direction by both the carrot and the stick. The poor, on the other hand, will have to pay virtually no tax.

Consumption of electricity and water should also be taxed or priced in a progressive manner. Consumption of electricity upto 30 units per month may be free. Consumption between 30 to 1,000 units may be priced at, say Rs 5 per unit. Consumption above 1,000 units may be priced at Rs 15 per unit to provide a disincentive. High price of essential commodities for the rich will reduce their claims and enable greater supply to the poor.

The ambit of consumption tax should be enlarged to indirect consumption as well. People living in self-owned houses are consuming housing. This consumption must be taxed by imputing a notional rental value to the self-occupied house. A part, say 33 per cent, of perks obtained from companies and expenditures incurred in official government travel should also be considered consumption and taxed.

The government, unfortunately is moving in exactly the opposite direction of imposing a uniform goods and services tax (GST) on all items irrespective of the nature of the consumer. This move is wholly retrograde. It may be efficient from the standpoint of tax collection and economic growth but the loss in terms of social unrest will be huge.

The suggestion is that existing rates of excise and sales tax, or the proposed GST, must be classified according to the category of the consumer. Simultaneously, existing income tax should be made more progressive. Indian businessmen should be subjected to high taxes. These two measures will provide both social justice and economic growth.
We need to celebrate wealth while decrying consumption.

There could be an objection that high customs duties would provide undue protection to Indian manufacturers. This is a false argument. What matters is the difference between customs and excise duties, not their level. The competition between imports and domestic production remains the same as long as the rates of customs and excise duties are similar.

We must reverse our policy of reducing customs duties to global low rates. The current policy is that all countries should reduce customs duties in order to encourage free trade. It is thought that this will provide cheaper and better goods to consumers across the world. This is correct. However, we have to assess the damage done to the social fabric in the process of providing equal rates of taxes on goods consumed by the rich and poor.