Tax Reform in India

Nicholas Kaldor
Whether the political or .social urges which led to the recent reforms continue to prevail or not, I am
convinced that the Indian tax system could not be frozen still at the point which it has now reached. If an
effective tax structure is to be created, reform will have to be carried a great deal further; if on the other
hand political forces were to become dominant which would effectively bar this development, there would be
little point in preserving such a complicated system of taxation.
Among the new taxes the expenditure tax and the gift tax are so heavily riddled with loopholes and
exemptions that they bear only a superficial resemblance to the taxes whose introduction I originally recom-
mended.
Analogous criticisms can be made against the (rift-tax Act. which in its final legislative form is only
a pale shadow of what it was originally intended to he.
Even if these loopholes were plugged, the administration of the system will not become effective
until far-reaching reforms are introduced for checking tax evasion.
I fully maintain the view that with a system of direct taxation of the kind I suggested, the maximum
of rate of income-tax should not exceed 15 per cent, it should be evident, however, that, this system has by
no means been fully adopted; nothing has been done to tighten up business taxation, while the new taxes, owing
to the truncated form in which they have been adopted, will only produce a fraction of yield which they would have
produce otherwise.

A N effective system o f progressive
direct t a x a t i o n is v i t a l to the
s u r v i v a l o f democratic i n s t i t u t i o n s
in I n d i a . The need for this arises
not merely on financial grounds
to raise adequate resources for
purposes of accelerated economic
development but in order to b r i n g
about the degree of social cohesion
a n d co-operation t h a t is essential
for the successful f u n c t i o n i n g of a
democratic system. In a c o m m u -
n i t y where there is such a wide gap
between the position of a p r i v i l e g -
ed m i n o r i t y of well-to-do a n d the
vast m a j o r i t y w h o live i n dire
p o v e r t y social cohesion can o n l y
be achieved if economic inequality
is effectively lessened and the ten-
dency t o w a r d s increasing concen-
t r a t i o n of w e a l t h is effectively
counteracted. T h i s can only be
done t h r o u g h the i n s t r u m e n t of
t a x a t i o n . It is in any case i n e v i -
table t h a t heavy burdens should be
laid on the b r o a d masses of the
population, if I n d i a is to a t t a i n a
satisfactory rate of development in
the c o m i n g decades. I t w i l l not be
possible to c a r r y t h r o u g h this pro-
g r a m m e successfully w i t h the con-
sent a n d co-operation of the people
if the privileged m i n o r i t y of the
well-to-do are n o t made to bear
a f a i r share of t h i s burden. More-
over i n m a t t e r s o f t a x a t i o n , l i k e i n
the a d m i n i s t r a t i o n of the law, it
Substance of an address given to
the i n f o r m a l consultative com-
m i t t e e o f the P a r l i a m e n t i n N e w
D e l h i on December 16, 1058.
is not enough that justice should
be done it must also be seen to
be done. If o w i n g to defects in
the tax law, or in their adminis-
t r a t i o n , h i g h l y progressive taxes
on w e a l t h or income have no v i s i -
ble effect on the p r e v a i l i n g econo-
mic inequality, or in the standards
of l i v i n g of the rich, the mere
enactment of advanced tax legis-
lation w i l l prove fruitless.
A Fair Start
In the last few years I n d i a has
made a fair s t a r t towards creat-
i n g an effective system of progres-
sive t a x a t i o n w i t h the i n t r o d u c t i o n
of the new taxes on capital gains,
on wealth, on personal expenditure,
and on gifts. It has thus l a i d the
basis for a system w h i c h may
serve as a model to other democra-
cies, both developed and under-
developed. B u t it is no use b l i n k -
i n g the fact that, the reforms so
f a r introduced are, at best, a
beginning; that the legislation
of some of the new taxes is
seriously defective whilst the mea-
sures for their effective adminis-
t r a t i o n have not yet been provided;
a n d t h a t other and equally i m p o r t -
a n t reforms in the field of business
and company t a x a t i o n have not
been tackled at a l l . Unless some
of the recent legislation is amend-
ed in i m p o r t a n t respects, a n d u n -
less it is supplemented by legisla-
tion in other fields and by
f a r - r e a c h i n g reforms in the a d m i -
n i s t r a t i v e field, there is a serious
risk t h a t this noble attempt a t
195
creating an e g a l i t a r i a n democracy
w i l l end in failure.
