Increasing tax efficiency

Tax officials across the country will welcome Finance Minister P Chidambaram's statement that, with tax collections growing handsomely, they can expect an incentive bonus. Certainly, there is reason to celebrate when the tax to GDP ratio has climbed quite significantly, and when direct taxes on incomes and profits (which have grown by more than 40 per cent for two years running) overtake indirect taxes on goods and services. Any modern tax system reduces taxes on commodities and focuses more on taxing incomes "" that way the system causes fewer distortions and also becomes more egalitarian. But it may be premature to equate rising tax collections with rising tax efficiency; the growth in revenue could simply be a result of the sharp growth in profits, a trend that now seems to be tapering off as the economy slows. The finance minister has already referred to the problem with excise duties, which for many years have been rising at less than half the growth rate for industrial output. The key question is whether compliance has improved, and whether the tax net is catching all those whom it is intended to catch.

On this score, the news is not so good. Analysis of major tax trends and efficiency levels, done by Sanjay Kumar, AL Nagar and Sayan Samanta of the tax department and the National Institute of Public Finance and Policy, show that while there has been improvement in the indices of tax compliance, there are action areas that need urgent attention. Indeed, in an article in this newspaper last week, Mr Kumar argued that compliance rates have not gone up so significantly as to the general demand for lower tax rates.

For instance, the trio points out that, of the 660,000 companies registered in the country on October 31, 2004, as many as 44 per cent did not file their tax returns. The data also suggest that a tenth of those filing income tax returns in earlier years do not file them in subsequent ones. Tax arrears, similarly, have grown from Rs 22,928 crore in 1995-96 to Rs 98,612 crore in 2005-06 "" and only 8-9 per cent of these arrears get collected each year. Also, 80 per cent of the delinquent taxes, it appears, involve just 200 taxpayers - so the creation of special cells to collect arrears would be in order. When it comes to personal taxes, the trio looks at the share of income tax that comes in the pre-assessment stage and how much is in the post-assessment stage "" this has remained more of less the same in the last decade, with around 85 per cent of total collections coming from those declared along with the filing of returns. This would suggest that the impact of tax audit is not as significant as might have been hopes, and also that the tax department has not been able to make very productive use of the data it collects through the Annual Information Returns. One possibility that suggests itself is that tax officials find it easier to practise discretion at the audit stage; the other is that India simply does not have enough officers to do the kind of detailed audits that are required to make a difference "" while an average tax official in India handles the audit work of 37.5 cases, the figure is 1.2 for the US, 4 for Canada, 4.6 for Australia and so on. If the finance minister is keen to keep alive his magic of collecting more taxes than budgeted, he will have to pay attention to some of these issues.