The Hindu Business Line : Hallmarks of the new age

Buoyancy in tax collection, apart from the general performance of the economy, depends on the structure and stability of tax policies and improvement in tax administration.

Revenue is not to be measured against any one single factor. Apart from tax policy and administration, domestic and external factors also have an impact on revenue. However, a transparent and modern tax administration with the right attitude and accountability is needed to ensure the growth momentum.

The main purpose of taxation is to raise resources to fund government expenditure. The problem of tax design is to find a way of raising resources that is administratively and politically feasible and promotes equity and efficiency. There must clearly be some trade-offs between revenue, administration, political acceptability, equity and efficiency.

Effective tax administration requires setting up an environment in which citizens are induced to comply with tax laws voluntarily. This can become a reality only if non-compliance costs more — the penalties likely to be suffered in case of tax evasion exceed the tax to be paid. How effectively the tax administration can foster compliance would depend ultimately on their perceived ability to detect and bring tax offenders — unregistered taxpayers, stop filers, tax-evaders and delinquent taxpayers — to book. The tax administration must deal with all these categories of taxpayers simultaneously; otherwise non-compliance will shift to the gap where the administration exercises weaker control.

SELF-ASSESSMENT

Efficient tax administration requires that its task be performed at minimum cost to the community. Tax systems all over the world have, therefore, tended to move towards regimes in which taxpayers "self-assess" their tax liability and pay the amount due without any special prodding from tax authorities. But self-assessment will result in high compliance only if accompanied by the action of the tax administration that lends credibility to the sanctions prescribed in the law against non-compliance; and the quality service to taxpayers.

The economy is showing signs of steady and sustained growth. Macro-economic indicators are encouraging despite high and volatile international prices of petroleum products. GDP growth in excess of 8 per cent is taken for granted.

Growth in imports and exports since 2002-03 has been above the nominal GDP growth rates showing increased integration of the Indian economy with the global. Import is growing at the rate of above 30 per cent and export by 20 per cent. The rupee is appreciating steadily vis-à-vis the dollar.

CONSISTENT GROWTH

The improvement in the Centre's over-all fiscal position has attributed to the comfort provided by the buoyancy in tax revenue. The impressive performance of the revenue department has been specifically mentioned in a number of post-budget debates and discussions. Since 2002-03, the Centre's net tax revenue has been consistently growing above the nominal GDP growth rate.

The growth in indirect tax collection since 2004-05 has been consistently above 16 per cent. The budget estimate of indirect tax collection for 2006-07 also assumes the growth rate of 16 per cent.

Economics seems to defy logic. Tax revenue is perceived to be the reflection of the overall health of the economy. But facts do not support this presumption. Historical data shows varying trends. This may be due to inter-play of various forces in the economy. One may wonder why excise collection has not moved in tandem with the manufacturing sector growth. Growth trends in Customs, excise and service tax collection often are not uniform and even contradictory. In February this year, Custom revenue grew 3.89 per cent, excise revenue 18.42 per cent and service tax by 83.86 per cent. The overall growth of indirect tax collection was 16.19 per cent.

Buoyancy in tax collection, apart from the general performance of the economy, depends on the structure and stability of tax policies and improvement in tax administration. Last three years' steady and high growth in indirect tax collection shows stability in tax policy and improvement in the tax administration.

UPWARD TREND

The sudden change in the upward trend of indirect tax collection, despite progressive reduction in Customs duties and convergence of central excise duties to the median CENVAT rate of 16 per cent, merits attention.

Lack of buoyancy in excise revenue compared to the manufacturing sector growth or Index of Industrial Production is a matter of debate. If one looks at excise collection in isolation this inference is inevitable. But excise revenue is not merely a function of the performance of domestic manufacturing sector but critically linked to imports and exports.

Higher growth in import of capital goods and raw materials will reduce the excise duty collection. The reason is that the countervailing duty collected and accounted as customs duty on imported capital goods and raw materials are taken as input credit and utilised to pay excise duty on domestically manufactured goods. Ideally, countervailing duty is to be accounted under domestic taxes and not under Customs duty.

Input taxes paid on goods or services used in the manufacture of export goods or services are refunded under various duty neutralisation schemes for exports.

When exports grow faster, such duty neutralisation schemes impact excise duty collection negatively. Buoyancy of the sum total of excise duty, CVD and duty foregone due to exports with reference to total GDP for 2004-05 was 0.91.

COMPREHENSIVE GST

Taxation of goods and services uniformly is a forward step in the direction of comprehensive Goods and Services Taxation (GST). Taxing economic transactions till the point of final consumption matters and not the distinction between goods and services.

Comprehensive GST prevents misallocation of resources and ensures economic neutrality. Discriminative tax policies cause distortion in competition and resource allocation.

Taxing of services though started in the year 1994, widening of the service tax base in a significant way started since 2003-04. Service tax collection during 2005-06 is expected to exceed the budget estimate of Rs 17, 500 crore and the Budget Estimate for 2006-07 is Rs 34, 500 crore. Tax-GDP ratio of service tax, which was 0.1 in 1995-96, is expected to go up to 0.7 in 2005-06. The higher buoyancy in service tax collection is expected to continue till the base expansion is comprehensive.

In 2004, input credit scheme was extended comprehensively across goods and services. To the extent input services are used for the manufacture of excisable goods, excise collections tend to slow down. Customs, excise and service tax revenue are inter-related and need to be viewed in totality.

The buoyancy of total indirect tax collection in 2004-05 with reference to total GDP that was 1.3 against the buoyancy of 0.5 of excise collection with reference to manufacturing GDP confirms this approach.

Tax exemptions do serve limited purposes but they are implicit subsidies and in the long run tend to cause economic distortions. Many of the exemptions have been withdrawn, but there is still a long way to go.

With end-use-based exemptions, it is difficult to eliminate the direct contact with the officers of the Department. Exemptions increase the transaction cost and provide incentive for misuse.

The real economic cost of exemptions is difficult to estimate. They inevitably encourage rent-seeking. Clear guiding principles with an institutional mechanism to control fresh exemptions may be a preferred option. In this year's Budget, a beginning has been made to create awareness on the economic cost of exemptions and the desirability to abolish them.

Revenue is not to be measured against any one single factor. Apart from tax policy and administration, domestic and external factors also have an impact on revenue.

However, a transparent and modern tax administration with the right attitude and accountability is needed to ensure the growth momentum. Can the Revenue Department rise to the occasion and continue to play its role?

(The authors are members of the Indian Revenue Service. The views are personal.)