Whether the p o l i t i c a l or social
urges w h i c h led to the. recent re-
forms continue to p r e v a i l or not, I
am convinced that the I n d i a n t a x
system could not be frozen s t i l l at
the point w h i c h it has now reached.
If an effective t a x structure is to be
created, r e f o r m w i l l have to be
carried a great deaf f u r t h e r ; if on
the other hand political forces were
to become d o m i n a n t w h i c h w o u l d
effectively bar this development,
there w o u l d be l i t t l e point in pre-
serving such a complicated system
of taxation.
A m o n g the new taxes the expen-
diture tax a n d the g i f t tax are so
heavily riddled w i t h loopholes a n d
exemptions t h a t they bear only a
.superficial resemblance to the taxes
whose i n t r o d u c t i o n I o r i g i n a l l y
recommended. Though the new
capital gains t a x represents a con-
siderable advance on the f o r m in
w h i c h it was o r i g i n a l l y enacted in
I n d i a , it s t i l l suffers f r o m serious
shortcomings w h i c h undermine the
basic purpose of personal income
t a x a t i o n of securing equality of
treatment between different tax
payers. The w e a l t h tax alone was
enacted in a f o r m t h a t is compara-
t i v e l y free f r o m loopholes, though
this too contains features that
could justifiably be criticised.
Defects of Expenditure-Tax
The most serious defect of the
Expenditure-tax A c t is that it
ties the l i a b i l i t y to this t a x to a
 January 1959
minimum income limit which
opens the door to endless m a n i p u l a -
tions a n d is b o u n d to m a k e the
t a x l a r g e l y ineffective i n practice.
E x p e n d i t u r e represents an a l t e r n a -
t i v e base to income f o r measuring
spending power or a b i l i t y to pay.
The difference is o n l y t h a t the
l a t t e r taxes savings a n d exempts
dis-savings, whereas the former
exempts savings a n d brings dis-
savings into charge. There
m u c h to be said { f o r a d m i n i s t r a -
t i v e a n d other reasons) f o r m a k i n g
use of b o t h principles of t a x a t i o n ,
a n d l e v y i n g some o f the taxation
on an income base, a n d some on
an expenditure base. B u t i t i s
essential, in this case, t h a t the
l i a b i l i t y to the one should n o t be
made dependent OP the extent of the
l i a b i l i t y t o the other. B y m a k i n g
the l i a b i l i t y to the expenditure t a x
dependent on the size of income, a
concession is made to savings
without making a corresponding
charge on dis-saving.
T h i s is f a r more serious t h a n it
m a y appear a t first s i g h t since i t
is a l w a y s open to a n y t a x payer to
m a k e his income smaller t h a n it
could be (even t h o u g h he m a y not
always be in the position to m a k e
i t l a r g e r ) . T h i s pro vision thus
makes it possible to a taxpayer to
telescope his income i n t o p a r t i c u l a r
years in w h i c h his spendings are kept
low, a n d to telescope his spending
i n t o those years i n w h i c h his i n -
come is kept l o w enough to entitle
h i m to exemption f r o m the expen-
diture t a x . I t i s therefore bound
to have a h i g h l y destructive effect
—one Is almost tempted to say
t h a t t h i s p a r t i c u l a r provision alone
makes the t a x a l i t t l e more t h a n a
show-piece.
