The ‘carbon tax’ could be designed as an excise or an import duty on a range of goods or sectors, suggest Ehtisham Ahmad and Nicholas Stern. If implemented by the Central Government, it could be levied at the production stage; and if made operational by the states, it would most likely be implemented at the final sales point.
Thus they write in ‘Effective carbon taxes and public policy options,’ which is one of the essays in honour of Amaresh Bagchi, compiled in ‘Public Economics: Theory and policy,’ edited by M. Govinda Rao and Mihir Rakshit (www.sagepublications.com).
Concern with climate change and the externalities from greenhouse gases give a global perspective, and this is probably best seen as an issue for federal taxation, the authors note. They add that the excise/ import duties route is simple to administer and avoids the difficulties in the intra-state taxation of transactions that would arise if different states were to go for different rates of the VAT. “Moreover, it is not advisable to introduce differentiated VAT structures at the state level, as this is likely to generate potential for avoidance and difficulties in collection.”
Conceding that the structure for both taxes and subsidies is often complicated and that they can apply to intermediate as well as final goods, the authors explain the specific considerations in their modelling. “As most carbon taxes involve the taxation of intermediate goods, such as petroleum, kerosene, gas, or coal, a full assessment requires the estimation of the effects of this taxation on the prices of all other goods, that is, the effective taxes that arise from any form of carbon tax.”
This not only permits an assessment of the different commodities on which the tax might be levied, but also permits an analysis of the incidence of the tax on households in different circumstances, they elaborate.
Of interest is an example drawn from Pakistan, using data from the 1980s, about the category ‘housing, fuel and light,’ containing a composite grouping of commodities. The carbon-related components bore an effective tax of 0.35 for petroleum products, 0.21 for electricity, and 0.57 for gas – referring to the direct and indirect tax element, in the price of each good – covering all types and sources of taxation levied at that time, the authors inform. “In the Indian case, demand elasticity was available for the ‘fuel and light’ grouping and the composite effective tax for this category was 0.27 for roughly the same period.”
Ahmad and Stern underline the need for an empirical assessment of effective carbon taxes so as to help design any compensatory measures for the poorest people. They recommend that with federal collections, a sharing mechanism with states, which could be used finance compensatory mechanisms at the state level, would greatly enhance the overall political-economy incentives for the central carbon tax.
The essay calls for a similar approach to cap-and-trade scheme, where quotas are allocated through auction to key upstream industries, and trading could then take place between enterprises.
Local property tax
Another instructive essay in the collection is Govinda Rao’s ‘Normative framework for fiscal federalism for economies in transition,’ where he says that the most important local tax to be developed to strengthen fiscal decentralisation is the local property tax. In order to develop property tax as a significant contributor to local revenues, it is important to establish clear property rights and develop legal and regulatory systems, he elucidates.
While in many socialist countries, such as Vietnam and China, assignment of property rights and development of a legal system are still in transition, in India, property rights have been assigned and legal institutions exist, distinguishes Rao.
He frets, however, that often, the records are not properly maintained and vestiges of planned regime – such as the Rent Control Act and the Urban Land Ceiling Act – continue to plague rationalisation of the property tax system. “Also, the property owning class as a pressure group in a local government can be a formidable hindrance to the development of a modern property tax system.”
On the substitution of administered prices with taxes, a major reform agenda in many planned economies, Rao observes how this can change the revenue assignment system. For, in many transnational economies, the sub-national governments do not have tax powers, and enterprise income has to be substituted by transfers. “Some countries such as Romania still assign local enterprise taxes to sub-national governments, and in some others local governments stake ‘source entitlement’ claim. Nevertheless, by and large, the substitution of administered prices with taxes has been to centralise tax collections.”
The author finds that on the one hand, the move to decentralise functions has resulted in greater expenditure responsibilities and on the other, substitution of enterprise income with taxes leads to centralisation of tax powers. The prime example of this, according to him, is China, where after recentralisation of tax powers in 1994, the fiscal dependence of the sub-national governments has significantly increased.
Urging that meaningful fiscal decentralisation requires significant sub-national taxing powers, Rao reminds that linking tax and expenditure decisions at the margin is critical to ensuring expenditure efficiency and accountability. He rues that states levy a host of inefficient taxes, including a cascading type sales tax and tax on the interstate sale. “Below the state level, even in urban areas, the property tax is not well developed and this has led the local governments to levy inefficient taxes, such as the tax on the entry of goods (octroi) into local areas.”
A disturbing insight in the essay is about tax compliance. Despite the claim that the local level provides incentive for revenue collections by increasing tax compliance, the experiences of a number of socialist countries such as Russia, China, and Laos have shown that tax compliance will actually decline when the tax collection is decentralised, avers Rao. He, therefore, cautions that the design of decentralisation merits due attention before these economies make a transition to the market.
Of topical interest should be the essay titled ‘GST reforms and intergovernmental considerations in India’ by Satya Poddar and Ehtisham Ahmad, which acknowledges that GST has the potential to be single most important initiative in the fiscal history of India. “It can pave the way for modernisation of tax administration – make it simpler and more transparent – and significant enhancement in voluntary compliance. For example, when the GST was introduced in New Zealand in 1987, it yielded revenues that were 45 per cent higher than anticipated, in large part due to improved compliance.”
The authors also cite the case of Canada as suggestive of the potential benefits to the Indian economy. The GST in Canada replaced the federal manufacturers’ sales tax, which was then levied at the rate of 13 per cent and was similar in design and structure as the Cenvat in India, the authors narrate.
“It is estimated that this replacement resulted in an increase in potential GDP by 1.4 per cent, consisting of 0.9 per cent increase in national income from higher factor productivity and 0.5 per cent increase from a larger capital stock (due to elimination of tax cascading).” These benefits, however, are critically dependent on a neutral and rational design of the GST, reads a caveat in the essay.
The authors make a fervent plea for the vigorous pursuit of a fundamental reform, opportunities for which present themselves only infrequently. Even while appreciating that achieving the correct choice is a political economy balancing act that takes into account the technical options and the differing needs and constraints, the authors see a silver lining in the substantial consensus among all stakeholders in the country for a genuine reform.
“In the circumstances, an incremental or timid response would be neither politically expedient, nor would it serve the needs of India of the 21st century. Experience of countries with modern VATs, such as New Zealand, Singapore, and Japan, suggests that a GST with a single-rate and comprehensive base can be a win-win proposition for taxpayers and the fisc alike.”