Making tax machinery more efficient is essential to reform the economy post demonetisation
DS Saksena | January 31, 2017
Demonetisation has had some intended and many strange and unintended consequences. It appears that the zeal to reform the economy post-demonetisation has permeated to the general public, which has led to a mushroom growth of tax experts. Currently, the media – both print and electronic – is awash with the suggestions of these self-styled tax experts. This flood of suggestions – often from respected academics – has severely eroded the trust of the public in the current tax system so much so that people often wonder whether our tax administration is in proper hands.
Coming to the current crop of suggestions making the rounds; it is widely believed that demonetisation was inspired by a suggestion from the Arthkranti think-tank. This belief is buttressed by the fact that Arthkranti acknowledged their contribution and the PM called the Arthkranti people for a meeting about demonetisation. It would be interesting to note that the second part of the Arthkranti proposal involves replacing all taxes by a single tax on bank transactions. Despite the proposals being in the public domain for some time, no one has had the courage to point out that the implementation of the second part of Arthkranti’s suggestions could prove even more calamitous than the first part (demonetisation). For one thing, a significant part of the tax revenue of all countries comes from taxing MNCs and cross-border transactions. This requires that the tax systems of all countries should be roughly similar. If we follow the Arthkranti model and replace all taxes by a single banking transactions tax, then we would not be able to tax MNCs and cross-border transactions properly and would hence forego a significant amount of revenue. Secondly, in the current system the amount and incidence of taxation is well known. If we implement the Arthkranti suggestions, no one can predict what amount of tax would be collected and who would bear the tax burden. Thirdly, a banking transactions tax would discourage banking transactions and people would prefer to deal in cash – which is contrary to the objectives of the government.
It is the favourite proposition of almost all commentators that income tax evasion has increased exponentially through the years. Relying mainly on anecdotal evidence such as the abundance of houses, luxury cars, etc. compared to the number of persons disclosing an income in excess of Rs 10 lakh, these self-styled tax experts theorise that tax evasion is rampant and stands at many times of the actual taxes collected. However, the proposition that people who are in possession of valuable assets but are disclosing meagre income are necessarily evading tax is not correct in all cases. Such anomalies arise due to some fundamental flaws in the Indian taxation system. For example, dividends (if shareholding is less 10% of the total shareholding) from companies, share in profit from partnership firms and long term capital gains from sale of shares are exempt from income tax. This leads to a situation where if Mr X holds 9% shares in a big public limited company and receives Rs 150 crore as dividend then Mr X does not need to pay tax. Similarly, if Mr Y is a partner in a large partnership firm and earns partnership income of Rs 5 crore then Mr Y does not need to pay any tax. Similarly, if Mr Z sells some shares and earns long term capital gains of Rs 200 crore then Mr Z does not need to pay any tax. Mr X, Mr Y and Mr Z are the persons who do not pay tax but buy big cars and big houses and come to the notice of the aforementioned tax experts. On the other hand, if someone earns a salary of Rs 5 lakh per annum then he is in the tax net. It would, therefore, be more apposite if the learned experts trained their guns on these inequities in the tax system instead of drawing flawed conclusions and pillorying the income tax department for inefficiency and worse.
Relying on similar logic, some writers have gone so far as to surmise that income tax evasion, which allegedly stood at 10% to 30% in 2002 (again without evidence), has deteriorated to some figure between 200% and 300% of the tax collection in 2016. However, if we dispassionately analyse official statistics, we would find that tax collection has increased from Rs 68,305 crore in financial year 2000-01 to Rs 7,42,295 crore in 2015-16 i.e. an increase of 987%. These statistics show that the rate of increase in income tax collection is much more than the sum of the rates of the GDP growth rate and inflation. This would mean that contrary to the perception of “experts”, tax evasion has declined over the years – probably through technological advances and better performance of the income tax department.
Then there is the oft repeated lament of many middle class citizens: the neighbourhood paanwalla/panipuriwalla has a taxable income but does not pay any tax. Carrying the logic further, it is argued that if the income tax department catches all such paanwallas and panipuriwallas then tax collections would head north and honest citizens would have to pay less tax. However, this alluring suggestion is un-implementable. The reason would be obvious once we look to the comparative number of paanwallas and income tax officers. If we take cognizance of the fact that only 8,000 tax payers pay 90% of tax then we would appreciate that tax collection would not increase significantly even if we catch all such paanwallas and panipuriwallas and extract the maximum tax from them. Tax collection could also suffer because income tax officers would be busy with small cases rather than bigger and more revenue yielding ones.
Again, many suggestions put in the public domain are based on faulty statistics. Two gentlemen writing in a leading daily suggested that should the tax rate be pegged at a flat 12% then tax collection would rise to Rs 3.24 lakh crore from Rs 1.89 lakh crore in financial year 2013-14. However, if we look at official statistics we find that income tax collection for the financial year 2013-14 was Rs 6.38 lakh crore and not Rs 1.89 lakh crore as assumed by the learned authors. The income tax projection for financial year 2016-17 is Rs 8.32 lakh crore – much higher than the projection of RS 3.4 lakh crore assumed by the learned gentlemen, should their system be made operational. Rather, if we implement the suggestion of reducing the tax rate then we would have a huge revenue deficit because as I pointed out earlier, only 8,000 tax payers (paying tax at the rate of 34.4%) pay 90% of the entire tax collected by us. So if we reduce the tax rate, across the board, to 12%, tax collection would fall sharply. I would also venture to add that income tax is a progressive tax designed to reduce inequalities of income.
Having a flat tax rate would defeat this fundamental purpose. If the government wishes to increase tax collection in this manner it would be better advised to increase the excise duty on petrol which would be progressive to some degree since only rich people use petrol vehicles. Such an impost would also be much easier to collect.
The way the tax administration is perceived in India is partly due to the monolithic nature of the government – of which the tax administration is only a small and insignificant part. However, the ground reality is entirely different. Our tax system, like our entire judicial system is similar to the tax system of other civilised countries. Without exaggeration, one can truthfully say that not India alone but all countries have some or the other significant implementation issues. Vodafone, which has large (but contested) tax arrears in India, has been accused by a UK parliamentary committee, of settling tax dues of £7 billion by paying only £1 billion. Google is playing hopscotch with tax administrations of a number of countries by routing all transactions through Ireland and paying only 2.5% tax. Yet, unlike India, no one questions the basics of tax administrations of their countries.
To understand what I really mean, suppose you were misguided enough to write to a government department offering a suggestion for better administration. After a week or ten days, you would receive a cyclostyled letter informing you that your suggestion had been noted and was under active consideration, but invariably after two or three months you would be informed that your suggestion was not found viable. Like the government of India, the tax department also never responds positively to suggestions or criticism. Apparently, despite India being a democracy, all departments run only on the inherited wisdom of underlings fortified from time to time by the invaluable inputs of the minister or secretary or someone designated by them.
I may add that tax payers, investors (both domestic and foreign) look for stable tax regimes. More particularly, if the tax liability is known beforehand foreign investors do not mind paying tax because in such a case taxes can be factored into the cost. What no one wants is uncertainty and rapid change in tax policies. The record pull out of foreign capital from India in the last quarter is mainly due to the perception that there are no constants in our taxation system. To undo the damage wrought by demonetisation, as of now, it would be much better to eschew radical changes in the taxation system. Rather, the focus should be on making the tax machinery more efficient by providing it with better infrastructure in terms of men and material.
Saksena, an IRS officer of 1979 batch, retired as principal chief commissioner of income-tax, Mumbai in September 2016.
(The column appears in the February 1-15, 2017 issue)
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