I n addition, the Expenditure-tax
A c t contains a l o n g series of
exemptions of various kinds—such
as expenditure on marriages, on
medical expenses, election expenses,
the purchase of cottage i n d u s t r y
products, etc—which have no
counterpart in the income t a x laws
a n d w h i c h w i l l make i t very diffi-
cult to administer it effectively, I
do not w i s h to argue the m o r a l or
economic j u s t i f i c a t i o n f o r exempt-
i n g any p a r t i c u l a r f o r m o f person-
a l expenditure f r o m t a x a t i o n — a n y
one of these exemptions m a y have
something to be said f o r I t , either
on grounds of fairness or expedien-
cy. B u t it is surely inequitable to
axempt particular categories of
THE ECONOMIC WEEKLY ANNUAL
personal o u t l a y f r o m expenditure But if t h i s limitation is held to be
t a x a t i o n if these are n o t also ex- justified, on w h a t basis c a n one
empted f r o m income t a x a t i o n . differentiate between inter-vivos
g i f t s a n d g i f t s b y deed o f w i l l ?
F o r the g r e a t m a j o r i t y of people
income provides the sole source of There is a l o n g l i s t of exemptions
expenditure; t h e i r a b i l i t y to spend i n the present G i f t - t a x A c t w h i c h
is confined by income t a x a t i o n j u s t has no counter-part in the Estate-
as effectively as by expenditure d u t y A c t ; a n d the provisions of
t a x a t i o n . I f i t i s n o t justified t o t h a t A c t are so f r a m e d as to m a k e
reduce a man's l i a b i l i t y to income- It possible f o r an owner through
t a x o n account o f his h a v i n g the mere process of spreading the
is
exceptional expenses to bear on gifts over t i m e to reduce t h e i n c i -
illness or on w e d d i n g f o r example, dence of the g i f t t a x to a s m a l l
w h y is it justified to reduce his f r a c t i o n of t h a t of the estate duty,
l i a b i l i t y t o expenditure t a x ? W h y or even to a v o i d the t a x altogether.
should people whose source of As is well k n o w n , it was the i n t r o -
spending is c a p i t a l as w e l l as i n - duction of the estate d u t y w h i c h
come be more leniently treated led to the wholesale passing on of
t h a n people whose o n l y source of p r o p e r t y by means of inter-vivos
spending is the income w h i c h they g i f t s so as to avoid t h a t d u t y hence
earn? A n d ( b e a r i n g i n m i n d the the need f o r a g i f t tax. B u t the
h i g h exemption l i m i t t o expenditure present tax, b y f a i l i n g t o integrate
t a x and the l o w exemption l i m i t t o g i f t s over successive years f o r t a x
Income t a x ) w h y should the neces- purposes, a n d by g i v i n g a series of
sitous expenditures of large spend- exemption to g i f t s of p a r t i c u l a r
ers be so carefully looked after kinds ( i n c l u d i n g a large annual
when the necessitous expenditures exemption) entirely fails in this
of small and moderate spenders purpose.
are not? F r o m t h e point o f view o f
equality of treatment whatever These loopholes in the expendi-
concessions are made on grounds ture a n d the g i f t t a x legislation
of necessitous expenditure f o r the are bound to reduce the yield of
one t a x o u g h t to have t h e i r coun- these taxes to a s m a l l f r a c t i o n of
ter-part in the other t a x . w h a t they should have been w h i c h
in t u r n Is bound to create agita-
Gift Tax Equally Defective t i o n for t h e i r complete removal.
