How to make the current tax system progressive? (Part 2)

A progressive tax is a tax that imposes a lower tax rate on low-income earners compared to those with a higher income, making it based on the taxpayer’s ability to pay. That means it takes a larger percentage from high-income earners than it does from low-income individuals.

Well, tax rates are indeed very high in India. Illustration below shows who gets what from customer’s wallet.

In 2018, as per estimates, almost 98% of cars were sold with a price tag (Ex-Showroom) of less than 20 Lakhs ₹. High level of tax, in a way has dissuaded demand for premium and luxury cars in India.

Strange thing is, irrespective of value of the car, beyond 4m length, effective tax slab is not progressive in nature. For illustration, we chose the 2018 best-selling sedan’s petrol top-end models from different segments. Point is, 59 Lakhs ₹ (Ex-Showroom) Mercedes Benz E Class is taxed mere 3% higher than Maruti Ciaz, carrying 11 Lakhs ₹ price tag (Ex-Showroom).





The Question : Should 11 Lakh ₹ Ciaz be taxed at premium & Luxury car level & 2 Lakh ₹  cheaper Dzire should enjoy 16% concession, for just being under 4m in length?

Again, comparison with a sub 4m car is inevitable here. Look at the example below, and think if Maruti Ciaz can be considered as symbol of conspicuous consumption over Maruti Dzire? Say, if both the cars are taxed at same rate, Ciaz will be mere 76,000 ₹ more expensive than Dzire, that too because of additional features and spaciousness. But the current tax structure considers it other way.

Also, companies have started offering luxury features in sub 4m cars and taking the prices to a new level, and still enjoying tax concession, basically defeating the purpose of higher differential rates to dissuade conspicuous consumption.

Since length of car is considered as a parameter of conspicuous consumption, and during biggest tax reform- 2017 GST implementation, 4m length parameter for qualifying lower tax slab was left unchanged, it seems there is a need of an intermediate tax slab, to make the tax system progressive.

Simulation

At the time of GST implementation, Government have had a chance to reform, however, fear of revenue loss has ensured that the tax level remained high. So, here we tried to take help of an economic theory called ‘Laffer Curve’ to understand, if there is a scope for reduction in taxes or introduction of an intermediate lower tax slab.



‘Laffer Curve’

In economics, the Laffer curve illustrates a theoretical relationship between rates of taxation and the resulting levels of government revenue.

  • It illustrates the concept of taxable income elasticity—i.e., taxable income changes in response to changes in the rate of taxation.
  • The Laffer curve assumes that no tax revenue is raised at the extreme tax rates of 0% and 100%, and that there is a rate between 0% and 100% that maximizes government taxation revenue.
  • The Laffer curve is typically represented as a graph that starts at 0% tax with zero revenue, rises to a maximum rate of revenue at an intermediate rate of taxation, and then falls again to zero revenue at a 100% tax rate.
  • One of the conceptual uses of the Laffer curve is to determine the rate of taxation that will raise the maximum revenue (in other words, “optimizing” revenue collection).
  • One implication of the Laffer curve is that reducing or increasing tax rates beyond a certain point is counter-productive for raising further tax revenue.
  • However, the shape of the curve is uncertain and debatable among economists.

Source :https://en.wikipedia.org/wiki/Laffer_curve

For this study, we have focused only on 4m SUV (Monocoque), 4m Sedan (Monocoque) vs 4m-4.35m SUV (Monocoque), 4m-4.5m Sedans(Monocoque),  as these are key volume segments which can impact tax revenue of Government, leaving the bigger and more expensive cars aside. For illustration, below we tried to estimate the revenue generated by the products for Companies and Governments.

Owing to higher tax rate and price, 4m+ cars certainly generate more revenue for Government than the sub 4m cars. In case of 4m car, it’s the car company which pockets larger realization from customer.

Hypothetical Case

For simulation we have reduced effective tax rate of 46%, by 7%, to new intermediate slab of 39%. Reduction of tax rate will certainly reduce the Government Revenue on face value. However, price elasticity of demand will ensure spurt in demand for 4m+ cars, leading to substitution from sub 4m cars, for simplicity we assumed that overall volume demand remains fixed (10,86,654 units in this case).

But the real world situation will be quite different. Look at the illustration below, Hyundai Creta despite having much higher price tag, sells quite well for itself, in comparison to much cheaper Maruti Brezza. So, imagine if price gap reduces, customer will switch to bigger car for a better value proposition, and may yield far better revenue for Government. In worse case also, Government will largely remain revenue neutral with the move.





For illustration, hypothetical Laffer Curve may look something like below.

This study is based on estimated data and economic theory to illustrate tax rationalization impact. Outcome of Laffer Curve is debatable, but an intermediate tax slab on more pragmatic parameters may help improving Government tax revenue collection and may also improve value for customer and better realization for companies.

(The article is written by Rohan Rishi. You can connect with him at emailrohanrishi@gmail.com)

Passenger Cars Taxation Structure in India – A Study (Part 1)

Tax, by definition, is a compulsory contribution. It is one of the major source of revenue for Government. At the same time Government can use tax system to alter the market forces of demand and supply. Also, it can be used as a tool for redistribution of wealth, for fostering economic equality, thus the idea of higher taxes on luxury goods and services.

