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Quick ways to improve tax collection
February, 21st 2013

This budget season, I am unable to resist the temptation of putting forth my suggestions. First of all, the fiscal deficit needs to be reduced and it can only happen by increasing revenue and/or reducing expenditure. In FY13, expenditure was reduced but more on the capital expenditure side and a cut in capital expenditure can’t be sustained without adverse impact on future growth. There is a reasonable opportunity to raise revenue since our tax-to-gross domestic product or GDP ratio is about 16% versus 22% average in Latin America and 36% in OECD (Organisation for Economic Co-operation and Development) Countries.

Many Indians don’t pay appropriate taxes. While measures like goods and services tax (GST) and Direct Taxes Code are important from the long-term point of view, following quick remedies can improve tax collection significantly without introduction of new taxes.

Cap on tax-free long-term capital gains: Long-term capital gains on listed securities were exempt from income-tax to increase participation by retail investors in capital markets. But ultra high networth individuals (HNIs) have benefited from tax-free capital gains more than retail investors. A cottage industry can start investing in illiquid securities for converting unaccounted income into legal income through tax-free capital gains. A reasonable cap on exemption for capital gains will protect retail investors’ interest and at the same time increase tax collection. Tax deduction on housing loan interest can be increased from the current Rs.1.5 lakh as the multiplier effect of increase in housing activity can uplift growth by a good margin.

Link transactions to filed taxes: The income-tax department collects information on various types of transactions such as buying and selling of securities, cash deposits and so on. As per newspaper reports, 1.2 million transactions couldn’t be linked to tax returns filed. Significant tax collection can happen if this information is used to detect undisclosed income. A sustained campaign to highlight the ability of tax department to detect undisclosed income will improve tax compliance.

Monitoring jewellery stores: Most jewellery stores have a 24x7 surveillance system and cash counting machines at jewellery stores suggest large usage of cash in purchasing jewellery. In-house recordings of jewellery stores can be used to find people who bought gold without paying taxes for the same. As a bonus, this will also help reduce demand for gold.

Curtailing unaccounted money: Real estate provides a major avenue for deployment of cash/parallel economy proceeds. Reintroduce presumptive purchase of properties that are undervalued. This provision, in its short period of usage, was able to reduce the extent of black money in the real estate sector. Incentivize the government machinery to acquire as well as dispose of property in a profitable manner so that past errors of buying overvalued properties can be avoided.
Create a special task force to track economic activities that are predominantly settled in cash. Trading hubs, party contractors, big-ticket purchases and cash couriers are all worth tracking for bringing the parallel economy under the tax net and increasing tax collection.

Increase service tax: Services contribute more than two-thirds of the GDP but service tax contributes less than 20% of tax revenue. Service tax increases compliance as it is levied at the consumption stage. While service tax net has been widened, there may be more opportunities, especially in the unorganized sector. A nominal tax on a presumptive basis may incentivize the unorganised sector to come under the service tax net.
Streamline provisions: The forgotten tax revenue at Rs.5.12 trillion or 72% of tax revenue in FY11 suggests that there is an urgent need for streamlining provisions. Maybe some of the exemptions are past their expiry date and need to be removed. This simplification will provide level playing field to entrepreneurs, who don’t want to arbitrage tax regulations for profit.

Need for effective dispute settlement mechanism: Tax arrears of Rs.1.45 trillion for FY11 suggest the need for launching an effective dispute settlement mechanism. A consent system can save considerable time and effort and convert arrears to actual tax collection. Resources saved on pursuing legal cases can be directed towards finding out undisclosed income from the information collected on various transactions

The government is asset rich and cash flow poor. Sizeable amount of revenue can be generated by auctioning various entitlements, which are provided technically free to citizens but the cost is paid by consumer in some form. Postal stamps, road names, celebration in important places (imagine the price neo rich will pay for a wedding at Raj Bhavan or a birthday celebration in Rani Baug Zoo), auto number plates, parking slots, fast track channel for preferential access in queues from immigration and security check at airport to temple lines and so on. Obviously, the government can exercise its veto power to maintain the decorum and quality of such services.

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