The Flat tax

The B-School had invited a star tax practitioner to talk to the Class of 2006 on the basics of taxation. It was an opportunity which the CA grabbed with alacrity. He had always believed that the syllabi and students at the B-Schools had “style but no substance”. He would show them up for how shallow they were. As he walked into the class looking extremely prosperous, all suited and booted, the class rose up in awe of the man the nation called TP. No one really knew where the name came from; but it had stuck.

Fifteen minutes into the class as TP spoke to a spell bound audience, the first crack in his armour began to show up. He was speaking on “entry level”, “maximum marginal rate” and the “incidence of tax” with a healthy sprinkling of wit and wisdom. He told them that as good citizens we must pay our taxes. It was then that Boka set the cat amongst the pigeons. “Sir, Taxation in India has become far too complicated for the average Indian; yet tax is too important a subject to be left exclusively in the hands of the tax experts.” TP smiled. All his life he had made his money thanks to India’s complex tax system. And here was a rookie who wanted to change all that.

“Why can’t we have a single tax slab? Say, tax everyone at 20%? Why should we have three slabs 10%, 20% and 30%” asked Debbie, the baby faced lass, who loved simplicity. “Not to speak of a surcharge that adds insult to injury” remarked Goggles. “You mean have proportional tax and not graduated or progressive tax?” asked Flowers. Seeing a few eyebrows raised, Flowers took it upon himself to elaborate. “A flat tax, (a k a proportional tax) is a system that taxes everyone at the same rate viz a proportion of income. In contrast, under progressive income tax citizens with higher incomes pay tax at a higher rate than those with lower incomes”. A tax is an involuntary fee paid by individuals or businesses to a state, or to functional equivalents of a state, including tribes, secessionist movements or revolutionary movements. ... Citizenship is membership in a political community (originally a city but now a state), and carries with it rights to political participation; a person having such membership is a citizen. ... A corporation is a legal entity (distinct from a natural person) that often has similar rights in law to those of a Civil law systems may refer to corporations as moral persons; they may also go by the name AS (anonymous society) or something similar, depending on language (see below). ... A progressive tax, or graduated tax, is a tax that is larger as a percentage of income for those with larger incomes. ... Income tax is a direct tax which is levied on the income of private individuals. ... A progressive tax, or graduated tax, is a tax that is larger as a percentage of income for those with larger incomes. ...

Debbie remembered someone speak at a debate saying that there was a time in India when the maximum marginal rate was 97.5% and that in addition you had to pay a wealth tax of 5%! That is, for every rupee that you earned beyond a point you paid approximately 98 paisa as tax. And of whatever little was left you paid wealth tax. God why would one want to earn, the speaker had thundered.

“Sir, does any country adopt flat tax” asked Debbie. Before TP could open up, Flowers was quickly off the block. “Eleven years ago, in 1994, Estonia became the first European country to introduce a “flat tax” with a uniform rate of 26%. Latvia (25%), Lithuania, Russia (13%) Slovakia (19%), Ukraine (13%), Serbia (14%), Georgia (12%) and Romania (16%) soon followed suit”. Boka offered an explanation. “The flat-tax movement has hit off in the erstwhile communist countries because these countries were starting from scratch in choosing a tax code and they opted for the one that was simple and efficient”. TP was beginning to have second thoughts over his “all style and no substance” argument.

“Why would you think that flat tax is convenient,” asked TP. His tone may have conveyed annoyance but it was a put-on to get the best out of the group. Goggles said, “I read somewhere that in the US the cost of administering progressive taxation is about 10% to 20% of revenue collected”. Boka offered him support. “Flat tax is an administrator’s joy. As every Rupee is taxed at the same rate, the taxman is not bothered about who is being paid how many rupees. He can simply withhold 20% of a company's payroll, without being concerned about individual pay packs.” Debbie closed out, “But if a second rate of tax is added, the tax collector has to find out how much money is going to whom before he can be sure of collecting the right amount from the right person!”

“Any specific examples” asked TP. Ah, he hadn’t counted on his wards’ wide ranging reading habits. “Flat tax can yield good results,” said Flowers. “When in 1994 Estonia repealed its high tax rate on the rich it did not hurt the tax base. Actually that year the revenues rose to 40% of GDP. Ditto in 2002. The country now plans to cut its flat rate from 26% to 20% by 2007”. Debbie remarked, “Sir, in Russia in the year 2001, the government combined its 12%, 20% and 30% personal income tax bands into a single 13% rate. A year later tax collections were up by 26%”. “Flat and up” closed out Flowers.

Boka decided to offer his spin to the Russian experience. He said, “Flat tax is simple. The government's revenues surged not because the Russians suddenly started working hard, but because tax administration and compliance became easier. So if flat tax is to be introduced in a country, the idea should be sold on the simplicity plank.”

“Well, what is wrong with progressive taxation” asked TP. “Is it not wiser to make the rich give up a bigger share of their disposable incomes? Doesn’t a flat tax violate this principle?” he asked rhetorically. “No”, said Debbie. “A flat tax usually combines a threshold (that is, an exempt amount) with a single rate above it. The system can be made progressive by playing around with these two variables”. Wow! Goggles drove another nail, “A flat tax increases the incentive to work, unlike a progressive tax, which discourages extra effort from society's best-paid members. Sir, a graduated income tax is graduated robbery.”

Neta, the guy with political ambitions, decided to stand up and be counted in the dying moments of the class. “In India we need radical tax reforms. So far we have been playing at the fringes. Our Income Tax Act needs to be cut down by half. A flat tax will provide the answer. Okay, the leftists might make noise but the tax’s sheer convenience and ease of administration hold out the promise of a clean and transparent system, which India badly needs”.

The only thing that the class hadn’t mouthed was Adam Smith’s canons of taxation thought TP. As he got ready to respond to their arguments, the gong went.