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1.Towards a new direct tax system (The Hindu)

2.How to make Indian cities more competitive (Live Mint)

1.Towards a new direct tax system (The Hindu)

Synoptic line: It throws light on the new proposed system to change the direct taxation laws in India. (GS paper III)

Overview

  • The second round of the great Indian tax overhaul has been flagged off. Government has appointed a committee headed by Arbind Modi to review the Income Tax Act of 1961. This is a welcome move, and comes in the wake of the admittedly rocky transition to a new indirect tax regime with the introduction of the goods and services tax (GST).
  • As we will explain later in this editorial, a new direct tax system could help lower GST rates in the future.

 Problems with present regime

  • The existing direct tax law is riddled with problems. It is extremely complicated, has ambiguities that create an excess of litigation, offers scope for administrative discretion that is often the fount of corruption, imposes high costs of compliance that especially hurt those with lower incomes, and has many exemptions that hurt allocative efficiency by distorting the decisions of participants in the economy.
  • A clean direct tax code which will cover income tax, corporate tax, dividend distribution tax, fringe benefit tax and wealth tax should help promote economic efficiency as well as protect horizontal and vertical equity.

Proposed new regime

  • All direct taxes were to be brought under a single code with unified compliance procedures. The code was drafted in simple language to minimize ambiguities; every subsection was a short sentence to convey a single point. The code aimed at flexibility by keeping only general tax principles in the law, while details were found in the income-tax rules.
  • The uncertainty on tax rates after every Union budget was to be dealt with by stipulating tax rates in the code itself, and these could be amended by Parliament. Taxes would not be used to meet regulatory goals, which were best served by the new sectoral regulators who have been put in place over the past two decades.
  • A new direct tax system can serve two very important political economy functions. First, it is no secret that too few Indians pay direct taxes. There is only one Indian filing annual tax returns for every 16 voters, and the fact that millions of voters do not earn income because of their age or gender is balanced by the fact that not every person who files his tax returns actually pays tax.
  • This asymmetry between direct tax payers and voters has created a political system that quite naturally cares more about spending to buy votes rather than building a more effective tax system that will spur economic growth.
  • Second, the inability to grow the direct tax base rapidly enough and this is what a cleaner direct tax system can achieve has meant that the Indian state has to depend a lot on indirect taxes, which are fundamentally regressive. That is true even in the case of a value-added tax such as the GST.
  • Almost nine out of every ten rupees collected by the government before the economic reforms came from regressive indirect taxes, a testimony to the hypocrisy of Indian socialism. There is a far better balance between direct and indirect taxes now, thanks to the tax reforms of the 1990s, but the proportion of direct taxes in the total pool has to increase further to make the tax system more progressive.

Way ahead

  • A clean direct tax code will help achieve three key goals. First, it will help make the Indian economy more competitive through tax stability, minimal exemptions and the focus on allocative efficiency.
  • Second, it could alter the Indian social contract by increasing the number of people paying income taxes. Third, higher direct tax collections could lower the tax burden on the poor by creating fiscal space for a reduction in GST rates.
  • The focus right now should not be on lowering marginal tax rates, other than the commitment to bring down the corporate tax rate to globally competitive levels, but on increasing the tax base through a better direct tax system.

Question– What is the need to do introduce new direct taxation system in India? What approach can be adopted in this regard

2.How to make Indian cities more competitive (Live Mint)

Synoptic line: It throws light on the economic plans to induce growth in Indian cities. (GS paper III)

Overview 

  • Policymakers launch new programmes to make India more competitive, accelerate growth and create jobs, cities will play a key role in this structural transformation. India is still at an early stage in this transformation, given that it is a lot less urbanized for its stage of development.
  • The growth potential through urbanization is huge, given that India is one of the most densely populated countries in the world. The 100 smart cities programme is an effort to address this gap.

