Simpler tax laws, low rate can help get more people to pay up
May, 09th 2016
Much about taxes tend to be dismal. Data recently released by the Indian government shows hardly 1% of our population actually pays income tax. The horror that millions are getting away without paying taxes hurts every honest taxpayer, including yours truly. If we want more people to pay taxes, we need a low tax rate, simpler tax laws that do away with most deductions and exemptions, a near complete dismantling of the tax administration, and a government that chooses to be lean. Instead we think about taxes rather conventionally.
Citizens do not necessarily see paying taxes as a patriotic duty. Taxes pay for defending our borders, fund the police and legal systems, run the legislative and administrative machinery of the government, ensure essential public infrastructure including transport, and provide social benefits to the less privileged. Therefore, when people do not pay taxes, there is no money to run an efficient government. However, there is no evidence to show that higher tax revenues lead to better governance. The Scandinavian countries are the only known exceptions where the governments take on a larger role, and citizens willingly pay a higher rate of tax. Everywhere else, citizens uniformly dislike taxes.
In the socialistic set up that was India in the early years after Independence, the role of the government was large. However, that did not lead to better outcomes for citizens, with the country being dragged through a period of stagnated economic growth and poverty. There is overwhelming evidence of poor quality, high cost and inefficient delivery of goods and services by the government.
The private sector now dominates services that should have been provided by the government, especially in education and healthcare, at much higher costs. This indirect tax impacts the poorer and weaker sections, and this outcome is not about adequacy of tax revenue but about inefficiency in utilisation. Tax avoidance thus becomes a social norm. Citizens utilise resources better for their selfish use, rather than hand it over to be frittered away by the government.
Corruption and low tax compliance are related. In dictatorial anarchies where the rulers swindle public money, tax compliance is the lowest. Public welfare is low too in corrupt regimes that run out of money, running costly and poorly administered welfare schemes. Venezuela's elaborate food stamp programme has left citizens in misery, without basic items of food, while the government bemoans the lack of tax resources to fund the program. IMF has published a series of research papers, which shows a direct correlation between corruption and low tax revenue.
A large amount of tax revenue is wasted in corrupt regimes in several ways. The tax administration involves personal interactions with tax authorities, who enjoy discretionary powers to review taxes paid, impose fresh taxes and penalties. Tax evaders in collusion with corrupt officials, trade off payments to administrators over tax payments to the government. Small businesses in India often see paying income tax as a needless additional burden. Corrupt regimes are inefficient in implementation of public projects and do not utilise tax revenues optimally.
Time and cost overruns in public projects, poor quality outcomes, and poor selection of vendors lead to misuse of tax revenues. Government projects in India, from the municipality to the central level, suffer from corrupt practices. A corrupt administration does not impose the rule of law, or administer taxes fairly, leading to larger number of evaders going scot-free.
It is common for tax regimes to be needlessly complex in design. Research shows how an elaborate system of deductions, concessions, provisions, definitions and exemptions might have actually led to low effective tax rates for the richer class. Those who can afford the services of a tax adviser, and those businesses which can modify structures to reduce tax outgo, exploit the loopholes.
High income-earning entities will spend the money required to avoid paying consistently high taxes. It is legal to use tax planning and in a competitive business environment, tax becomes an item of cost to minimise. Governments respond to poor tax revenues by keeping tax rates high, or by arguing that lowering the tax rates would lead to loss of revenue. Keynes famously likens this attitude to that of a businessman who refuses to reduce the price of his goods, since he is already making a loss.
While common sense will require using a lower price to expand the market, both the businessmen and the government will argue that their current losses makes it difficult to do so. There is enough evidence to show that high taxes are counterproductive. The incentive to produce is reduced, economic output drops, unemployment increases and revenues shrink. Every period in the world's economic history, where high tax rates were used as a tool to shore up revenue, or bring about income equality, failed. Those who lived through the 1970s India where marginal rate of income tax was 97% would vouch for the ills these punitive taxes unleashed.
We cannot achieve better compliance by tinkering with margins, or modifying subsections of tax laws in every annual budgeting exercise. We should be able to implement a tax regime that is not punitive or confiscatory, but basic and nominal to not evoke grudge. What if we had a very nominal rate of taxation on our income, say 10%, that is paid at source without exception as a direct debit from the bank account through which all payments must mandatorily flow, What if we give up the notion that tax has to focus on the rich, and instead incentivise keeping more of what we legitimately earn? A low rate that is easy to administer and tough to evade would enhance revenues. Getting the government to use the money responsibly is a different challenge though.
What if we give up the notion that tax has to focus on the rich, and instead incentivise keeping more of what we legitimately earn? A low rate that is easy to administer and tough to evade would enhance revenues. Getting the government to use the money responsibly is a different challenge though.