INCOME-TAX EVASION—FAILURE OF ONE DOZEN EXPERT COMMITTEES---S S Bagai

SUMMARY

Tax Evasion- Since 1947, nearly one dozen expert committees, including the Kelkar Task Force, have persisted in making wrong recommendations for changes in the income tax (I.T.) system due to their neglect of the most basic and fundamental problem of massive tax evasion.

Tax evasion is entirely the result of reckless pushing up of rates. For instance, income just above Rs one lakh (in rupees of 2003) was not taxed at all upto 1939; at 3 % till early 1960'^s, and now the rate stands increased by nearly 7 times, to 20 %. Similarly income just above Rs 1.5 lakh was not taxed at all upto 1939; at 6% till early 1960'^s and now at 31.5%.

Till 1939, India had a highly civilized and clean I.T. system. Exemption limit ( in rupees of 2003 ) was Rs 2 lakh and the rates of tax on income up to Rs 10 lakh were all below 8 %. Some other developing countries still have such tax systems, which command respect and compliance from the taxpayers and consequently provide more than double of India's revenue.

Salary earners are the principal victims of lowering of the exemption limit to Rs 50,000 and pushing up of the rates.

Tax evasion continues to cause immense damage not only to the finances of the government but to the entire economy of the country, because a major part of the tax evaded money gets stored abroad.

Tax evasion can be stopped almost totally and income-tax revenue doubled from its long term fixed level of around 3% to 6% of GDP, by adopting rates similar to those introduced by President Putin in Russia.

Folly of Taxing Small Income Earners Since last four decades government is persisting with the extremely unwise policy of forcing a few million large income earners to evade tax on a major part of their income through atrocious increase in rates, and is now chasing and harassing crores of small income earners, who cannot possibly provide much revenue. Recently added two crore tax payers are probably not contributing even 0.05% of GDP to revenue.

Other Evils - Currently I.T. system stands thoroughly damaged as it suffers from several other major evils like, huge litigation, widespread corruption, complexity of law and unrecoverable arrears. But they all arise from tax evasion or attempts to control it. Countries which have very little tax evasion are free from these evils also. All the expert committees including Kelkar's have failed to take even casual notice of these evils, leave aside dealing with them seriously.

INDIA’S REVENUE STAGNANT AT 3 % OF GDP AGAINST 8% IN MANY OTHER DEVELOPING COUNTRIES.

Since 1947 the main object behind the appointment of nearly one dozen expert committees, including the Kelkar Task Force (KTF), was to advise the government on how to collect more revenue. Till the 1950’s, almost all the developing countries of the world, including India, were collecting income-tax (IT) revenue between 2 to 3 % of GDP.

With industrialization and economic development, income of a few million successful entrepreneurs and partnership firms and companies through which they operate, goes up very sharply. They can easily pay very substantial amounts of additional income tax, provided governments do not try to snatch away too much from them.

Those countries which adopted low rates and hassle free tax systems have succeeded in pushing up their IT revenue to around 8 % GDP. In India it still remains around 3 % of GDP only because the government continues to persist with the utterly wrong policy of trying to snatch away too much from the successful entrepreneurs.

Realizing that there is something fundamentally wrong with the current policy, government goes on appointing one expert committee after another in quick succession, in the vain hope of getting correct advice for changing the system. Three of them were set up in the last one decade alone.

FAILURE TO MAKE SYSTEMATIC STUDY

However all these committees have been making inappropriate recommendations because none of them conducted a systematic study of the system.

They should have raised and answered the following three most important questions in order to arrive at sound conclusions.

1. HOW MUCH REVENUE OTHER COUNTRIES ARE COLLECTING

They should have started their study by finding out how much revenue similarly placed countries, which have started growing industrially after the second world war, are collecting.

