Almost 50 years ago, Stanley Surrey, an eminent tax expert, cautioned that in developing countries too much preoccupation with what to do (tax policy) may lead to too little attention on how to do it. Yet, in many developing countries including India, the tax system has acquired complexity far beyond their administrative capacity. Here the tax administration has limited capacity, there is a large unorganised sector and the ability to organise the information system is poor.
The problem in India too is that it evolved a tax system that is beyond its capacity to administer. Tax structures were designed not merely to raise revenue but also to be an effective instrument of inter-personal and inter-regional equity, promotion of savings, encouraging investments in preferred areas and activities, and so on. Most of all, it had the function of reducing incomes of the rich to establish a socialistic pattern of society. This complex structure provided scope and incentive for tax evasion. As the probability of detection became low and penalty even when detected was negligible, evasion became a rule rather than an exception. Thus, while trying to equalise incomes among less than 1 per cent of the population we created a tax system that violated equal treatment of equals.
Over the years, desirability of a simple tax structure has been realised. It has been realised that equity in fiscal policy means increasing incomes of the poor and this is largely achieved through public expenditure. Despite this, the legacy of the past continues. The plethora of exemptions and preferences, area based incentives, use based exemptions, incentives for selective financial instruments and selectivity and discretion in the application of tax laws — all these have complicated the tax system. Therefore, the primary task of improving tax administration is to drastically simplify tax structures. This calls for a simple, broad-based, low rated and less rate differentiated tax structure.
In designing a tax administration three important aspects must be considered. These are architecture, engineering and management. The architecture includes the legal framework and processes and procedures. Engineering aspects deal with organisational structure and operating rules for tax administration and management aspects actually administer the taxes. Simple tax structure helps to have an unambiguous legal framework. The functional organisation of tax administration enhances effectiveness and creates environment for promoting tax compliance.
The most important component of tax administration is the organisation of information system. Collection and collation of information is important to determine tax liabilities and modern technology helps to do precisely that. The introduction of Tax Information Network (TIN) for administering the income tax by the government is, in part, the realisation that real or effective tax system depends on how information is collected and processed. The initiative was taken up last year and within a short time a strong infrastructure foundation for processing of tax information has been established. The task of organising TIN has been assigned to National Security Depository Limited (NSDL). The objective is to integrate the primary information on tax payments made by the banks, tax deducted at source (TDS), and collate information on high value transactions. The system is geared to ensure that the tax deducted at source is actually deposited with the government, the credits claimed TDS forms are actual and not fictitious by matching the TIN information with TDS. Besides, TIN has helped to process the returns and refunds at a fast rate.
The government has given approval for the second phase of TIN. Besides better organisation of information, the system will help dematerialisation of TDS certificates. This will help to match the tax deductions in the TDS with TIN and with bank challans, and subsequent organisation of information in terms of permanent account numbers of taxpayers. Results of these initiatives are already visible. The personal income tax revenue is expected to increase by over 20 per cent and this comes over 18 per cent increase in the last year and about 20 per cent increase the year before. Surely, as the information system is organised better, the government will be able to enhance the tax-GDP ratio.
While the recent initiatives are important, they need to be supplemented with other initiatives. As already mentioned, there is considerable scope for simplifying the tax system further both in direct and indirect taxes. Another necessary initiative is to have effective information exchange between various tax departments and process them to good effect. Besides exchanging information between income tax, excise and customs departments, it is important to link the information on VAT. With the introduction of VAT at the state level, a wealth of information on manufacturers and traders on their transactions will be available.
It is also necessary to undertake other complementary measures to improve administration. The establishment of a large taxpayer unit will help the administration to specialise in the complexities these taxpayers deal in. Self-assessment schemes for smaller taxpayers and systematic risk assessment to select cases for detailed audit can help to improve tax compliance. Alongside, a mechanism for speedy disposal of disputed cases is essential.
It is also important to treat taxpayers as contributors to national progress rather than potential criminals and provide ways and means to reduce the compliance cost of tax payment. In countries like India, as Milka Casanegra put it, “tax administration is tax reform” and we should focus our efforts to improve it. This is, however, possible only when there is willingness on the part of the political classes to improve tax administration and enforcement. Most reforms fail because politicians are a cog in the wheel and resist effective reforms. If they are on the side of reforms, the necessary condition is satisfied and sufficient conditions too will follow.
The writer is director, National Institute of Public Finance and Policy