One of the major passenger car taxation reform happened, was in the year 2006.  This had led to birth of whole new segment of automobile quite unique for India – The sub 4m SUV & Sedan segment, with engine capacity of less than 1200cc for petrol and 1500cc for diesel.

In recent times, the segment has witnessed phenomenal growth.

Though Maruti was quite late to the 4m party, in 2012 with 4m Dzire, but has played pivotal role in growth of 4m segment.

Sedan Segment

SUV Segment

What made this happen?

Roots of sub 4m length car segment or small car can be traced back in 2006 Budget speech of the then Finance Minister Mr. P. Chidambaram. Government’s idea was “To make India a hub for the manufacture of small and fuel-efficient cars that will drive economic growth and employment.”

2006

“On cars, I propose to reduce the excise duty to 16 per cent from 24 per cent, but only for small cars. A small car, for this purpose, will mean a car of length not exceeding 4,000 mm and with an engine capacity not exceeding 1,500 cc for diesel cars and not exceeding 1,200 cc for petrol cars. I am confident that industry will seize the opportunity to make India a hub for the manufacture of small and fuel-efficient cars.”- Budget speech – Mr. P. Chidambaram (Minister of Finance-Government of India)

2008

“I have looked at specific sectors where growth is flagging. These sectors are important because they are growth and employment drivers. Some of them also have large externalities. Therefore, I propose to reduce the excise duty on small cars from 16 per cent to 12 per cent and on hybrid cars from 24 per cent to the general revised rate of 14 per cent.”- Budget speech – Mr. P. Chidambaram (Minister of Finance-Government of India)

2017

With GST coming into effect from July 2017 and subsequent revision in September 2017, very idea of 2006 tax structure was cemented.





Tax slab is based on 4 parameters

  • Length of the car (4m)
  • Engine size (1200 cc Petrol Engine/1500 cc Diesel Engine/1500 cc Engine-length more than 4m)
  • Alternate drivetrain as energy source
  • Ground clearance of 170mm (for SUV longer than 4m)

These parameters were not substantiated in the 2006 budget and the only highlight was “fuel-efficient cars”. 2017 GST reform has left everything unchanged, except an increase in tax on hybrid cars. So here we tried to analyze the validity of few of these parameters.

1) Length – 4m

It seems that any car longer than 4m is considered as symbol of conspicuous consumption, and thus taxed at much higher rate (17% min). But question that comes to mind is, why only 4m is considered as small, why not 3.8m or 4.2m?

Look at the example below, and think if Maruti S-Cross can be considered as symbol of conspicuous consumption over Maruti Brezza? Say, if both the cars are taxed at same rate, S-Cross will be mere 45,000 ₹ more expensive than Brezza, that too because of additional features and spaciousness. But the current tax structure considers it other way.

Also, other school of thought behind 4m length rule could be of solving road congestion and parking problems with small cars.

In reality, small vehicle doesn’t solve road congestion problem but an efficient public transport system may. On small cars, James May (earlier with Top Gear-BBC) once said “Length is not an issue, as roads are infinitely long but finitely wide, it is just easy to park.”

Below illustration shows that a 4m car will save parking space in case of parallel parking.  It helps in cities like Delhi, where old houses don’t have parking space and majority of cars are parked on street. But parallel parking alongside road, itself, leads to the very problem of congested roads. Modern and well planned buildings have perpendicular or angle parking, which often proves to be more space efficient.

Conclusion :

Without much substantiation in budget, 4m length rule sounds more whimsical than logical. It needs to be carefully examined by policy maker for any future tax reform.



2) Engine size (1200 cc Petrol Engine/1500 cc Diesel Engine/1500 cc Engine-length more than 4m)

It seems engine size was considered as proxy parameter for “fuel-efficient cars”. To be precise – 1200cc for Petrol Engine and 1500cc Diesel Engine for cars less than 4m in length.

In India, since Government and car companies do not provide CO2 emission data on their website, so, for our study we referred to data from the UK Government agency – https://carfueldata.vehicle-certification-agency.gov.uk/. Readers need to understand that the UK follows Euro6 emission norms, which is far more stringent than India’s current BS4 emission norms. In our comparison, we chose cars which are on sale in both the countries, and also included the engine not available in India from Suzuki.

1200cc Petrol Engine

For study, we have considered Hyundai i20 naturally aspirated 1200cc engine and Suzuki Swift turbocharged 1400cc engine. In India, both the cars will be in different tax bracket, owing to engine size. Swift despite having much bigger engine is slightly more fuel efficient, with almost similar level of greenhouse gas emission, and still, it will be penalized in India with higher tax. Of course technology used is different, but end result will help Government to solve twin problem of pollution and reduced consumption of imported oil.

Larger engine will of course consume more fuel, but how much more will depend on engine’s characteristic and the way it has been engineered. For example, Suzuki’s engine having different displacement but using similar technology doesn’t loses much on fuel efficiency, despite being high on power, and CO2 emission is almost at same level.

