Tax System - Simplified

Tax
What is tax? Well, there are hell lot of view about this. Let take it as a tool for redistribution of income. We can also say that tax are imposed for fulfilling expenditure obligations of the government. Lets see some terms about tax. Incidence of tax - the event of tax being imposed. Impact of tax - when tax makes its presence felt, that is impact of tax. Direct tax - (Incidence + Impact @ same point) i.e., the tax is being imposed on you and you feel it. Indirect tax - (Incidence + Impact @ different point)i.e., the tax is being imposed on you but you make others pay for it.

Okay, lets see how taxes are imposed on people.
1. Progressive Taxation
You gain more, you pay more taxes. This may seem like, you are getting rewards for being poor. And the riches get the punishment og more tax so they try to evade taxes.
2. Regressive Taxation
Its the opposite, If you earn more you pay less taxes. This is imposed on small industries excise duty. If they produce more they can pay less taxes. Hence SMEs encouraged.
3. Proportional Taxation
Whatever your earning may be, you have to pay a fixed tax.

Hmm, How good a tax system can be?
To answer this question economists give some principles. So if a country's tax system follows those principles, then it is deemed to be good tax system. So, what are they?
1. Fairness
Persons in similar situation should pay similar taxes (Horizontal equity). And the 'better off' people pay more taxes (Vertical equity).
2.Efficiency
Cost of payment of tax should be less (Online, one click instead of long queue in IT office). And the tax system should not decide how much you save or invest or spend etc (Less interference on the allocation of resources). Moreover, by imposing tax on pollution, smoking nation will get double divident (money+social purpose).
3. Administrative Simplicity
The activities like computation, filing, collection, etc of taxes should be as simple as possible.
4. Flexibility
The tax system should be in such a way that it can be modified easily in future.
5. Transparency
The government should say aloud that "I got this much money from taxes and I gave you these services".

Wow! Now the government have tax money collected. So what it should do with that?
Well, It has to obviously spend on development. Here also three types are present - Progressive, Regressive, Proportional. Here, progressive spending is good. Because, its always good spend only as much as you earn.

References: 
Indian Economy - Ramesh Singh

The Srikrishna's code

    For any economy in the world, the financial sector serves as the backbone. Because, for an economy to grow and sustain the business activity of industries and other players has to be stable and growing. This becomes possible by providing positive environment and support to domestic entrepreneurs. The financial markets and banking system and other financial sector institutions supports the entrepreneurs by providing them long term funds, short term funds, loans and such other mechanisms for resource mobilizing. So, any crisis in the financial sector of an economy is a doom. This makes it essential to regulate this sector properly.

    In Indian economy, the financial sector regulation is carried out by few institutions like RBI, IRDA, PFRDA, SEBI etc. Recently a Financial Stability and Development Council has been setup to promote coordination among these regulatory institutions. Anyway, there is a need felt for reforms in financial sector legislation for the long term financial sector regulations which involves systemic risks. For this, government has appointed Financial Sector Legislative Reforms Commission chaired by Justice Srikrishna. The recommendations of this commission is released recently.

    This commission has proposed a new regulatory architecture. As per the recommendations, an Unified Financial Agency should be created by merging existing four agencies namely SEBI, FMC, IRDA, PFRDA. The commission also recommends to continue RBI with modified functions. Totally, the commission recommends for seven agencies with distinct functions.

1. FSAT (Financial Sector Appellate Tribunal) - to replace Securitied Appellate Tribunal
2. Resolution Corporation - to replace DICGC (Deposit Insurance and Credit Guarantee Corporation)
3. Financial Redressal Agency - new agency
4. Public Debt Management Agency - new agency
5. FSDC (Financial Stability and Development Council)
6. RBI
7. UFA (Unified Financial Agency) - new agency

While quoting the rational behind this huge changes in existing regulatory architecture, the commission said in coming 25 to 30 years India's GDP will be eight times the current GDP, so there is a need for drastic changes. Anyhow implementation of these recommendations may not be smooth as there exists some difference of opinion inside the commission itself.

Reference:

http://www.thehindu.com/business/Economy/srikrishna-panel-moots-indian-financial-code-bill/article4558956.ece

So, what is this FSDC is all about?

