Democrazy and other taxes

Lunch with BS: Parathasarathy Shome


One of the world's top tax experts explains the natural ceiling to the pace of India's tax reforms.

He’s won the Brazilian equivalent of a knighthood for his work on reforming that country’s tax system which was, in many ways, as complex as the one we have in India. As part of the IMF for over 15 years, he’s worked on reforming taxes in most Latin American countries and his work on calculating tax evasion under VAT a decade ago became popular enough to be called the Shome Index. Yet, the major tax reforms we’ve seen in the country so far have been seen as someone else’s baby — Dr Raja Chelliah first and then Dr Vijay Kelkar. So has the finance minister’s advisor on tax policy met his match in the Indian taxman, asks Business Standard.

That’s an unfair question, says Parthasarathy Shome, as we settle down at the capital’s tony sea-food restaurant Ploof and order some sea-bass for him and tuna for me. The wine looks tempting but we’ve both got meetings, so it’s sweet lime soda for me and neither-salt-nor-sweet for him. We’ve got our timings mixed up, so the table upstairs is not possible as there’s a kitty party going on upstairs. What’s a kitty party, Shome asks to my utter surprise. Academics!

It’s unfair, Shome resumes, to compare the changes he made in tax policy in not just Brazil but all over Latin America since those countries were always more market-oriented, they didn’t seek to fine-tune every tax policy in the manner we do. The government here, Shome says, is a lot more paternalistic, and so wants to ensure no one gets hurt by changes in policy (“you tend to recognise every distress you cause”), so changing tax policy is inherently different. In no other country, not even in Bangladesh, where he helped restructure tax policy, has Shome seen the tax authorities pay so much attention to petitions made by various associations/lobby groups. “Democrazy” is the term he has for it.

That said, Shome says the government has made major reductions (81) in exemptions this year, including changes in depreciation and investment allowances, and the one removing tax exemptions on non-religious charities was a difficult bullet to bite. But isn’t that too slow and, in any case, what’s the point of reducing exemptions, I ask, if new ones such as the hilly areas-ones in Uttaranchal and the ones for SEZs are going to be added on?

Shome gets diplomatic here, and argues structural difficulties. Once these incentives were announced, he says, a lot of people have begun shifting/organising their production facilities to take advantage of them, and so it becomes difficult to end the exemptions quickly.

The reply I get on why the FM hasn’t imposed a service tax on lawyers (hint, hint!) when he’s levying it in other areas is equally incomprehensible. Lawyers, like journalists, Shome adds to disarm me, are a heterogeneous lot, as are the people who employ their services, and so it is difficult to levy a tax on them as fixing a threshold level for them is difficult — but in the long run, he agrees, everyone has to be in the net.

Shome says the finance minister is of the view exemptions have to go, and I sense that’s all the reply I’m going to get on the matter. He gets back to the larger philosophical theme of removing tax exemptions and says a large part of them are in fact a response to an inverted duty structure, and so cannot go till this is fixed. By way of example, he offers vanaspati. Thanks to the policy of having higher import duty for farm products, you can, for instance, import vanaspati at a lower rate than you can palmolein, which is an input — so you have to find some way to “protect” vanaspati for no real fault of its own.

But why not just go in for a flat import/excise duty instead of the finance minister playing favourites and deciding what the duty will be for shoes that retail at under Rs 250 with a different one for those between Rs 250 and Rs 650? Didn’t he recommend it? Everything was considered, he says, but let’s think this through. Let’s say the revenue-neutral rate is 12 per cent — since there are goods taxed at 4 and 8 per cent as well, what this means is that various goods will have to be moved to a higher rate. Similarly, any change in import duties (even the move to a flat rate) will dramatically alter the effective protection for each industry. How do you just get industry to transit to this in a short time, he asks.

How did they do it in Latin America, I ask, and has he become a “realist” now, succumbing to all the usual explanations given by people who want to preserve the status quo? Apart from the fact that Latin America didn’t have this huge baggage of exemptions to clear, an additional issue is that the industrial bases there were a lot less diverse in comparison — so there was a lot less industry that got hit in Latin America.

And, yes, he has become a lot more realistic he says. But he’s always been realistic, he adds, recounting that when he was working the tax policy report for the 9th Plan, the Planning Commission’s then Deputy Chairman KC Pant said he’d expected a more “pure” report — that is, he didn’t want Shome to tailor the road map based on the possible problems in executing it.

So, the exemption raj cannot be unraveled, I ask dejectedly. No, Shome is reassuring, about a third of the quantum of exemptions the Budget talks of (Rs 158,000 crore) can be removed provided the government comes out with focused policies to deal with such industries — that involves retraining and this has been done in Latin America. It doesn’t help, he adds, that setting up and exiting businesses in India is also a lengthy and tortuous process — another reason for going a bit slow.

How does he respond to the perception that he’s the man responsible for the slew of bad taxes the finance minister has introduced — the cash withdrawal tax, the fringe benefit tax, the securities transaction tax (STT)? Shome laughs, and mentions the trails the taxman has uncovered due to the cash withdrawal tax. He mentions a paper of his a decade ago where he concluded a financial transaction tax was not a great idea, but seeing the success of it in raising revenue in Brazil, he was persuaded to change his mind provided it was low enough (as the STT is) to not distort things. On the FBT, he points out without absolving himself, others have recommended the same.

Perhaps, I think, as I walk Shome to his car, the late Raj Krishna also included the pace of change when he coined the phrase “Hindu rate of growth”.