It, therefore, makes much more sense to simplify and rewrite the I-T act; allow the department to collect tax according to its mandate, and to entrust the task of granting subsidies to the ministries concerned.
Thirty years ago, the eminent constitutional and tax jurist, Nani Palkhivala, observed that the Income-Tax Act was a national disgrace because, between 1962 and 1990, it had been mutilated more than 3,000 times!
Thirty years on, amendments continue to be enacted at a relentless pace. From its inception, the I-T Act must, by now, have been amended more than 6,000 times. Many of these amendments have been hastily drafted without consultation and have given rise to innumerable legal controversies, cluttering an already overworked and inefficient judicial system. Today, the I-T Act must surely be amongst the most complicated enactments in the world. This sad state of affairs has had several unfortunate consequences.
Complexity breeds uncertainty that business hates. Tax laws in our country—particularly retrospective amendments in the law such as the one occasioned by the Supreme Court’s pronouncement in the Vodafone case—discourage foreign direct investment. If foreign direct investment still comes, it is not because of our tax laws but despite them.
But even more importantly, complex laws, through unnecessary litigation, generate large arrears, very few of which are actually collectable. At the end of FY18, the last year for which figures are available in the public domain, such arrears stood at Rs 11.14 lakh crore, or 111.11% of the annual collections of that year (Rs 10.03 lakh crore). The situation is analogous to a firm whose bills receivable exceed its annual turnover! (Alarmed, the Central Board of Direct Taxes has, in order to reduce litigation, recently taken action to raise the threshold for filing of departmental appeals; but this hardly addresses the problems that beset both policymaking and implementation).
Apart from administrative problems, complex laws also raise compliance costs of taxpayers, who must incur considerable expenditure in hiring chartered accountants and lawyers for preparing their accounts, filing returns, facing scrutiny and fighting litigation. If anecdotal evidence is to be believed, such compliance costs are today amongst the highest in the world. This is one reason for low voluntary compliance.
Our tax laws are complex because the policymakers are obsessed with overruling unfavourable rulings of the Income-Tax Appellate Tribunal, the high courts and the Supreme Court, forgetting that the uncertainty generated by the amendment often outweighs these short revenue gains.
Besides, policymakers also have a penchant for deploying the I-T Act for achieving many conflicting objectives, other than just raising revenue. This legislation has been used for providing special deductions for promoting all manner of socio-economic activity ranging from exports to scientific research, from rural development to skill development projects; and from infrastructural projects to housing projects. The question is not whether the state should provide such subsidies. The question is whether the I-T Act is the best vehicle for achieving such objectives. When the government chooses the income-tax route, it subjects the citizen to a great deal of harassment. Tax officers are trained to maximise revenues; and will use any pretext to deny such exemptions and deductions. The poor citizen has to litigate for years before she gets her due. This is hardly what the policymakers intended.
It, therefore, makes much more sense to simplify and rewrite the I-T act; allow the department to collect tax according to its mandate, and to entrust the task of granting subsidies to the ministries concerned. This way, there will be much more certainty both towards collections and outgoes.
There is another myth on taxation that needs to be busted. This relates to progressive taxation—namely, that a person should progressively pay a higher proportion of his income as tax, as his income keeps increasing. When FM Nirmala Sitharaman increased the rebate under section 87A of the Act to Rs 5,000 for individual incomes up to Rs 5,00,000, she absolved about 79% of individual taxpayers from any obligation to pay income tax. Currently, therefore, only less than 21% of individual taxpayers pay tax. These people constitute about 1% of the total population of this country. The income-tax regime cannot effect a major redistribution of income except within this small, already well-off segment of society. Such an exercise would be counterproductive because it would discourage savings and hard work and incentivise evasion.
Thus, when through the Finance Act of 2020, the FM gave individuals the choice to be taxed at lower rates without claiming exemptions and deductions, she was on the right track, to the extent that she was trying to phase out the latter and moving towards a more efficient tax structure. She, however, misdirected herself only when she increased the number of tax bands from four to seven.
Policymakers often forget that even with a single rate above a certain threshold, a rich man will pay more tax, as she earns more. If this band is optimally determined, it may, through higher savings, investment and growth, maximise revenue as well. Even so, if the polity is more comfortable with multiple bands, above the basic exemption limit, these should not exceed three.
Palkhivala would heartily have agreed that a government that sacrifices growth for revenue or equality will, in the end, get neither growth nor revenue or equality. On his birth centenary, we can remember him by this thought.
The author is Former chief commissioner, Income-Tax