Tackling urbanization and growth

  • The link between urbanization and growth has been well recognized globally, our understanding of what makes cities more competitive is still evolving. With more than 600 districts in India, and many more districts aspiring to join the ranks of 100 smart cities, a deeper understanding of the drivers of competitiveness, and providing benchmarks to measure, monitor and improve performance will help local leaders to pursue city competitiveness agenda better.
  • While the spatial aspects of cities need more attention, a key driver of city competitiveness is the strength of its entrepreneurial foundation and its ability to attract new enterprises.
  • There are several drivers of city competitiveness, including demographic traits, infrastructure traits, urban traits, financial traits and industry traits. Noida in Uttar Pradesh, with a focus on modern services, is following a different growth path, compared to Surat in Gujarat that is focused on manufacturing. There is one thing common to both. Both have a strong entrepreneurial foundation. 

Drivers of Competitiveness

  • Demographic traits: The demographic traits, including age profile and population density of a city, provide insights into the size of local market, and the potential supply of local entrepreneurs. Most entrepreneurs always start their businesses in their current local area. While some entrepreneurs move to other cities to start their businesses, this is mostly confined to niche, high-growth industries, such as modern services and biotech, where a few dominant clusters form.
  • Structural traits: Two key structural traits of city competitiveness are its physical and human infrastructure. Basic services like roads, electricity, and water supply are essential for all businesses, but new and small enterprises are particularly dependent upon local infrastructure. Human capital is becoming increasingly more important for city competitiveness. A higher level of education is associated with higher rates of self-employment and better start-up performance. Besides physical and human infrastructure, the overall connectivity of a city to major cities is also an important structural trait of competitiveness. The driving time from the central node of a district to the nearest 10 largest cities Ahmedabad, Bengaluru, Bhubaneshwar, Chennai, Delhi, Guwahati, Hyderabad, Kolkata, Mumbai, and Patna is a good proxy for physical connectivity.
  • Agglomeration economies: A good city infrastructure enables entrepreneurs to benefit from agglomeration economies. There are three different channels of agglomeration economies. The first is proximity to customers and suppliers, which reduces transportation costs. While transportation costs have declined dramatically, and firms can trade long distances, the fundamentals remain important. The second channel is the Chinitz effect, which is very strong for small and medium enterprises (SMEs), especially women-headed enterprises. The third channel is labour pooling. Labour is the most important input for any new firm. Entrepreneurship is driven by the availability of a suitable labour force.
  • Some industries cluster more than others. Modern services cluster more in larger cities, while manufacturing moves into smaller cities. Service industries tend to be less land-intensive, and more skill-intensive, so they cluster in large cities such as Bengaluru and Hyderabad. Manufacturing, which tends to be more land-intensive, and less skill-intensive, migrates to smaller cities in search of cheaper land.

City competitiveness

  • Two key drivers of city competitiveness in India are education and physical infrastructure. These two structural traits are true for both manufacturing and services. The high population density of a city makes large-scale manufacturing enterprises less competitive, and forces them to move to rural settings to become more competitive.
  • While manufacturers avoid the high costs of urban areas, they also avoid the most remote areas of India in favour of settings that are relatively near large population centres, likely to access customers directly or to connect to shipping routes.
  • City competitiveness is also determined by the ability to attract small and women-headed enterprises. The size of local population of a district plays an important role for informal manufacturing. The strength of local, within-district physical infrastructure, and the strength of local household banking environment matter a lot for SMEs. This contrasts with large firms, where education matters more.
  • Organized manufacturing establishments have access to broader resources that reduce dependency on local infrastructure and household finance. Input cost factors are more influential in the location choices of small start-ups, while output conditions and labour markets are more important for large entrants.
  • For the service industry, overall district population is as important as it is for the unorganized manufacturing industry. Population density and travel time to major cities are not important, while the district’s age profile does contribute to higher entry levels. Agglomeration economies operate as strongly for new entrepreneurs in India as they do in advanced economies. This matters more for small enterprises.

Way ahead

  • India’s urban transformation will take place at a 100 times faster pace than what developed countries have experienced. India is at the forefront of this global transformation. While cities raise special challenges in forming public-private partnerships in building physical and human infrastructure, they also provide a quick opportunity to accelerate growth, create jobs, and promote shared prosperity.

Question– What are the growth propellers for modern cities? What should be the govt’s approach to enhance them?