If they had done so they would have found a wide gap between the quantum of India’s and those countries IT revenues. The following table shows the amount of revenue collected in five countries during 1996-97:

Income-tax Collected As Percentage of GDP IN 1996/1997

Country Percentage

Malaysia 8.4 %

Singapore 9.0 %

Hong Kong 7.8 %

Indonesia 8.6 %

India 2.6 %

2. HOW OTHER COUNTRIES HAVE SUCCEEDED ?

Huge gap between the amount collected by India and other countries should have set these committees thinking and forced them to find out the reason behind it.

If they had pursued the subject seriously they would have discovered that the reason behind the vast difference in figures of revenue was the massive tax evasion in India. Although it is difficult to measure the quantum of tax evasion there exist some indicators which give a broad idea.

QUANTUM OF TAX EVASION IN INDIA

A rough idea about the quantum of tax evasion in India could have been formed on the basis of the following four major indicators:

(i) the number of individual tax returns with income above Rs 2 lakh ( in terms of rupees of 2003 ) has not gone up even three times in the course of last six decades. In 1939 there were 2.7 lakh such returns and currently their number is around 7 lakh only. Actually the number of persons with income over Rs 2 lakh must have gone up 30 times or 50 times. This one fact alone shows how widespread tax evasion in the country is;

(ii) the quantum of income taxed in the hands of companies in many developing countries exceeds 15 % of GDP, while in India it is hardly 5 %;

(iii) large amounts of tax evaded income disclosed in the frequently launched disclosure schemes, despite their high rates;

(iv) huge quantity of black money that changes hands in property transactions, sent abroad or spent lavishly within the country.

Even a quick survey of other countries would have shown the extremely low level of tax evasion in them. Actually the very fact that they are collecting large amount of revenue shows that evasion must be negligible.

3.WHY TAX EVASION SO LARGE IN INDIA ?

The most important question that these committees should have considered is the reason behind so much tax evasion in India. They were not unaware of the existence of substantial tax evasion. But they always disposed of the subject casually by blaming it either on low morality of India’s taxpayers or loopholes in law or laxity in administration. They kept making meaningless suggestions such as ‘change the mindset of the taxpayers’.

OTHER COUNTRIES RATES.

If any of these committees had looked at the rates of successful developing countries it would have at once discovered why their tax evasion is negligible and the revenue collected by them is two to three times more than India’s.

A few countries main rates are mentioned here.

The city of Hong Kong has the most ideal tax system in the world. Without taxing interest, dividend, capital gains and international trading income, it has been collecting more IT revenue than the whole of India, even in absolute terms. For individuals its exemption limit is around Rs 14 lakh, starting rate is 2% and maximum rate is 20%. Companies are taxed at 15%. The city is also almost totally free of the evils like litigation, bribery and accumulation of tax arrears. Because of massive voluntary compliance, it does not need an army of law enforcers. It employs one Commissioner (counterpart of CBDT), two deputy commissioners and five assistant commissioners. India employs thousands of them.

Singapore has exemption limit of Rs 5 lakh, starting rate of 4% and applies its maximum rate of 22% to income above the equivalent of Rs one crore. Rates of mainland China are far from the ideal, but unlike India it has the good sense to apply the rate of 30% to income above the equivalent of Rs 30 lakh.

Russia taxes entire individual income, above the personal allowances, at the single rate of 13%.

INDIA’S RATES

A comparison with India’s rates would have shown that the rate structure is the main culprit responsible for forcing most of the taxpayers to evade tax on a major part of their income.

Just like the other countries mentioned above, even India had a fairly reasonable rate structure till 1939. Thereafter under the misconception that higher rates will lead to higher revenue, India went on raising the rates.

The rates were increased in two ways. One was to push up the top rate, applicable to high income earners, which reached nearly 98%. This has, however, been brought down to 31.5%.

But the much more damaging method was to go on shifting the super heavy rates to absurdly low levels of income.

History of one such rate, that is the 30% rate, will show how the government recklessly went on making the burden of tax intolerable and forcing major part of the income to flow outside the tax system.

The rate of 30% was applicable to income above Rs 60 lakh in 1939, 6 lakh in 1959 (in rupees of 2003) and now it applies just above the petty amount of Rs 1.5 lakh.