Even with similar technology and engine displacement, Suzuki’s engine is more efficient than Hyundai’s, without substantial loss in power.

1500cc Diesel Engine

For study, we have considered Ford Ecosport  1500cc engine and Honda Civic 1600cc engine. As one can easily notice, Honda’s engine, despite being bigger from Indian tax law perspective, is more powerful, still far more efficient and far less polluting. Because, fuel efficiency, besides engine size, also depends on lot many other factors like body shape, aerodynamics, tire friction etc.

Conclusion :

Engine size cannot be considered as proxy for determining fuel efficiency or CO2 emission. Rather it all depends on host of many factors, mainly engine characteristic and how well it is engineered. If real objective of Government is to control pollution and reduce consumption of imported crude oil, then real world fuel efficiency and emission level should be considered as parameters for tax slab rather than just engine size.



3) Alternate drivetrain as energy source

2017 GST brought biggest change for Hybrid cars.

Tax rate has had gone up by whopping 16%, and actually hampered the sales of only successful hybrid car in India – Toyota Camry.

Still tax on electric vehicle was kept quite low, irrespective of the car size or the price band it falls in.

Disregarding the fact, that technologically superior battery electric vehicles (BEV) produced by Tesla, Jaguar, Audi & Mercedes are in luxury category. Below example is taken from UK as these BEV are not on sale in India.

Data Source : https://www.carbuyer.co.uk

So, maintaining low tax rate on expensive BEV will undermine the principle of current tax system, which seems to be designed to dissuade conspicuous consumption. Moreover, due to high price tag, luxury BEV will never be able to democratize the electric car ownership in India.

Globally, for any Government, primary driver to promote and incentivize electric cars are :

  • Reduction in air pollution and lowering greenhouse gas emission
  • Cutback on imported crude oil (to avoid outlay of foreign exchange)

In case of China, secondary driver is to promote and develop new sunrise sector – Battery & Electric car. Because, China, despite being world’s largest exporter of several goods, have very slim presence in car export. Which is why, they see electric car and battery as an opportunity and thus building huge scale, similar to what they did with smart phones.

Coming back to Indian context, 100% electrification of vehicles is not possible in short and medium term, without any major breakthrough in on-board electric energy storage or generation technology. Also, in case of India, a battery electric car just shifts the pollutants from tail pipe to the source where electricity is generated. Since 75% electricity is generated by coal fired power station, for now, it is far more polluting than internal combustion Engine.

Source: Wikipedia
Source: Wikipedia

Under such circumstances, electric cars drawing power form the grid will also have operational CO2 footprint. So here we took two modern and top-selling BEV from UK and calculated the operational CO2 emission equivalent if charged hypothetically from the Indian power grid, based on average CO2 emission of power plant that feeds electricity to Grid (gm/kWh).

Data Source :

  • Electric energy consumption (Km/kWh)

https://carfueldata.vehicle-certification-agency.gov.uk/

  • CO2 Emission Equivalent – Indian Grid Electricity (gm/kWh)

http://www.cea.nic.in/reports/others/thermal/tpece/cdm_co2/user_guide_ver13.pdf

Result is quite intriguing, when we compared it with petrol (Euro 6 compliant) and fully-hybrid vehicles from UK in same segment. Hypothetically, if these UK specific BEV draws electricity for charging battery from Indian Power Grid, will have either similar operational CO2 footprint or even higher than their fully-hybrid or petrol counterparts.

Therefore, while formulating long term BEV adoption plan for the country, policy makers should first focus on electricity producing source diversification (with either renewable and/or nuclear source), otherwise achieving CO2 emission reduction targets will always remain elusive and monetary incentive to promote BEV may not yield desired results.

In short and medium term, the primary goal still can be partially achieved with Hybrid technology, as it proves to be more practical, cost effective (relative to BEV) and act more as a bridge for the transition from internal combustion engine to fully electric vehicles (Battery or Hydrogen), for all.

Below example illustrates how fully-hybrid cars are far more fuel efficient, relatively reduces the greenhouse gas emission, and no slouch on performance either.

But incentive should always be for fully-hybrid vehicles and not for the mild-hybrid ones, as later, only helps to reduce greenhouse gas and doesn’t have much impact on fuel efficiency.

Conclusion :

Best way is to weave the tax system around the primary objective of controlling pollution and reducing dependence on imported crude oil. Thus, tax structure should have parameters like emission level, power efficiency, rather than engine size or drivetrain technology, and at the same time, tax system should remain progressive as well.

A progressive tax is a tax that imposes a lower tax rate on low-income earners compared to those with a higher income, making it based on the taxpayer’s ability to pay. That means it takes a larger percentage from high-income earners than it does from low-income individuals.

Below is one such plausible and pragmatic tax formulae, taking into account all the factors, with an upper ceiling, say – 50%. GST base rate could be adjusted (5% or 12%) to maintain the affordability of cars among masses.

If taxation system remains technology agnostic, then, fully-hybrid and electric vehicles (Battery EV or Hydrogen EV) shall redeem themselves on their merit.

(The article is written by Rohan Rishi. You can connect with him at emailrohanrishi@gmail.com)