Vexing taxing problems

Centre-state data sharing is currently a distant dream but can be ground-breaking if implemented
Neelkanth Mishra | Last Updated at January 2, 2017 23:24 IST

(This was published in the Business Standard: link)

Recent developments have reopened some long-running debates about our country, like of “state capacity” (how closely does the execution of a policy mirror the government’s intent?), the depth and breadth of corruption (a surprisingly large number of people appear to have been complicit in the black money making its way into bank deposits in the last two months), and our abysmally low tax to gross domestic product (GDP) ratio. Of these, the last seems to hold the key to the first two, so let’s drill down on it.

Some have argued that in global comparisons our low tax to GDP squares up well with our current level of development. Such analysis chides anyone demanding a change and is in all likelihood well intended: If you make a car designed to run at 120km per hour run at 200km per hour, it will break down. But this unfortunately confuses cause with effect (is our low ratio of tax to GDP because we are poor, or are we poor because of the low ratio?), is perhaps too superficial (ignoring country-specific nuances), and most importantly, unambitious (should one just accept status quo as our fate?).

Let’s start with personal income tax: It is now well known that too few people pay tax, and even those who do under-report their income. Of 237 million non-agricultural workers in India (the remaining 222 million workers were in agriculture, where income is tax-free), 37 million people filed tax returns in the financial year 2013-14, and an additional 12 million had tax deducted at source (TDS) but did not file returns. The combined total of 49 million is still only a fifth of the non-agricultural workforce.

There are three different problems here. Firstly, only 17 million people reported salary income above Rs 1.5 lakh; i.e. just 40 per cent of the estimated 43 million formal sector workers. Given that there are 17 million government employees, and even the lowest paid would be earning more than Rs 1.5 lakh, it points to a severe compliance problem even among the salaried class in the private sector.The alternative explanation that 60 per cent of formal sector workers earn less than Rs 1.5 lakh is most likely incorrect, but if true, it is even scarier, raising the question of quality of private sector employment; their quantity has anyway been low.

Secondly, the average disclosed income of the 17 million individuals who report only business income and no salary is nearly 40 per cent lower than the average salary in India. This is surprising, as a meaningful part of India’s GDP is outside the corporate sector and business income for households running their own enterprises generally gets reported as individual income. This statistic flies in the face of the observation (admittedly anecdotal) that buyers of posh apartments and cars mostly are business owners; very few salaried individuals own apartments.

Thirdly, with agriculture now less than a third of rural GDP, there is significant non-agricultural income in rural households. Half of two-wheelers in India and a third of Maruti cars are sold in rural areas, but as nearly every rural household has some farming link, all of their income escapes the tax net. As rural habitations urbanise, the next logical move for a step jump in the tax base has to be a move to tax non-agricultural income for farmers.

While a solution to the third problem, however desirable, may be politically tough, that for the first two is not. It can simply mean better analysis of data already available with the government. This is beginning to happen, like high-value PAN-linked purchases are investigated if inconsistent with tax returns, or the surge in high-value deposits after the demonetisation exercise. But this is still in very early stages: For example, I recently discovered to my shock that there is limited data sharing between the direct and indirect tax departments of the government, i.e. the Central Board of Direct Taxes (CBDT) and the Central Board of Excise and Customs (CBEC). While it appears obvious that the owner of a business that reports large revenues in its indirect tax filings should also have high income and therefore be paying income tax on it, this simple matching does not happen currently. No wonder that income tax filings on business income appear under-reported. In early 2016, CBDT and CBEC signed a Memorandum of Understanding (MoU) to kick-start this process: It is quite incredible that two departments of the same ministry have to sign MoUs to share data, as if they were two different nations. Similarly, provident fund data could be used to identify salaried individuals not filing returns.

There appears to be significant evasion in indirect taxes as well. The report of the Arvind Subramanian committee, set-up to recommend the revenue neutral rate (RNR) for goods and services tax (GST), shows multiple approaches to estimate the RNR. The indirect taxes approach tried to mirror current indirect tax collections, and arrived at an RNR of 18 per cent. The direct taxes approach and the macro approaches, however, arrived at an RNR of 12 per cent. The nearly 50 per cent larger taxable base as estimated by the direct taxes and macro approaches point to major compliance issues in indirect taxes.

Many solutions have been suggested to improve tax compliance, like GST, demonetisation, simplification of tax rules and reduction of tax rates. While each has a role to play, a concerted effort on better utilising data already available with different central government departments may be an easier starting point. Centre-state data sharing is currently a distant dream but can be ground-breaking if implemented: The co-dependence engendered by GST may help.