Prime Minister Narendra Modi told his government's tax officials last week that they must widen the tax base. This is an unexceptionable statement. However, this goal cannot be achieved without undertaking reforms in tax administration - an area that has been largely ignored by successive governments in the past. Significantly, a clear pointer to the urgent need for reforming tax administration came from the prime minister's startling revelation that just about eight per cent of individual tax collections took place as a result of the revenue department's attempts at unearthing individual cases. These are tax collections that result from the various notices the tax department sends out to recover taxes after random scrutiny of cases or tracking high-value transactions.
If this is what the government's data reveal, then the first item on the agenda for reforming tax administration should be to seriously consider abolishing tax collection targets. Setting estimates of annual tax revenue collections at the time of presenting the annual Budget is perhaps a necessary tool for the government to manage its finances. But it is not reasonable any more to expect the tax department to treat those numbers as its annual targets. Nor is it advisable for the government to judge the performance or effectiveness of the tax department on the basis of whether it meets those targets. This is because the root of why revenue department officials harass taxpayers is the pressure they are under to meet the tax collection targets. In many cases, revenue department officials raise tax demands that they know to be unsustainable. But they send such notices largely in an attempt to meet targets.
In an ideal situation, tax revenue should flow from economic activity and the tax effort should be focused on cogently matching revenue with such activity, to examine where revenue might be falling short. For the tax department, therefore, it would be reasonable to maintain a dynamic tax collection target that will depend on a variety of factors including the pace of economic activity and close monitoring of which sectors are doing better than others and, therefore, capable of generating higher revenues. Such a system is already in vogue in some developed countries and should be introduced in India.
Simultaneously, tracking down actual tax evasion should be handled more intelligently, using data and cross-checking to track evasion. Thanks to technology and widespread digital tracking of economic activity, the government has access to huge data but it is not putting them to effective use. It is time the revenue department used more data instead of using blunt methods of harassment.
Another change the government should consider is to disallow the tax department from going in for a third round of appeal if it has lost a tax case at two successive levels of adjudication - at the appellate stage and the next higher stage of appeal. This should bring down the number of such pending cases, reduce fruitless legal action that clogs the courts, and save taxpayers avoidable legal expense and trouble. At present, tax arrears arising out of individual income-tax disputes are estimated at around Rs 2.77 lakh crore, while a higher amount of Rs 3 lakh crore of arrears is realisable even though there are no disputes. If reforms in tax administration are speeded up, many such problems would be a thing of the past.