Reforms may curb tax evasion

Income Tax day on July 24 comes at a time when the public domain is filled with discussions on tax evasion and tax reforms. The immediate catalyst for this renewed interest is obviously the withdrawal of high value currencies of Rs 500 and Rs 1000 denominations from circulation on November 8, 2016.

This was followed by a major structural change in indirect taxation, by bringing in Goods and Services Tax (GST) which subsumed major Central and State taxes like Central Excise, Service Tax and Value Added Tax. Though not a new tax invention, the task of introducing harmonised rates of tax for the Union and across all States is an arduous one in a federal set-up like ours, with vastly diverse economic tastes and preferences.

This reform is also expected to curb tax evasion through a process of peer and self-audit in the mechanism to avail of input tax credits.  Overall, better direct tax enforcement and indirect tax reforms have filled the air with hope and positive predictions of analysts.

It will not be an exaggeration to state that the country looks at the tax personnel to curb the menace of parallel economy through better enforcement strategies and structural reforms.

It would be surprising to many, if it stated that a battle can be fought, without a fair idea about the size of the opponent. But this is precisely what the income-tax personnel are engaged in. No one has a clear answer for the question of what is the size of the parallel economy in our country.

(Parallel economy includes legal part of the economy in which a part of the transactions is evaded and totally illegal transactions outside tax net. In fact, there are objections to the word ‘parallel’ itself as this does not run separate and parallel to the official economy, but has closely intervened transactions with it. The term black economy is consciously avoided as it is criticised to be having racist overtones).

The last official attempt to measure the extent of parallel economy in India was done in 1985, that is three decades ago.  The study was led by two leading public finance experts, the late Rajah Chellaiah and Shri Shankar Acharya. The report  (Aspects  of the Black Money in India, www.nipfp.org)) , estimated the size of parallel economy in India at 21 percent of the Gross Domestic  Product. 

A later report of the World Bank (Policy Research Working Paper No 5356 July 2010) also makes a similar estimate. The White Paper, published by the Ministry of Finance in 2012, however, refrained from making an estimate of the size of the parallel economy.  But recent unofficial estimates put parallel economy at 60 – 80 percent of GDP.

Despite all these, the fundamental question is what is the prime reason for tax evasion. Many say, it is prevalence of cash transactions. Though the argument has force in it, there is a need to look beyond this. Cash as a form of saving has become much less popular today, compared to what it was 50 years ago. The proportion of cash to bank deposits has come down from 100 percent in 1966-67 to 15 percent in 2015-16 (source: Hand book of Statistics on Indian Economy published by Reserve Bank of India, www.rbi.org.in).

What gets revealed here is that though less cash helps in tracking down transactions and makes tax enforcement easier, it is not a sufficient condition to eliminate tax evasion. The fact that tax evasion does not abate despite tax rate reduction and technology induced administration compels us to look for other reasons as well. It would be simplistic to hold cash economy as the sole problem bedevilling nation’s economy and tax compliance. Studies have revealed that societal ethics is a strong determinant of tax behaviour. Tax consciousness is a psychological construct and its level is strongly correlated to good governance and a feeling of empowerment among citizens.  The state machinery as a whole has to move towards responsible governance with empathy to the public and citizenry should get the feeling of being a substantial stakeholder. Tax personnel can play a substantial but not a complete role in this. Unfortunately, the entire blame for low tax consciousness and resulting low compliance comes to lie at the door of the tax department.

The most apt message tax personnel can convey by setting standards in good governance is: “Better governance and empowered citizenry for higher tax consciousness and compliance”.