Income tax reform: Go beyond simplifying India’s unwieldy code

The government has initiated action on its budget promise to revamp India’s Income Tax code and invited suggestions from the public on four areas of reform: simplification of language, reducing litigation, easing the compliance burden and getting rid of obsolete provisions. 

This is welcome. Pruning the tax law of archaic elements, simplifying its language and reducing the number of hoops through which a taxpayer must jump to comply with it will reduce scope for confusion. 

Clarity will make it easier for people to pay what they owe without disputes arising over their liability. An assurance to tax officers that they would not be penalized in the name of causing the exchequer a loss, except in clear cases of their collusion with tax evaders, would also help keep litigation down.

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While this is not stated explicitly, an overarching goal of the exercise should be to raise tax collections. India’s income-tax intake stood at 3.5% of GDP last fiscal year and is budgeted to rise to 3.6% in 2024-25. 

In rich countries of the Organization for Economic Co-operation and Development (OECD), income tax collections, along with social security contributions, account for nearly half their total tax mop-up of 34% of GDP. Personal income tax alone accounts for more than 8% of GDP. 

In India, the overall tax mop-up by the Centre and states put together is only about half the OECD’s level. India cannot become a developed country without the state being adequately equipped to provide substantive governance and invest in the future. