Real reform will set in only when officers, at all levels, stop regarding taxpayers as potential tax evaders and see them as citizens with equal rights.
Picture the twin-cities of Nogales, Mexico, and Nogales, Arizona (the US), situated at the US-Mexico border. Once one, they are now divided by a crude fence, mounted on top of an equally crude wall, which has been built apparently to prevent smuggling and illegal immigration. When you stand at the fence and look northwards, you will see the Arizona-half of Nogales. Move a few steps southwards and you will be in Nogales in Sonara, Mexico. Nothing much separates the two cities. They share a common location, history, language, and culture.
North of the fence, however, income are three times those in the south; teenagers go to high school; people have access to Medicare and life expectancy is high. People go about their day-to-day business fearlessly, confident that their disputes will be settled quickly, and their contracts are protected by law.
South of the fence, life is quite different. Public health and educational systems are poor. The police itself is mixed up with gangsters and running a business is a risky affair because of the many palms that have to be greased.
In Why Nations Fail, Daron Acemoglu and Jack Robinson, two eminent social thinkers from MIT and Harvard, try to answer the question why the two Nogales have developed so differently, while having so much in common. The reason is the same as why some nations succeed and others don’t: Successful nations run inclusive institutions that work for the benefit of the society as a whole; other, less fortunate nations find their economic and political institutions captured by vested interests and exploited for private benefit.
At a time when it finds itself hamstrung in pushing through its reform agenda in the Rajya Sabha, the present government seems quite appropriately to have decided to also focus on institutional reforms.
The income-tax (I-T) department is a case in point. In FY01, income tax collections worked out to 3.15% of the GDP and accounted for 36.33% of central revenues. By FY14, the corresponding figures had already increased to 5.6% and 55.87%.This pattern of revenue collection is now similar to many OECD countries. This reliance on income tax is healthy because as compared to excise duties, this tax causes minimum distortion to consumer and producer preferences. Unfortunately, the institutional framework and attitudes have failed to keep pace with the modernisation of the pattern of revenue collection. Very recently, however, the Centre has taken a number of measures to modernise the functioning of the I-T department and instil confidence in taxpayers. These certainly deserve to be appraised.
The annual confidential report has now been modified so as to make Assessing Officers (AOs) more accountable to their immediate superiors on the quality of taxpayer services they provide and the assessments they make, the pace at which they take decisions, and the efforts they make to rope in new taxpayers. Reporting officers are now required to specifically measure and rate performance along these parameters as well. The purpose behind this reform appears inter alia to be to make officers much more mindful of applying the law judiciously. There is after all no point in their raising unjustified demands if these are bound to be knocked off in appeal.
While scrutinising cases, officers are ordinarily required to confine their queries to the reasons why the computer picked up the case in the first instance, and to avoid roving and fishing enquiries.
In order to reduce the compliance burden of taxpayers, those who file returns electronically will now be required to file appeals and supporting documents too in the same manner without having to set foot in any of the I-T offices. Because of built-in validation of information provided, it is expected that defective appeals will decline.
After the Bombay High Court noted a large increase in the number of cases where revenue had filed appeals frivolously, the department ordered a review of all such cases all over the country. In order to bring more responsibility into initiation of litigation before high courts, it has directed that filing of all such appeals will henceforth have to be approved by a collegium of chief commissioners. The limits of tax effect below which no litigation will be permitted has now been doubled and raised to R10 lakh in the case of the tribunal and R20 lakh in the high courts; and fixed at R25 lakh in the case of the Supreme Court. This is expected to cut litigation by 50%.
Cumulatively, what is the likely effect of all these measures? They are a very good beginning, to be sure, but much will depend on how they are implemented. Annual confidential reports have been amended in the past as well, but unless attitudes change, they will continue to be written the way they have, with reporting officers continuing generally to rate their subordinates at least at the minimum level required for promotion. A system has to be devised by which not more than 5% of a cadre can be classified as outstanding. It makes no sense in over-rating average officials, and promoting everybody, because that way, the ratings themselves become meaningless.
Similarly, measures taken to reduce high-pitched assessments and litigation are welcome. But real reform will set in only when officers, at all levels, stop regarding taxpayers as potential tax evaders and see them as citizens with equal rights. One possible way this can be accomplished is to involve taxpayers and other stakeholders much more in tax administration. In other words, as in the case of OECD countries, the approach needs to be much more collaborative and participative. In the US, for example, collections from day-care providers improved considerably when tax administrators worked with them to understand the nature of their problems and simplified forms to meet their needs.
The ancient Egyptians had, in their day, found a way of constructing multiple locks so as to divert canal waters according to the needs of farmers. Likewise, developed tax administrations provide for multiple channels for redressal of grievances, allowing the taxpayer to choose the one most suitable for her needs. In India, taxpayers resort mostly to filing appeals when they are aggrieved against an order. It may be worthwhile for the government to consider other mechanisms—such as conciliation, mediation and closing agreements—which are popular in other countries. These alternative dispute resolution mechanisms, where responsible, respected citizens help in settling tax disputes, can prove very useful in instilling confidence, infuse fresh thinking and make the system less arbitrary.
The I-T department performs an important sovereign function, but how it collects tax is as important as the amount of tax it manages to collect. A young trainee officer thus should never be advised, as at present, to err in favour of revenue; instead, she should be told not to err at all. The department, she must understand, has to assess and collect taxes, according to the law, at the lowest possible cost to the government and the taxpayer. That means avoiding arbitrariness and acting responsibly at all times; then alone will voluntary compliance with the law improve, and the department become reminiscent of Nogales, Arizona rather than Nogales, Sonara.
Clearly, much hard work lies ahead.
The author was formerly chief commissioner of income-tax and ombudsman to the income-tax department, Mumbai.