By the 1960’s rates had become intolerable for higher income groups, but two-third of the individual taxpayers were still paying tax at 3% and 6% only. Subsequent increases in rates have forced most of them also to become tax evaders.

In 1960 income above Rs one lakh ( in rupees of 2003 ) was taxed at 3% and it is now taxed at 20%. Pushing up the rates nearly 7 times at certain levels of income is the root cause of massive tax evasion.

MERCILESS TAXATION OF PARTNERSHIP FIRMS.

India is not only taxing the individuals at atrocious rates but also the business entities. Partnership firms are the most mercilessly taxed class of taxpayers and consequently evade tax on the bulk of their income. In most of the countries their income is taxed only once, and that is in the hands of partners, as was being done in India also till 1956. Thereafter India started the most oppressive system of taxing firms and partners both. And since 1993 it has switched over to the equally obnoxious system of taxing even the pettiest of firms at the rate applicable to companies.

Look at the absurdity of the current system. If one individual earns income of Rs 10 lakh he pays tax of Rs 2,87,700 but if two or ten individuals share the same income through a firm they pay tax of Rs 3,67,500. Such patently unfair provisions have driven firms largely outside the tax system. Currently they appear to be the biggest tax evaders in the country.

The KTF also finds nothing wrong with this and wants the present system of taxing partnership firms to continue.

HEAVY BURDEN ON CORPORATE INCOME.

Currently the tax burden on distributed corporate income works out to 56.67%, if shares are held directly by individuals and 60.08% if they are held through an intermediary investment company.

The rate of 30% recommended by the KTF is alright for large companies. But small companies will never be prepared to pay tax at 30%. Currently they evade tax on the bulk of their income. To persuade smaller companies to pay tax, and to induce the larger partnership firms to become companies, the KTF could have recommended the UK pattern of taxing companies at three rates of 10%, 20% and 30%.

The secret of success of many developing countries in pushing up their IT revenue lies in inducing the larger partnerships to become companies, paying tax at 10% or 15%, without subjecting their distributed income to multiple taxation.

EXTREMELY NAIVE IDEAS ABOUT APPROPRIATE RATES

None of the expert committees tried to find out the type of rates necessary to improve compliance and bring down tax evasion. They had extremely naïve ideas about rates.

For instance, in 1992 Chelliah Committee recommended the rate of 27.5% on income above Rs 50,000 (equal to Rs one lakh of to-day). Such recommendations were based on massive ignorance. It never occurred to the learned members of this committee that by proposing a rate 9 times higher, compared to its level in the 1960’s, they would be promoting defiance and tax evasion and not revenue.

Two years back, Shome committee recommended that the rate of 30% should be applied on income above Rs 2 lakh. And the KTF wants it to be applied above Rs 4 lakh.

Expert committees suggesting rates without the slightest regard to their effect on tax evasion is bad enough. What is still worse is that even businessmen's top organization, FICCI, wants the rate of 30% to be applied to income above Rs 3 lakh when China applies it above Rs 30 lakh and India itself applied above Rs 60 lakh at one time. Rates are the most crucial element of the IT system. Such a casual approach to the rates is the root cause of almost all the problems of the I.T. system.

WHAT MISLED THE COMMITTEES

It seems what has been misleading all the expert committees, comprising highly learned people, is the drastic reduction in the top rate from its peak point of nearly 98%. What further keeps misleading them is that India’s maximum rate is very close to the top rate of many of the developed countries.

All these committees have failed to realize that it is not the maximum rate alone which matters. What governs acceptability by the taxpayers is the rate applicable at each level of individual income, and the rates applicable to different business entities.

PRINCIPLE GOVERNING THE RATES

Countries like Russia and Hong Kong have discovered the most appropriate principle that should govern the fixation of rates, i.e. that they should be acceptable to the vast majority of the taxpayers so that evasion is kept at the lowest possible level. And they have also found that even the richest of the rich cannot be persuaded to pay tax at a rate higher than 15, or at the most 20 percent.