    As we know the economic crisis in 2008 originated in US has affected many countries across the world. Many economies are experiencing slowdown. It is important for every economy to learn and prevent such crisis in future. This crisis has called for changes in the regulatory mechanisms in US. As a result US has passed a comprehensive "Wall Street Reform and Consumer Protection Act", popularly known as Dodd-Frank Act. This act provides for comprehensive financial sector regulation, consolidation of regulatory agencies by establishing "Financial Stability Oversight Council" etc...

    US is dominant and well connected economy (especially with emerging economies like India). The implementation of this "Dodd-Frank Act" will be followed by financial adjustments by other economies. Due to this regulatory consolidation in US and global slow down, pressure mounted on Indian economy to take its initiatives towards regulatory reforms to prevent such crisis in future. Thus, a super-regulatory body much like "Financial Stability Oversight Council of US" has been created in India and named as "Financial Stability and Development Council".

    The FSDC consists of,

• Finance Minister as chairman and other member includes, 
• Governor Reserve Bank of India (RBl),
• Finance Secretary and/ or Secretary, Department of Economic Affairs (DEA),
• Secretary, Department of Financial Services (DFS),
• Chief Economic Advisor, Ministry of Finance,
• Chairman, Securities and Exchange Board of India (SEBI),
• Chairman, Insurance Regulatory and Development Authority (IRDA),
• Chairman Pension Fund Regulatory and Development Authority (PFRDA).

    The main functions of this council will be, maintaining financial stability, promoting financial sector development, inter-regulatory coordination etc...

    It is important to note that the parts of financial sector like, Banking, Insurance, Securities, Provident Fund etc... were previously had its own regulators namely RBI, IRDA, SEBI, PFRDA etc... The new FSDC will serve as an institution promoting greater coordination among the financial regulators.

Financial Stability Report of RBI

    The Financial Stability Report of RBI is an attempt to communicate the risks to financial stability that is beginning to happen. As per latest (December 2012) FSR document, the growth of Indian economy has moderated due to global headwinds and domestic policy uncertainties. Some highlights of the report is given below,

      1. Global risks like Euro sovereign debt crisis and US fiscal cliff remain.

      2. Investment and consumption expenditure fell due to fall in domestic savings, persistent high inflation and regulatory and environmental issues. This has resulted in decreased growth.

      3. Rising gold import resulted in widening current account deficit.

      4. No change in inter-connectedness of the system. First time the liquidity contagion in the system has been assessed.

      5. Asset quality of banking system is under stress, but still system is capable of tackling any macroeconomic shocks. Since the quality of asset deteriorated, it may be challenging for Indian banks to migrate to Basel III norms. 

      6.  Financial inclusion, Financial literacy and Consumer Protection has been recognized as important for Financial Stability and these has been discussed in this report for the first time.

For the full highlights and report, click here.

Banking Sector Reform in short

Narasimman Committee on Financial System - I (1991)
   Recommendations:
    1. Lesson CRR from 15% to 3-5%, allow SLR on beneficial investments. Do OMO (Open Market Operations) for evening out money supply.
    2. Phase out "Priority Sector Lending". Keep it within 10% total lendings of a bank. Give for only weaker sections.
    3. Let the market decide interest rates on deposits and of loans. Let the "Bank Rate" be an anchor and others linked to it.
    4. Abolish dual control of banking sector (RBI and Banking Division of FinMin), let RBI be the sole agency of banking regulation. Reduce public sector banks and let it apolitical, autonomous and professional.
    5. Tackle the menace of Non Performing Asset through Asset reconstruction Companies.

Narasimman Committee on Financial System - II (1997)
   Recommendations:
    1. Make the banking system stronger by merging public sector banks and all India financial institution and close down the loss making ones.
    2. After mergers let banking system be on 3 tiers,
        Tier-I International orientation
        Tier-II National orientation
        Tier-III Local banks
    3. Strong legal frame work for debt recovery (SARFAES Act)
    4. CRAR - 10%
    5. Rationalize bank's board.
    6. Don't give money to the public sector banks from budget allocations (Budget recapitalization of banks).
    7. Depoliticize banking staffs.
    8. Setup Board for Financial Regulation and Supervision for whole financial institutions, banks and NBFCs.
    9. Licensing private banks, that's good... keep it up.