Opponents of these taxes are cer-
Analogous criticisms can be made t a i n t o ask, i f such complicated
against the G i f t - t a x A c t , w h i c h i n taxes y i e l d so l i t t l e , w h a t is the
its final legislative f o r m is only a point o f h a v i n g t h e m a t all?—ignor-
pale shadow o f w h a t i t was o r i - i n g the fact t h a t the l o w yield w i l l
g i n a l l y intended to be. The pur- be the v e r y consequence of the
pose of a g i f t t a x , l i k e t h a t of the loopholes a n d exemptions on the
estate duty, is to r e s t r i c t the free- introduction of w h i c h t h e y have
d o m of Individuals to pass on their insisted. In the absence of loop-
property r i g h t s to others, As the holes, the g i f t t a x a n d the estate
A m e r i c a n economist H e n r y Simons d u t y t a k e n together at the current
once said, the whole of private rate schedule, could be expected to
property, a n d the income derived y i e l d some 20-— 30 crores of rupees
f r o m i t , is a g i f t f r o m the com- a n n u a l l y . As it is, the combined
m u n i t y . I t i s only b y the w i l l o f yield w i l l a m o u n t to less t h a n one-
the community that particular fifth of this sum. The expenditure
i n d i v i d u a l s can enjoy the privileges tax, properly administered, a n d i n
o f ownership protected b y l a w a n d the absence of the present loop-
a d m i n i s t r a t i o n ; a n d the c o n s t a n t l y
holes, should y i e l d at least 15—20
e v o l v i n g p r o p e r t y laws define the crores of rupees at the current
actual n a t u r e o f the r i g h t s w h i c h schedule of rates, In its present
these privileges confer. Inherit- f o r m i t w i l l h a r d l y yield one-tenth
ance taxes are, in effect, a form o f t h i s sum.
of limitation on the privileges
conferred by ownership: they Incentive to Convert
allow an individual (subject t o Income into Capital Gains
various limits circumscribed by W i t h r e g a r d t o c a p i t a l gains the
l a w ) the u n f e t t e r e d enjoyment o f new legislation has the great ad-
his o w n property, b u t they do n o t vantage over the o l d one in that
a l l o w h i m t o pass o n h i s p r o p e r t y c a p i t a l gains are n o w integrated
unhindered t o the next generation. w i t h other f o r m s o f income f o r
106
THE ECONOMIC WEEKLY ANNUAL January, 1959

income t a x purposes. B u t t h e y are r a t e the same spending power, a n d reform m a y require a constitu-
not liable to Super-tax, w h i c h b o t h represent the same taxable t i o n a l amendment w h i c h , however,
means t h a t t h e y are only liable to capacity. The maintenance of the might well be carried w i t h the
a m a x i m u m rate of t a x of 27.5 h i g h m a r g i n a l rates o f income-tax support of the States, if the revenue
per cent, w h i l s t other kinds of thus serves neither the interests of resulting f r o m the extension of
unearned income are liable to a equity nor of revenue if it provides these taxes to agriculture is
m a x i m u m r a t e of 84 per cent.* the j u s t i f i c a t i o n for the continu- e a r m a r k e d to the States,
There is therefore s t i l l a v e r y con- ance of the differential t r e a t m e n t
Tax Evasion
siderable incentive f o r converting of capital gains or for the m a i n t e -
income i n t o capital gains, and nance of other equally serious E v e n if these loopholes were
thereby reduce the effective taxa- loopholes in income-tax legislation. plugged, the a d m i n i s t r a t i o n of the
t i o n of those w h o are in a position system w i l l n o t become effective
t o benefit f r o m i t t o w e l l below Elastic Definition of Expenses u n t i l f a r - r e a c h i n g reforms are i n -
the rates applicable to other t a x troduced f o r checking t a x evasion.