Unacceptable rates cannot be enforced by any type of penal or coercive measures, except in the case of taxpayers like salary earners. That is why currently the developed countries are able to enforce their atrocious rates mainly against salary earners, who cannot easily escape. For instance the U.S. collects nearly 8% of the total personal I.T. revenue equal to 10% of GDP from salary earners.

FOLLY AND FUTILITY OF TAXING SMALL INCOME EARNERS

The only way to increase revenue is to bring down sharply the quantum of tax evasion by a few million large income earners and not taxing of crores of small income earners. But some of the committees ( backed by IMF, leading economists and journalists) have planted in the minds of policy makers the extremely naïve idea that revenue can be increased by widening the tax base. Consequently the government continues to pursue the thoroughly wasteful and harassing activity of imposing the tortuous burden of filing returns on small income earners, through schemes like one-in-six. Bringing more than two crores of them into the tax net during the last five years has probably not added even 0.05% of GDP to the revenue. They file returns disclosing either no taxable income or only token amounts.

ATTACK ON EXEMPTIONS AND RELIEFS ENTIRELY DUE TO IGNORANCE. All the committees have failed to realize that revenue remains at an extremely low level primarily due to massive tax evasion and pushing medium and small scale business entities largely outside the tax system. Consequently they keep blaming other things like exemptions. The most glaring example currently in the news is the attack of KTF on individual exemptions. It believes that as the rates have come down almost all individual exemptions should be withdrawn.

If KTF had looked at the past history it would have discovered that till 1960’s there were hardly any exemptions. And the reason for that was that individual income above Rs one lakh (in rupees of 2003) was till then taxed at only 3 percent. Thereafter relief's and exemptions had to be brought in because the government went on raising the rates and income above Rs one lakh started getting taxed at 20% or even higher during same years.

KTF wants that the rate of tax at this level of income should continue at 20 percent but exemptions must go.

Most of the expert committees have been making this type of recommendations because of their failure to study the basic facts.

AGRICULTURAL INCOME RIGHTLY NOT TAXED

Another example of a recommendation based on total ignorance is that taxing agricultural income will reduce tax evasion and increase revenue. If KTF had looked at the data of other countries it would have discovered that probably none of them is actually able to collect tax in respect of agricultural income. In countries like the US, farmers always show more agricultural losses than income, and thereby reduce tax even on non-agricultural income. Imposition of this tax in India will mean harassment of illiterate farmers and benefit only the inspectors and tax practitioners. It cannot yield any revenue.

HIGHLY CIVILIZED, SIMPLE AND CLEAN TAX SYSTEM DURING BRITISH PERIOD

Even in1939 our British rulers were collecting as much amount of personal IT revenue ( as proportion of non-agricultural national income ) as the present government is doing, but in a highly civilized manner. Income up to Rs 2 lakh was exempt. Upto Rs 5 lakh the rate was 4.7% and income between Rs 5 to 10 lakh (all in rupees of 2003) was taxed at only 7.8%.Law was simple. IT Act had only 67 sections. Tax deduction at source (TDS) was required only in respect of salary income. There was no requirement of advance tax or self assessment tax. There were no annoying provisions like searches, surveys, charging of penal interest, obligatory payments by cheques or Permanent Account Numbers.

Countries like Singapore, which collect more than double of India's total IT revenue, still have such highly civilized tax systems. They treat the taxpayers with the same respect and consideration as our colonial masters did. They do not impose frivolous formalities and unnecessary paper work on them.

Singapore does not require TDS even in respect of salaries. It has a simple law and tax has to be paid only once after the close of the financial year on receipt of demand notice, and it can be paid in 12 interest free installments.

Government of independent India is forcing large income earners to evade tax on a massive scale and is desperately chasing small income earners by extending TDS to all sorts of petty amounts. The whole system has been made extremely oppressive and complicated, and that too without the slightest gain in terms of revenue. No wonder most of the smaller taxpayers treat IT as an enemy to be avoided at all costs.

