Reducing Tax Gap: Quantifying tax gap gives real picture of total revenue due & from whom it should be collected

January 25, 2021 7:00 AM

Since tax collections are not likely to be buoyant even during the next FY, the government may need to incur higher fiscal deficit if the current level of expenditure is to be maintained or enhanced.

The moot point is how the tax department can win the confidence of taxpayers.The moot point is how the tax department can win the confidence of taxpayers.

By Sanjay Kumar

The Centre’s tax-to-GDP ratio has hovered between 10% and 12%, the highest being in FY18. This year it may get hit, and range from 9% to 9.5%, a sharp decline from the budgeted 10.8%. In FY20, it was 10.5%.

The current year decline is understandable. Taxes constitute about 60% of total receipts of the government, and thus are major source of budgetary spend of the government. If revenues fall short, it can be expected the government would have to make do the receipts with extra borrowings and through increased disinvestment proceeds, etc. Alternatively, it would have to reduce its expenditure. Since tax collections are not likely to be buoyant even during the next FY, the government may need to incur higher fiscal deficit if the current level of expenditure is to be maintained or enhanced. Tax collections not improving constrains the government’s spending reach, and the high-profile programmes it may want to take up, from digital transformation to enhancing health spending to increasing infra spending, may get spread over multiple years. That could crimp the overall aspiration from a transformative India to an incremental India, given that the general expectation from this year’s Budget is it would be bold and transformative.

India’s tax collections as a percentage of GDP have not really moved up and are lower than Thailand (15%), Singapore (13%), Japan (12%), the UK (25.5%), and the OECD countries (35%). No doubt, tax collections would not get boosted without the growth in the economy, throwing up the question whether we are realising our potential, and if so, to what extent?

Some international research suggests that India’s tax gap—the gap between actual and potential tax collections—is quite wide. Studies suggest that despite systematic reforms, revenue productivity of the tax system has not shown any appreciable increase. A large number of taxes do not get collected. Disputes abound.

In direct taxes alone, tax arrears have accounted for over 50% of the budgeted collections for years. Sure, a large part of these arrears may be in dispute. But still a major chunk of these arrears remains uncollected year after year. Can this be rectified?

The government, through faceless assessment and appeals process, is trying the remedy the quality of tax audit/assessment, striving to bring in evidence-based audit, making sure the audit or appeal are technically reviewed by a panel of senior officers before the tax demand is raised. The expectation is that this will improve tax assessment and appeal quality, and that would have a positive impact on voluntary tax compliance. Improving voluntary tax compliance, however, is not dependent only on one aspect. There could be other reasons, too. Procedural incoherence or complexity of tax rules can also adversely impact compliance.

The moot point is how the tax department can win the confidence of taxpayers. It requires more. There are many corporate taxpayers who do not get their tax refunds for years. Many times, their refunds are rolled over against the new taxes. The reason is that everyone is fixated on the budgeted tax collection. That is quite a narrow approach. In such an environment, tax officers get constrained to collect taxes even when the underlying aspect which drives growth in taxes, i.e. the economy, is not doing well. It puts pressure on the tax system, including on the taxpayer and the tax collector, without reasonable tax gains.

Advanced tax administrations have moved to tax-gap reduction mechanisms. The tax gap may also include uncollected taxes, unintentional errors, underground economy and illegal activities. Quantifying the tax gap gives a picture of the total revenue due and from whom it should be collected (or in relation to what transactions), besides informing the government about the integrity of the tax system, risks to revenue buoyancy and performance of the tax department. The tax gap can be for each sector, industry-wise, geography-wise, etc. Overall impact could be the much-desired widening of tax net, a crucial aspect of any ideal tax administration. Reasonableness of the tax administration, making sure that only those who have not complied need to be chased, will urge taxpayers to voluntarily comply and instil fear amongst those who evade taxes. Even the tax department would have time and resources to concentrate on evaders. It’s a fair and reasonable approach, after all.

The author is partner, Deloitte India

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