How to avoid harassment of taxpayers because of overestimated tax revenue collections

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Published: March 3, 2020 5:15 AM

Overestimating tax revenue collections leads to harassment of taxpayers, and poor budget management. Independent fiscal institutions can help india overcome this

For example, in FY19, the revised estimate of central tax revenues was taken at Rs 22.48 lakh crore even as the actual collections reported by the Controller General of Accounts for the year was Rs 20.8 lakh crore.For example, in FY19, the revised estimate of central tax revenues was taken at Rs 22.48 lakh crore even as the actual collections reported by the Controller General of Accounts for the year was Rs 20.8 lakh crore.

There is a palpable fear of the taxman among businesses as the end of the financial year approaches. The pressure to achieve targets forces taxmen to place unreasonable tax demands, which often results in disputes and snowballs into large arrears. In her budget speech, the finance minister stated that there are as many as 4,83,000 cases of Direct Tax disputes with the Commissioner (appeals), Income Tax Appellate Tribunal, various High Courts, and the Supreme Court. The total disputed amount rose from Rs 5.24 lakh crore in March 2015 to Rs 9.52 lakh crore in March 2019. In the last year alone, the amount surged by 36%. The government wants to realise a substantial amount from the disputed sum through the Vivad se Vishwas scheme announced in the budget.

A major reason for the large build-up of disputed amount are the budget forecasts. Most often, the budget forecasts are targets rather than projections. For example, in FY19, the revised estimate of central tax revenues was taken at Rs 22.48 lakh crore even as the actual collections reported by the Controller General of Accounts for the year was Rs 20.8 lakh crore. In FY20, the revised estimate was lower than the budget estimate by 12%; it was lower by 22.8% in the case of GST, 20.3% in the case of corporation tax and 17.3% in the case of Union Excise Duties on petroleum products. While this may be partly due to the high nominal rate of GDP, assumed in the budget at over 12.5% as compared to the actual growth of 7.5%, the more important reason is to be found in making optimistic revenue projections to show lower fiscal deficits. The actual collections until December show that to realise the revised estimate, almost 36% of the tax revenue will have to be collected in the last quarter. Even though the budget estimates for the next year are based on a more realistic estimate of a 10% growth in nominal GDP, and the growth in total tax revenues estimated is just about 9% over the revised estimate of the current fiscal, realising even these could pose problems due to the optimistic revised estimates for the current year.

Overestimating tax revenue collections in the budget has three serious adverse consequences. The first is that it leads to harassment of taxpayers, and increases litigations. The high budget estimates determine the target for tax collectors and the performance of officers is judged on the basis of the extent to which they fulfil these targets. In the process, it incentivises the assessing officers who make unreasonable demands even as they know that these are outlandish. When assessment is contested with the Commissioner, who is the first appellate authority, 20% of the taxes must be paid. The amount of interest paid by the government every year on wrongful assessment is substantial.

The second adverse consequence is the poor budget management resulting from unrealistic estimation of revenues. The allocations to various departments are done in the beginning of the financial year, after the budget is passed in Parliament and the departments make their plans for spending. The sharp reduction in the allocation during the year results in unplanned cuts, with adverse implications on the productivity of spending. In FY20, significantly lower than the budgeted tax revenue has resulted in sharp cut backs in allocations to Central Sector Schemes (-11.6%) and Centrally Sponsored Schemes (-4.5%). Interestingly, the allocation to food subsidy was also cut by Rs 75,532 crore, but the Food Corporation of India was allowed to borrow from the National Small Savings Fund. In other words, lower-than-budgeted tax revenues in FY20 have resulted in recourse to off-budget financing, and cuts in central grants to states.

This takes us to the third important adverse consequence of unrealistically optimistic tax revenue estimates. The states prepare their budgets based on the estimated tax devolution and grants shown in the Union budgets as almost 40% of their revenue is from central transfers. The share is much more in low-income states.

Inability to realise the budgeted revenues results in a sharp reduction in the tax devolution, forcing states to cut back on expenditures for lack of additional sources of revenue and inability to take recourse to borrowing. In the event, capital expenditures of states become most amenable to cuts as it is difficult to cut the committed revenue expenditures. This results in time and cost over-runs of various capital projects. Similarly, when the allocations to central sector and centrally sponsored schemes are cut during their implementation, it puts states in a difficult position as often, the funds are committed to the implementing agencies. In fact, the pressure of spending is on them as they are closer to the people, and responsible for implementing the schemes. In all these cases, the unplanned cuts in expenditures have adverse consequences on budget management, and reduce productivity of public spending.

Unfortunately, governments do not employ any transparent model to make projections, and this provides scope to manipulate the estimates to show lower revenue and fiscal deficits under a rule-based fiscal policy calibration. There is little discussion in Parliament, or in the Finance Committee of Parliament, even when the estimates are way out of line with reality. This is one of the reasons why there should be an independent fiscal institution (IFI) appointed by Parliament—such as a Fiscal Council—to monitor the implementation of rule-based fiscal policy. More than 40 countries have such IFIs.

Hagemann (How Can Fiscal Councils Strengthen Fiscal Performance?. OECD Journal: Economic Studies, Vol. 1.2011) makes a detailed review of country specific studies on the effectiveness of IFIs in improving fiscal performance. The case studies of Belgium, Chile, and the United Kingdom show that fiscal councils contributed to improved fiscal performance. In Belgium, he concludes that the government is legally required to adopt the macroeconomic forecasts of the Federal Planning Bureau, and this has significantly helped reduce bias in these estimates. In Chile, the existence of two independent bodies—Trend GDP and Reference Copper Price—have greatly helped improve budget forecasts. The cross-country evidence shows that fiscal councils exert a strong influence on fiscal performance, particularly when they have formal guarantees of independence. Perhaps, the time is opportune for creating such an institution in India too, to ensure better budgetary management, and avoid ‘tax terrorism’.

The author is Former Director, NIPFP and Member, 14th Finance Commission. Views are personal

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