SALARY EARNERS PRINCIPAL VICTIMS IN INDEPENDENT INDIA

During the British period the bulk of the income of taxpayers used to get taxed at low rates. Now only a fraction of the real income gets taxed at absurdly high

rates. That is why the quantum of personal IT revenue still remains at the same level

( as proportion of non-agricultural national income ) where it stood during the British period. But as the salary earners cannot easily hide their income, the effective rates of tax have gone up sharply in their case. Reduction in the exemption limit from Rs 2 lakh to merely Rs 50,000 has brought millions of small salary earners into the tax net. Salary earners are obviously the principal victims of the IT system of independent India.

BLACK MONEY PROMOTED BY INDEPENDENT INDIA

As the rates till 1939 were as low as sensibly managed tax systems still have, the bulk of the income of the taxpayers used to get disclosed in tax returns. Consequently black money was unheard of before 1939. Massive generation of black money, which currently dominates the entire financial and economic life of the country, started in a small way during the war years and was hugely multiplied by independent India by forcing major part of the taxable income outside the tax system.

IMMENSE DAMAGE CAUSED BY WRONG ADVICE

Failure of all the expert committees to deal with the problem of massive tax evasion seriously has caused immense damage not only to the fiscal health of the government but also to the economy of the country. Large chunks of tax evaded income cannot be kept safely within the country and are sent to tax havens. Consequently, India’s economy continues to be deprived of large quantity of investable resources and lags behind countries which are largely free from tax evasion.

ALL EVILS ARISE FROM TAX EVASION

Currently I.T. system stands thoroughly damaged as it suffers from several other major evils like, huge litigation, widespread corruption, complexity of law and unrecoverable arrears. But they all arise from tax evasion or methods adopted to control it .Countries which have very little tax evasion are free from these evils also.

All the expert committees including Kelkar's have failed to take even casual notice of these evils, leave aside dealing with them seriously.

PRESIDENT PUTIN SHOWS THE RIGHT WAY

Till 1999 Russia’s IT rates were as atrocious and tax evasion as massive as India’s. Then came President Putin, who had no financial or tax background but through sheer commonsense he discovered within a few months that rates were the main culprit in the IT system . Broadly following the Hong Kong pattern, he immediately switched over to the single rate of 13% for taxing individuals. Later he got approved legislation prescribing rates ranging between 20 to 24% for companies and 6% for taxing dividend income. Consequently distributed corporate income can suffer tax of at the most 28.5%. These changes in rates brought down tax evasion to such an extent that Russia’s deficit budget got converted into surplus the very next year.

Recently he has got approved the most remarkable system for taxing businesses owned by small companies, partnership firms and sole proprietorships. Those having turnover equivalent to about Rs 2 crore can pay tax at 15% of the net income or 6% of turnover. After paying IT, they will not be liable to pay even sales tax and value added tax.

This is the way to bring down tax evasion to its normal level and increase the revenue. For his act of wisdom in reforming the IT system President Putin has received compliments from all over the world, and particularly from President Bush, who is now trying to follow him in the US.

REVENUE CAN BE DOUBLED FROM 3% to 6% of GDP

Tax evasion can be stopped almost totally, the whole system cleaned up and revenue doubled ( mainly through increase in corporate tax ) to around 6% of GDP by adopting rates similar to those introduced by President Putin in Russia, and preferably still the rates of Hong Kong.

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S.S.BAGAI G-14 Greater Kailash III, NewDelhi-110048

M.A.LLB, Tax Consultant Website http://www.oocities.org/sahi501/ITREF.htm

Tel: 2643-8567, Fax:5163-8336

e-mail ssbagai@vsnl.com

Dated 3rd February 2003

About the author- Born 1928. Passed M.A. Economics in April 1951 standing first in the (Delhi) university. Qualified in the I.A.S examination of the same year and joined the Indian Revenue Services next year. Resigned from service in 1966 and practicing as tax consultant since last 37 years, specializing in business reorganization, trusts and family partitions.