So, how do we collect more taxes? Using the GST and following up on the audit trails it generates.

India simply does not collect as much tax as it should. The Centre and the states together collect tax worth about 17% of GDP, as much as Burkina Faso or Honduras does. Poor tax collections crimp the government’s ability to spend on the things it alone can finance, and stunt the nation’s ability to excel. India has to improve tax collections, & that does not mean raising tax rates.

When Budget Day approaches, the discussion turns to tax cuts and the fiscal deficit. A more rational thing to worry about is the size of the budget, meaning government expenditure, relative to GDP. The Centre’s budget is about 13% of GDP. The states together spend more, accounting for 58% of the combined spending of the Centre and the states.

Harvest Direct Taxes…
How is the spending financed? Tax revenues, non-tax revenues (licence fees, dividends from state enterprises, etc), borrowings and some unborrowed capital receipts, such as repaid loans and disinvestment proceeds, provide the spending firepower.

Non-tax revenues are not normally very elastic. It is only when some court settles a long-pending dispute in the government’s favour on some revenue share or the other that this item zooms. Loan repayments are, likewise, steady and relatively small.

Disinvestment proceeds can be lumpy, big chunks in some years, tiny granules in others. Borrowings have to be kept in check, otherwise people begin to worry about macroeconomic stability. That leaves taxes. So long as extra tax collections come from better tax enforcement and not higher tax rates, these would be received with universal applause.

So, how do we collect more taxes? Using the goods and services tax (GST) and following up on the audit trails it generates. This is simply not being done in an optimal fashion. GST is a value added tax. How much value a company generates is easily deduced from the tax it pays, provided it comes within the tax net. Suppose a company pays Rs 36 crore as GST at the rate of 18%, it means that it generates Rs 200 crore of value. This is not the only information that GST provides.

The value added by a company breaks up into gross profits, on the one hand, and wages and salaries, on the other. This economic insight is useful for both the taxman and for trade unions worried about under-reporting and underpayment of workers employed by the company.

The identity that the value added by a company is the sum of gross profits and compensation to employees makes it difficult to hide taxable profits or the number of workers employed by the company. If the company claims its gross profits are only, say, Rs 50 crore, then, it has to provide a list of employees to whom it had paid Rs 150 crore.

Those employees can then be tracked down via their bank accounts, if they are real and not ghost employees. If so many employees together earning Rs 150 crore cannot be identified, it straightaway means the company has tried to understate its income.

Of course, gross profit would shrink to a much slimmer figure before it becomes ready to part with the taxman’s pound of flesh. But there are only so many deductions that can be justified to reduce taxable profits. Of course, all this presumes that the company is actually in the tax net.

Suppose the company in question is, say, a synthetic garment manufacturer that has managed to leave no tax trail whatsoever anywhere along its production chain, from synthetic fibre to garment through yarn, cloth and transport. How is this slippery phantom to be conjured into a taxable, tangible entity?

From GST Audit Trails
There are only so many companies capable of producing synthetic fibre. Simple input-output norms can yield how much of polyester and other such stuff they have made from the feedstock they have consumed. Make them account for every sale they have made of fibre.

Let these buyers of fibre identify, in turn, the makers of yarn they sold the fibre to. The mills that spin the fibre into yarn can then be asked to identify the individual textile mills or powerloom operators who bought their yarn, or simply pay up the tax on the garments, with a mark-up for the value added in fashionable design and marketing, that the square metres of cloth yielded by the quantity of yarn they had supplied could potentially give rise to.

Once the weavers are identified, find out who bought the cloth from them. Trace the garment makers thereon. The distributors next, the logistics providers involved and the shops that finally sold the garments. The method can be applied to other basic raw material producers as well. It means some sleuthing and some analytics. Deployment of fancy analytics can reduce the gumshoe quotient involved. A transporter’s invoice, atruck that overturns on the road and spills merchandise without tax papers, a whistle blower’s squeal — anything can lead to better collections.

This sort of an analytical and enforcement framework should have been ready when GST was rolled out. But that is milk already spilt. It should be developed now. India’s knowledge processing companies can run circles around tax dodgers, if the government would give them a chance to.