Appropriate tax administration

At a discussion at the London School of Economics led by the recently retired head of the UK tax department—Her Majesty’s Revenue and Customs (HMRC)—interesting observations were made with lessons to be learnt. The central question relates to what a successful public service is in the context of taxation.

Thus, the outcome of a good tax administration reflects three fundamental components: Tax determination, computation, and payment.  Associated questions immediately arise. Since tax determination necessarily requires information, who will be responsible for ob­tai­ning information? Since computation requires knowledge, on whom will it depend, who will ve­rify it, and what if there is a dispu­te? On payment, how is a taxpayer to be treated? A good tax administration will address all three fundamentals adequately.

An obvious measure of performance is cash received by the administration, though this is not without conflict for, the tax administration is likely to consider the best way to organise tax administration differently from the finance ministry. Rather than meet a specific revenue objective, the tax administration typically prefers to minimise the tax gap—how much revenue could not be collected—since this comprises a measure of the effort made by the administration rather than reaching a specific revenue target irrespective of the means or method in so doing.

However, collection cannot be made willy-nilly. There are alternative approaches. The US depends on private sector support such as H&R Block which helps fill tax returns for a significant number of taxpayers. In the UK, over two decades, there has been a rebranding of UK taxpayers as customers, a concept that substituted the earlier overbearing appearance of the revenue officer. And the administration itself provides filled-in tax return forms based on its own data, and asking customers to make adjustments to it to reflect the last tax year’s developments.

Yet, the UK’s is a passive approach—that is, the citizen takes responsibility for his own timely tax payment, building on the tax code provided by the tax administration, a term used by the UK to denote each customer’s tax calculation made and provided by the administration. The Indian tax administration aspires to do so. This is preferable to active chasing by the administration for money. Reliance on voluntary compliance is of the essence with greater emphasis on data analytics rather than use of paper, phone or seizures. In the UK, 98 per cent of tax comes in without any intervention. This occurs from two motivators — citizens pay up since paying up is a good thing to do or due to risk aversion to possible adverse action from the administration. It is the former motive that Indians have to arrive to.

HMRC is averse to changing this model since it is perceived to have worked well, essentially spending some £5 billion and collecting some £600 billion.  In the background are 54,000 staff members, the high number reflecting the responsibility that falls ultimately on its shoulders. To buttress voluntary compliance, one assurance in the UK is to get customers from one end of the process to the other as quickly as possible, an objective that the Indian tax administration is yet to accomplish. As I have indicated on several occasions, it is the speed of assessments and time elapsed on closing a scrutiny that are the ultimate judge and jury of the efficiency and equity achieved by a tax administration and, therefore, the confidence that it generates in the taxpayer.

It is not as though there are no weaknesses, challenges or difficulties faced by the HMRC. Some challenges appear to continue from the time I served as its chief economist almost a decade ago. One challenge is to break the inertia of a certain category of taxpayers who are generally willing to pay but tend to stay on the fence until nudged. A second is the recognition of the existence of some tax evasion reflecting cash transactions at home and evaders investing in financial funds abroad but not reporting it. Third is a challenge to minimise tax avoidance which is strictly legal but lies outside the intention of legislation. Of a £33 billion tax gap, tax avoidance is £2 billion. However, fourth, the taxman faces massive political and social resistance to his crossing a perceived threshold of justifiable action. In India, this has appeared strongly in the Tax Administration Reform Commission (TARC) recommendations.

Fifth, considerable challenge emerges from a territorial basis of taxation. Tax is collected on a national basis while, for collection outside the border, international collaboration becomes important. Indeed, while this is a universal problem including for the UK, emerging economies such as India face it more intensively. OECD’s Base Erosion Profit Shifting (BEPS) Actions recommended automatic exchange of information among tax administrations in certain aspects but precondition for much exchange of information would occur only after a process of justifications. Whether powerful tax administrations would take this up seriously is, of course, to be seen.  

In the future, HMRC plans to increase third party information, in particular from the financial system, since most economic activity is recorded somewhere in today’s e-world. In the UK, reflecting privacy, information is based on businesses—what are their volumes of operation—rather than on their customers. In India, however, the Annual Information Returns (AIR) collected from a comprehensive list of businesses and institutions actually include information directly on the financial transactions of their individual customers. Erroneous information from AIR resulting in mistakes in scrutiny and causing taxpayer anxiety has occurred in India. HMRC’s approach to third party information is more cautious. Indian administration needs to rethink its strategy on this.

Thus, HMRC’s approach has been one of soft touch and will continue to be so. Other than covert action, policy and action are attempted to be transparent. Search and seizure as an instrument is rarely used. Finally, individual tax accounts are kept away from politicians. Government can drive overall tax administration policy but cannot access individual accounts.

Many of UK’s practices, challenges and policies have found place in India’s 2014 six-volume TARC report. Its recommendations are being selectively implemented. For best performance, the UK merged its direct and indirect tax departments in 2006 following the global pattern. This fundamental comprehensive structural reform is awaited in India. 

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