Our tax system should go the ASEAN way

To meet a budget crunch, taxes on income, capital gains and dividends have gone up in the US, and may rise further. This has fed speculation that the Indian budget will follow suit. There is also speculation that Chidambaram will introduce an inheritance tax, as in the US.

Some Indian analysts think that soaking the rich will win votes in an election year, though there’s no evidence for this. Other analysts say a high tax on the super-rich will largely be evaded through trusts and other legal forms of tax avoidance, and will not fetch much revenue. The biggest tax evaders are small businessmen earning Rs 5-20 lakh per year, so the focus should be on bringing them into the tax net. A hefty tax on high incomes, it is argued, may disturb investors whom the government is trying to enthuse.

This debate misses a key question: what is our long term tax vision? Should our tax rates be aligned with those in ASEAN countries, or the US? I say we must go the ASEAN way. That means gradually cutting our taxes rates to ASEAN’s lower levels, not raising them (save maybe temporarily).

Budget problems in the US are totally different from those in India. The US has been badly hit by demographic change. Earlier, its baby-boom generation contributed more in taxes than it took out. But now the boomers are retiring, and will take out much more (through Medicare as well as Social Security) than the next generation will put in. Both George W Bush and Obama have greatly increased health entitlements. So, total US spending on three items — Social Security , Medicare and Medicaid (for the poor) — is projected to skyrocket from around 8 per cent of GDP today to 18 per cent by 2025. This is the crisis Obama has to tackle.

India, however, has excellent demographic prospects. The proportion of Indians in the working age group 15-60 will rise by up to 300 million over the next two decades. This means buoyant tax receipts. If economic reforms ensure that their productivity keeps rising, fast growth will add to the revenue boom. That’s exactly what happened in ASEAN’s boom years: a rising workforce and fast growth helped raise both living and social standards. This was growth with social justice. India should follow the same path.

Recall Chidambaram’s vision in his so-called dream budget of 1997. He said India should aim over time to align its tax rates with those in ASEAN countries. These were fellow-developing countries that had achieved miracle growth of 7 per cent for decades, and hence clearly had tax systems worth replicating. They were also competitors of India in export markets, so in a globalising world India needed to ensure its tax regime was competitive with ASEAN’s.

Singapore, the biggest ASEAN success, has a top income tax rate of 20 per cent (including dividends) and corporate tax rate of 17 per cent. It has no tax on wealth, inheritance or capital gains. In most other ASEAN countries there is no tax on wealth or inheritance. Both the peak income tax rate and corporate tax rate are around 25 per cent or less. Tax rates on capital gains vary from zero to 25 per cent.

The contrast with the US could not be greater. ASEAN countries aim to get tax revenue out of rapid GDP growth and improving demographics (more people in the workforce). They do not face the US problem of a doubling of welfare outgo on account of worsening demographics and slow growth. This is why ASEAN countries have a much friendlier tax regime, one that attracts people and capital, and thus ensures growth with social justice.

Thousands of Americans (including Facebook co-founder Eduardo Saverin) have migrated to Singapore and other tax-friendly places to avoid rising US taxes. French actor Gerard Depardieu has migrated from France to Russia, saying he wants to pay his fair share of taxes but finds the new 75 per cent rate confiscatory. The US has imposed an implicit “exit tax” on the assets of migrating citizens and green cards holders, to discourage their exit. This has no more hope of success than the Berlin Wall had earlier.

India clearly resembles ASEAN more than the US, and must avoid driving successful businessmen to Singapore. Our media devote much space to US problems and taxes, but that doesn’t mean India should take the US path.

If he desperately needs immediate revenue, Chidambaram can impose a temporary surcharge of 10 per cent on high incomes (as was done earlier in 2003). He can increase the Minimum Alternative Tax on corporations to 20 per cent. But he should combine that with a long-term pledge to move towards ASEAN rates.

What do you think?