The Hindu Business Line : How near is India to its taxable capacity?

While direct tax collections are on the rise, the contribution of indirect taxes as a percentage of GDP has stagnated the past four years. The kind of emphasis placed on the revamp of the direct tax administration is needed for indirect taxes too, says T. C. A. RAMANUJAM, adding that the tax administration seems to be missing the wood for the trees.

When the Mr Gordon Brown, the UK's Chancellor of the Exchequer, presented the Budget last month before the House of Commons, the British public felt exasperated at the fiscal damage done by Labour's spending splurge. Government spending rose, in real terms for six years, at an average annual rate of 4.9 per cent — well ahead of GDP growth. There was a massive swing in public finances from surplus to deficit.

Commented The Economist: "Inevitably, the tax-payer is picking up the bill: the tax burden is due to rise in the fiscal year that starts next month to its highest share of GDP in two decades — 38 per cent."

That should set us thinking. The Finance Minister, Mr P. Chidambaram, is struggling to raise the tax-GDP ratio from 10.4 per cent to 11.2 per cent. Where have we gone wrong? India is rated the fourth biggest economy in the world after the US, China and Japan (The Economist, April 1, 2006).

Corporate tax rates

Are Indian companies more heavily taxed than their counterparts in other countries? Table 1 lists the apparent corporate tax rates in various countries. India's tax rate of 30 per cent plus surcharge plus cess is not strictly comparable. According to the Budget papers, after availing themselves of exemptions, Corporate India pays a tax of only 19 per cent on profits. The corporate tax rates, at least prima facie, appear comparable with those in other countries.

Direct tax collections are on the rise. Although tax collection has gone up significantly, there has been virtually no increase in the number of assessees in the last three years. Direct tax collections went up from Rs 36,866 crore in 2002-03 to Rs 41,379 crore in 2003-04, and to Rs 50,929 crore in 2004-05.

The number of assessees remained almost constant, at 3 crore. Direct taxes contribute just 4 per cent of GDP and indirect taxes 6.4 per cent. There can be disappointment that Customs revenues have not gone up in spite of the rising oil prices and the liberalisation of imports.

The contribution of indirect taxes as a percentage of GDP has stagnated the past four years. More emphasis is placed on the revamp of the direct tax administration to check leakages and a similar focus is wanting in respect of indirect taxes.

The Finance Minister has announced that the quoting of the PAN (permanent account number) will be made mandatory and that IT officers will be enabled to issue PAN suo motu to such of those who are not willing to file their income-tax returns. This is a welcome announcement. But the law has to keep abreast of the ability of the recalcitrant tax-payers to beat the law.

Of the 43 million PANs issued so far, about one million are found to be duplicates and fraudulent. This came to light at the time of verifying the response to the IPOs of certain banks. It is a revelation that at the same time about 30 per cent of 17 lakh transactions reported under the Annual Information Return (AIR) up to December 31, 2005 did not have the relevant PAN.

The AIRs have proved to be a boon. Mutual fund transactions, property registrations and credit card details are all collated, and the Income-Tax Department is shooting off letters to verify if returns have been filed.

Taxable capacity vs total resources

American policy framers have found inadequacies in the age-old concept of taxable capacity measured in terms of a proportion of GDP. An article by Mahesh C. Purohit in Economic and Political Weekly of February 25, 2006 compares the relative tax effort and taxable capacity of the Central Government with the average tax effort of other similar countries, using various determinants of tax bases as per logarithmic formula. The results of the pioneering study are given in Table 2.

Does this mean that India's tax effort is found wanting, even in comparison to similarly placed countries such as Pakistan, the Philippines, Thailand and Sri Lanka? The data are bewildering.

The US Federal Reserve has developed a new tool for measuring the capacity of states to raise public revenue. This is known as Total Taxable Resources (TTR). The new measure takes into account all flows of income received by households in terms of total consumption of all goods and services plus changes in net worth.

It has been suggested that a comprehensive measure of income produced in a state should be used as a measure of the revenue raising capacity of the state. It should take into account all income produced in a state whether it accrues to residents or non-residents.

Measure of income produced and income received should be combined in order to provide a comprehensive indicator of a State's revenue raising capacity. A combined measure would provide a complete accounting of all income flows a state would potentially be able to tap in order to finance its public sector.

Any estimate of the tax effort as a ratio of the tax revenue to the taxable capacity will have to take into account the GDP or the GNI without ignoring various capacity factors such as size of population, administrative capability, degree of monetisation, availability of tax handles, etc. This is a suggestion for our national income accounting experts to work out.

Missing out on revenues

Much needs to be done in the field of our direct tax laws dealing with foreign companies. A competitive tax environment across the globe has resulted in the foregoing of large legitimate tax revenues due to India.

The OECD has been at the forefront of the battle against money laundering and its Financial Action Task Force has been cracking down on tax havens. It has identified 35 tax havens such as the British Channel Islands, the Bahamas, etc., on the basis of what is defined as "harmful tax competition" wherein countries try to attract people or companies that try to launder money or avoid paying taxes.

Instead of focusing on such larger issues on the international fiscal scene, our tax administration is frittering away energies on the collection of various cess, such as on iron ore Rs 7.72 crore, limestone Rs 16.49 crore, films Rs 0.90 crore, coffee Rs 50,000, and so on. A clear case of missing the wood for the trees.

(The author is a former Chief Commissioner of Income-Tax.)