Indias tax collection data revealed an interesting statistic recently. Up until August this year, over one-third of the total direct tax collection of Rs 60,970 crore was accounted for by the less glamourous cities or towns. The list includes cities such as Lucknow, Kanpur, Chandigarh, Guwahati and Nagpur where the growth ranged between 25% and 70%.

Many people, including tax officials, have been quick to say that this has got to do a great deal with the industrial buoyancy. Maybe, but it is no less clear that increased levels of compliance have helped lift growth in tax collections, especially over the last couple of years. True, the economy has expanded annually on an average by over 8.5% over the last four years, boosting tax mobilisation by an average of well over 30% during this phase.

But a critical difference has been in terms of compliance. Tax deducted at Source (TDS) returns for the salaried segment is now at least 90% and 70% for the non-salaried. This has been achieved because of the insistence of the tax department that at least 90% of the returns have to be Permanent Account Number (PAN) compliant, else the system rejects the returns. Not long ago, the compliance figure was just about 50% or so.

The move has paid off as reflected also in the swelling number of PAN cards issued. At last count, the number of cards issued in the country was 5.5 crore with 95 lakh cards alone issued in the November 2006-October 2007 period by the two issuers NSDL and UTI.

Little wonder, compliance figures are rising in other segments from a pretty low base such as credit cards, cash deposits and property transactions. The levels of compliance are yet to match those of salary returns, but that is where the government could step in.

Market regulator SEBI, in association with the government, was able to wield the stick of PAN in the securities market, but arbitrage opportunities are wide open in the insurance industry where the bulk of products sold are based on equity investment. PAN was envisaged as a national identity card obviating the issuance of such a card by either the home or labour ministries. The Kelkar Committee on Direct Tax, in its reforms report, had built a case five years ago for using PAN to effectively integrate it on the lines of the US Social Security Number system. That may be way off.

But just as in developed economies, the improvement in the tax-GDP ratio is due to the widening of the tax base and a better taxation structure and also a policy shift in favour of a unique business model the Tax Information Network (TIN). The policy reform unveiled at the fag end of the previous NDA government has seen the model based on build-operate-transfer basis really ticking.

For a country which has a young population (touted as one of its greatest strengths which could pay off in the years to come), the policy challenge would be, as the Kelkar committee said, to incentivise this segment and to co-opt them into the tax base. The committee recognised that leveraging this segment for both higher growth and tax revenues would call for the government to tread a fine line between incentivising effort and enterprise while simultaneously co-opting them into the tax base.

No such conscious effort seems to be on show as the going has been good. But such an effort ought to be mounted precisely now, well before a slowdown, for greater compliance does help in cushioning the fall during a relative low buoyancy phase.