The Hindu : Tax reform and human development

Online edition of India's National Newspaper
Tuesday, Dec 17, 2002

Opinion

Opinion - News Analysis

Tax reform and human development

By Prem Shankar Jha

The Finance Minister Jaswant Singh's reassurance to Indian taxpayers at the annual general meeting of the Federation of Indian Chambers of Commerce and Industry last week that the Government did not intend to withdraw income-tax concessions on investment made in housing has removed what was perhaps the only serious shortcoming in an otherwise exemplary set of proposals for tax reform. The reason Mr. Singh gave for rejecting this proposal of the Kelkar Committee is that it would severely cramp the growth of investment in the housing sector. In the last four years, since bank lending was deregulated, loans to this sector have been growing at 25 per cent per annum. That is in itself sufficient reason not to disturb it any more than is absolutely necessary. But it is only one of many reasons why the housing sector should be treated differently from the rest of the economy.

A much more important one is that in no other sector of the economy does private investment have such profoundly beneficial social side effects. This has been recognised in virtually every industrialised country. In 1981 when the Reagan administration in the U.S. carried out a drastic simplification and reduction of tax rates in much the same way as the Kelkar Committee is proposing for India today, it brought down the income-tax rate to a maximum of 27 per cent and eliminated virtually all tax concessions. The only one of significance that it maintained was the tax deduction on depreciation and interest paid on home loans. Mrs. Thatcher did the same for Britain.

In developing countries there are even stronger reasons for doing so. Industrialisation is associated with huge shifts of population from the countryside to the towns. The new migrants feel socially uprooted and in desperate need of establishing new homes. Large numbers of them leave their families behind in their villages and end up living in shantytowns that become a breeding ground for crime and social unrest. It is in everyone's interest to ensure that the new migrants find permanent homes in the cities and towns as rapidly as possible and that shanty towns, while inevitable, should remain as small as possible. The two main impediments that the migrants face in making the transition to permanent homes are the shortage of affordable land and the shortage of housing finance.

Till recently these constraints had received virtually no attention from either the Central or the State Government. Land was in effect `nationalised' by the Urban Land Ceiling and Regulation Act of 1977. The little vacant urban land that remained outside its purview therefore became impossibly expensive.

This shut not only the poor but also the bulk of the salaried working and lower middle class out of the market for shelter. The few shelter programmes that remained were almost entirely in the public sector and involved such heavy subsidies — with no effort to recover even the basic cost of land development — which they became impossible to replicate. As a result, as the States sank ever deeper into financial crisis during the 1990s, these were the first programmes to be quietly abandoned. The crisis was deepened by the absence of housing finance. Throughout the pre-reform period commercial banks, which had by then been almost entirely nationalised, were barred from financing housing development. As land costs soared in the wake of ULCRA and interest rates hovered around a crippling 15 per cent for the few housing loans that were available to the public from specialised institutions, even the affluent professional middle class was shut out of the housing market. The end product has been an urban congestion and decay that has no parallel in any other developing country outside of South Asia.

Only in the last three to four years have things begun to change. The progressive deregulation of the banking sector and the steady fall in interest rates (now as low as 9.75 per cent) has unleashed a huge boom in private housing. Banks flush with funds because of the prolonged slump in industry are vying with each other to lend money to prospective home owners. The exemption of interest up to Rs.1.50 lakhs has brought down the effective cost of finance for modest middle class housing by almost a third. Withdrawing this concession could nip the boom in this long delayed, but essential social investment in the bud. Were that to happen it would also deprive the economy of its most prolific source of new employment today.

This is not to suggest that the Government has only to continue the present concessions on investment in housing to solve the problems of urban shelter. The bulk of those in need of housing in the cities are too poor to afford any kind of `pukka' construction that conforms to the current municipal building codes. Nor can they afford the market price of even 50 square metres of land. The problems of urban shelter will never be solved if the State governments do not release or otherwise ensure the availability of large amounts of land for low income housing and amend the present building laws to permit `traditional' systems of construction to be used in the towns. But the present boom in private housing is at least relieving the bottleneck at the top of the urban pyramid. It is therefore a good beginning.

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