Of the l a t t e r the wide a n d
payors. Moreover, w h i l e the new The compulsory disclosure of
elastic: definition of deductible
l a w disallows certain of the ex- B e n a m i holdings, the a b o l i t i o n of
expenses in the case of business
emptions provided in the o r i g i n a l the system of b l a n k transfers of
profits is undoubtedly the most
A c t , the i m p o r t a n t loophole of shares a n d of bearer shares are
i m p o r t a n t . So l o n g as the owners,
exempting transfers of property essential ingredients of t h i s . The
directors and managers of busines-
through inter-vivns gifts and i n t r o d u c t i o n of a comprehensive
ses are able to pass off so m u c h of
t h r o u g h inheritance remains open, r e p o r t i n g system on capital t r a n s -
t h e i r l i v i n g expenses as business
w h i c h means ( i f A m e r i c a n experi- actions a n d of a single comprehen-
expenditure the incidence of t a x a -
ence is any guide) that only about sive r e t u r n for direct t a x a t i o n are
t i o n is bound to r e m a i n highly
one-third of the capital gains made other necessary ingredients. These
arbitrary, and the effective rate
by each generation come effectively are m a t t e r s w i t h i n the p u r v i e w o f
of t a x a t i o n on the business com-
w i t h i n the t a x net. the D i r e c t Taxes Administration
m u n i t y w i l l r e m a i n m u c h below the
E n q u i r y C o m m i t t e e recently set up
The effective rate of t a x a t i o n of apparent rate. In my report I
and it is very m u c h to be hoped
capital gains, even in the absence suggested t h a t the range of deduc-
that their recommendations w i l l
of any evasion, w i l l thus not be t i b l e expenses should be confined
pay due r e g a r d to these basic
27½ per cent, but something more to "expenses wholly, exclusively
requirements of the efficient ad-
l i k e 10 per cent. and unavoidably i n c u r r e d in earn-
ministration of an integrated tax
i n g the profits of the year" (as
There is undoubtedly some force structure.
against the present rule w h i c h per-
in the contention t h a t a h i g h rate mits the deduction of a l l such In closing I should l i k e to refer
of t a x on capital gains (such as the expenses w h i c h are " w h o l l y and to two particular matters on which
combined m a x i m u m rate of income exclusively l a i d out or expended the Government of I n d i a has fre-
tax and super-tax at present for the purpose of t r a d e ' ' ) . This quently been criticised f o r its
might have highly undesirable w o u l d undoubtedly strengthen the failure t o f o l l o w m y o r i g i n a l re-
economic effects. But this provides hands of the Revenue in disallow- commendations. One relates to
an a r g u m e n t not in favour of a ing expenses of various kinds, the f a i l u r e to reduce income-tax to
d i s c r i m i n a t o r y t r e a t m e n t of capital though the extent to w h i c h it w i l l the m a x i m u m rate of 45 per cent
gains, but in favour of reducing succeed in b r i n g i n g the t r e a t m e n t a n d the other to the extension of
the rates of t a x a t i o n on o r d i n a r y of business Incomes f u l l y i n t o line the w e a l t h t a x to companies.
Income. There is no real j u s t i f i - w i t h that of contractual incomes
cation for c o n t i n u i n g the discri- 45 per cent Income-tax
w i l l depend on the interpretation
mination between income w h i c h given to it by the Courts. It is I f u l l y m a i n t a i n the v i e w t h a t
takes the f o r m of capital gains a m a t t e r for consideration there- w i t h a system of direct t a x a t i o n of
a n d other income; they both gene- fore whether, in a d d i t i o n to a the k i n d I suggested, the m a x i m u m
s t r i c t e r general rule for deductive of rate of income t a x should not. ex-
I cannot, incidentally, see the expenses. the deduction of p a r t i - ceed 45 per cent. It should be e v i -
advantage of m a i n t a i n i n g the cular types of expenses (such as dent, however, t h a t this system has
d i s t i n c t i o n between earned a n d the so-called "expense accounts", by no means been f u l l y adopted;
unearned income o n c e the entertainment outlays, private n o t h i n g has been done to t i g h t e n
wealth tax is introduced—it cars, etc) should not be e x p l i c i t l y u p business t a x a t i o n , w h i l e t i n new
means using t w o separate i n - prohibited, taxes, o w i n g to the t r u n c a t e d f o r m
s t r u m e n t s f o r the same purpose. in w h i c h they have been adopted,
I t i s true t h a t the present w e a l t h A further source of hopholes w i l l only produce a fraction of yield
t a x rates are v e r y moderate. arises f r o m the n o n - i n t e g r a t i o n , or w h i c h they w o u l d have produced
The effective rates are only incomplete integration, of total otherwise. I n t h e i r present f o r m ,
o n e - t h i r d of the Swedish rates f a m i l y w e a l t h and Income. T o a n d w i t h the present a d m i n i s t r a t i v e
a n d y i e l d o n l y about t w o - t h i r d s close this it w o u l d be necessary to techniques, the new taxes w i l l h a r d -
of the schedule of the rates aggregate minor's income and ly yield 20 crores.
