Tax reforms: Let’s prove Einstein wrong

September 18, 2020 6:45 AM

Both e-assessment and e-appeals can curb unrealistic tax demands and grievances, in addition to reducing corruption, tax disputes and litigation

This recovery shows a promising way out for Indian MSMEs who are struggling in retail markets.This recovery shows a promising way out for Indian MSMEs who are struggling in retail markets.

By Bibek Debroy & Aditya Sinha

Direct tax payments and collection have always been messy. “Little else is requisite to carry a state to the highest degree of opulence from the lowest barbarism, but peace, easy taxes, and a tolerable administration of justice; all the rest being brought about by the natural course of things”. That is an Adam Smith quote, or so we think since the quote is indiscriminately used. Where did Adam Smith write this? Not in the 1776 Wealth of Nations. The quote is supposedly from a 1755 paper written by Adam Smith, quoted by Dugald Stewart in 1793. No such paper has ever been found, and no one other than Dugald Stewart has ever seen this 1755 paper. Nevertheless, since taxes are as certain as death, both taxpayers and tax administrators want a simple system.

The government has made attempts to make the tax process, meaning in this context, direct taxes, simpler and more people-friendly, both for organisations and individual taxpayers. The direct tax/GDP ratio is 5.18%. It should be higher, as it is in more advanced countries. Though easier to enforce, indirect taxes are inherently regressive. In the latest round of tax reforms, to make taxes and their enforcement more transparent, the government has focused on three aspects—taxpayer’s charter, faceless-assessment and faceless-appeals. These are designed to reduce taxpayer harassment. The 14-point charter outlines responsibilities of both the taxpayers and assessors and emphasises key delivery processes and outcomes, such as respecting the privacy of taxpayers, reducing costs of compliance and time-bound delivery of services.

E-assessment removes the possibility of biased evaluation by reducing physical interaction, introducing random allocation of cases through artificial intelligence (AI) and conducting a phased assessment with different officials. Assessment will also be done in a city other than the city of the assessee, thereby reducing the possibility of corruption. The national e-assessment centre will assign the evaluation of a case to any regional e-assessment centre through an automated allocation system. The assessment unit will then pass a draft order, which will be examined by the national centre, with a system of multiple checks and balances. In any transformation of governance to e-governance, the use of information technology reduces human interface and bribery and rent-seeking. Therefore, taxpayers should welcome e-assessment, and media reports about resistance are mystifying. The only explanation is the plausible hypothesis that every bribe-taker has a bribe-giver as a counterpart, and down the years, a comfortable nexus has been created. Similarly, e-appeals also eliminate physical visits, and appeals are allocated in a randomised manner to a zone other than where the initial assessment was carried out. Some have argued that appeals by nature are adversarial, as compared to assessments, and human interaction is essential in complex cases. This doesn’t sound very convincing and may again be an extension of the comfortable nexus hypothesis. If the tax demand is `100, a private illegal and bilateral contract of Rs 80 benefits both parties, though it privatises public revenue receipts. Nevertheless, to address this issue, the finance ministry has already stated there will be virtual hearings for such cases.

Both e-assessment and e-appeals can curb unrealistic tax demands and grievances, in addition to reducing corruption, tax disputes and litigation. As an aside, unrealistic revenue projections and targets don’t help. When nominal GDP growth declines, 14% direct tax revenue targets are just as unrealistic as 14% GST compensation to states. On appeals, the monetary limit for appealing before various adjudicating bodies has been changed. The hikes are to Rs 50 lakh before the Income Tax Appellate Tribunal (ITAT), Rs 1 crore before the High Court and Rs 2 crore before the Supreme Court. Disputes and tax litigation need to decline.

Till February 2020, direct tax revenues raised, but not realised because of disputes, was around Rs 8 lakh crore. Law ministry’s Legal Information Management and Briefing System (LIMBS) suggests that in around 85% of the total pending direct tax cases before various ITATs, High Courts and the Supreme Court, ITD (the department) is the petitioner. In the Supreme Court alone, ITD is the petitioner in more than 95% of direct tax appeals. Such a high volume of government litigation has the potential to crowd out the private citizen from the court system. In most of these appeals, CBDT may have lost at multiple appellate forums, be it CIT[A], ITATs or High Courts. It is possible to predict the outcome of such litigation with a reasonable degree of certitude. But despite this, ITD continues to appeal. This is partly because of the Prevention of Corruption Act (PCA). However, there can be a principle that if it loses at two forums, CBDT will not appeal further.

Plus, there are exemptions. A substantial number of pending cases can be attributed to exemptions, which blur the distinction between tax avoidance and tax evasion. Before proceeding to adjudication, they increase scrutiny by the tax department, making it difficult to reduce compliance costs. As with the justice delivery system, ex-ante, one doesn’t know the outcome of an investigation. Revenue foregone in 2019-20 due to exemptions/incentives for corporate taxpayers, non-corporate sector and individual/HUF taxpayers was around Rs 1,06,918.77, Rs 7,222.44 and Rs 1,16,273.57 crore respectively. Exemptions also explain why 57.8 million individuals submit income tax returns, but only 43.2 million don’t pay taxes. Only 14.6 million individuals actually pay income tax. Einstein said, “The hardest thing in the world to understand is the Income Tax”. Note that he said this to his tax accountant, Leo Mattersdorf.

Debroy is chairman and Sinha is assistant consultant, EAC-PM. Views are personal

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