The proposals of the Kelkar Committee have generated much discussion. Most economic reforms have some redistributive element, and tax reforms in particular, are especially so.
Relative to the expenditure side of a government's balance sheet, governments can more easily use tax policies to confer selective -- and large -- benefits to specific constituencies. The proliferation of indirect taxes and exemptions -- both of which result in large inefficiencies and are usually regressive to boot -- are classic mechanisms to achieve these goals.
Consequently, major tax reforms are an excellent 'natural' experiment to better understand the political economy of reform.
One obvious characteristic of the reforms evident in the numerous critiques of the KC report -- ranging from the Rajnath Singh Committee to a plethora of opinion pieces -- is the empirical vacuum that pervades Indian public policy discussions.
A prominent former finance minister pronounced that the report would have negative consequences for equity and efficiency even as he declared that he had only read the executive summary. At least his candour must be respected.
Most others would not even admit to that reality. Thus it is easy to declare (as with a member of the Rajnath committee) that retaining the tax exemptions on interest deduction on housing loans will strengthen the government's contract with its people.
If strengthening a government's contract with its citizens is indeed a priority, one might wonder why the government of the day is not feverishly using the mountain of accumulated foodgrain surplus to curb malnutrition and hunger or press for basic education and health facilities, which can be paid by higher tax collections but instead chooses to defend what in effect amounts to giving a cheque for Rs 150,000 annually from the public purse to India's richest (as in the case of interest deductions on housing loans).
It should be emphasised that objectives such as an emphasis on the growth of housing or increased savings are undoubtedly valid and essential for India.
However, what is amazing is how widespread is the belief that tax policy is the optimal instrument to meet these laudable objectives, with little regard to empirical evidence, opportunity costs and alternative mechanisms.
Thus the link between housing sector growth and tax breaks is seen as axiomatic. Correlation is deemed causal and empirical analysis that could test between alternative policies is conveniently ignored.
How responsive is housing to income tax exemptions relative to other policy changes such as reducing the overall interest rate regime, policy changes in urban land ceiling laws, conferring of property rights to slum dwellers, changes in local tax regimes such as the stamp duties, and the provision of supporting infrastructure, such as computerised land records?
Similarly what is the evidence that saving rates are affected by tax exemptions? Indeed, the substantial literature on this subject suggests that the latter affects the structure and distribution of savings and not its level, which is primarily a function of net disposable personal income (which for the most part will increase for all taxpayers if the recommendations of the KC are followed).
The search for easy, facile answers to complex problems -- the line of least political resistance and minimum analytical homework -- has bedevilled Indian public policy with very costly results.
Might markets be misallocating resources? Institute a control raj. Could high urban housing rentals adversely affect the poor? Legislate rent control. Power generation a problem? Give enormous selective incentives and create Dabhols.
What to do about shamefully high levels of illiteracy -- pass a constitutional amendment. Worried about energy security? Stop privatisation of oil companies. Terrorism a growing problem? Institute POTA. Alas, reality is rarely that susceptible.
If anything the recourse to such simplistic fiat reveals the 'softness' of the Indian State, in particular its pitiful capacity to rein in powerful interest groups.
The reactions to the KC report also strongly challenge a belief that the twin evils thwarting liberalisation are venal politicians and recalcitrant labour.
It is evident that the role of India's professional and capitalist classes is scarcely better.
Professionals, particularly charted accountants and lawyers have been generally quite critical, reflecting a reality that as exemptions go so will some of their earnings. Individuals and firms hire batteries of charted accountants and lawyers whose sole purpose is to play with numbers and engage in arbitrage opportunities between different types of exemptions.
Although capital stands to gain substantially in the long run -- a simple, transparent tax regime reduces transaction costs, creates a level playing field across different sectors, reduces uncertainty over potential investment horizons and especially rent seeking opportunities by tax officials and policy makers.
Nonetheless in the short- term, a number of large and prominent corporations who currently pay zero taxes, will have to pay substantially more. This loss of hundreds of crores is naturally a potent rallying point for these corporations who are also potentially large campaign finance contributors.
Despite the potential long-term benefits, industry groups have not collectively tried to aggressively counter the much stronger selective lobbying against some of the KC proposals on corporate taxes.
The role of another powerful interest group might explain the mystery of why the Rajnath Committee is opposed to the revised KC recommendations on a ceiling on interest deduction up to Rs 50,000 on housing loans.
If this is followed, only 15 per cent of all borrowers will be above this exemption limit. Since borrowers are a small fraction of the voters to begin with, and the propensity to vote in India declines with income, clearly there is little reason to fear the potential loss of votes on this account.
Rich home owners are also unlikely to contribute to party finances simply because of this exemption. So why defend these regressive benefits? More likely it is to safeguard the interests of housing finance companies and building contractors.
The latter has traditionally been an important source of financing for all political parties, and stands to lose since there is a considerable volume of unsold higher income housing stock.
Finally, the reactions to the KC report also reveal the role of the messenger in the political economy of reform. It is very evident that the media itself is not an objective player -- unhappily it itself has become an interest group.
Stories of planting of news, if not outright payoffs to reporters to strategically place stories have become so common that a seemingly independent media has become a vested actor in its own right.
My point here is not to argue that the recommendations of the Kelkar Commission are beyond reproach. In particular, those on the dividend tax and capital gains tax are contested, even amongst public finance specialists.
As this government ponders on what it should do, it needs to be emphasised that one of the most troubling aspects of India's public finance in the 1990s has been the decline in the tax to GDP ratio.
It cannot be over emphasised that a nation that cannot raise taxes is deeply compromising its future well being and its national security.
About five years ago the then United Front government selectively implemented aspects of the 5th Pay Commission. The result, as we all know now, was one of the worst fiscal decisions in independent India's history.
If that mistake occurred on the expenditure side, by taking selective aspects of the KC report, this government risks making similarly grievous mistake on the revenue side -- a mistake that history will find difficult to rectify and forget.
(The writer is associate professor, Department of Government, Harvard University and visiting professor, IIM-Ahmedabad)
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