w h i c h I recommended. B u t it property w i t h t h a t of the parents, In the absence of these gaps In
is better in t h a t case to increase a n d to include a g r i c u l t u r a l income legislation and w i t h an efficient
the rates o f t h e w e a l t h t a x t h a n a n d property w i t h i n the scope of system of administration, they
to m a i n t a i n the sur-charge on the U n i o n income t a x , w e a l t h t a x should produce at least 50 crores
unearned incomes. a n d capital gains t a x . This latter more—quite a p a r t f r o m the g a i n i n
107
 January, 1959 THE ECONOMIC WEEKLY ANNUAL

income t a x revenue r e s u l t i n g f r o m
l o w e r t a x evasion, a n d the d i s a l l o w -
ance of c e r t a i n classes of business
expenses. As against t h a t t h e lose
o f revenue r e s u l t i n g f r o m t h e re-
d u c t i o n o f income t a x t o the celling
rate of 45 per cent w o u l d only
a m o u n t to 18 crores. I doubt
w h e t h e r the interests w h i c h agitate
f o r the l a t t e r w o u l d w i l l i n g l y ex-
change the present h i g h rates of
s u r t a x for these f u r t h e r legislative
a n d a d m i n i s t r a t i v e changes w h i c h
would involve them In additional
t a x a t i o n a m o u n t i n g to several times
t h i s sum.
Wealth Tax on Companies
As regards the w e a l t h - t a x on
companies, I w o u l d agree t h a t this
does not serve the same purpose of
securing equity in the d i s t r i b u t i o n
of the burden of t a x a t i o n as the
w e a l t h - t a x on i n d i v i d u a l s . On the
o t h e r h a n d It is no more inequitable
t h a n the t a x a t i o n o f the profits o f
companies as such they b o t h i n -
v o l v e the t a x a t i o n of legal entities
over a n d above the t a x a t i o n o f i n d i -
viduals w h o o w n t h e m , a n d o n p r i n -
ciples w h i c h are u n r e l a t e d to the
t a x a b l e capacity of the owners. B u t
considered as an a l t e r n a t i v e to a
h i g h e r rate o f profits t a x a t i o n o n
companies, it has t h i s to be said
i n its f a v o u r t h a t its economic
affects are d i s t i n c t l y more favour-
able t h a n t h a t of t h e profits tax.
F o r It penalises f i r m s w h o earn a
l o w r a t e o f profit o n the capital
w h i c h they employ a n d favours
those firms whose e a r n i n g power is
h i g h . I t thus rewards efficiency and
penalises inefficiency, a n d in the
present stage of I n d i a ' s develop-
ment, it is w e l l w o r t h w h i l e to offer
special Inducements to companies
w h o use the resources at t h e i r com-
m a n d e f f i c i e n t l y . F o r t h i s reason I
should favour p u t t i n g more o f the
burden o f t a x a t i o n o n companies i n
the f o r m of a w e a l t h tax, a n d less
In the f o r m of a profits tax,- i e,
o f r a i s i n g the w e a l t h t a x rate
( w h i c h at ½ per cent is v e r y l o w )
i f the combined income-and-profits
t a x rate on companies were cor-
respondingly reduced.

M a n y other features of the pre-

sent company tax legislation,
such as the excess d i v i d e n d tax,
r u n completely c o n t r a r y t o t h i s
and these ought to be abolished
a n d the whole system of com-
pany t a x a t i o n r a t i o n a l i s e d and
simplified w i t h o u t delay,

198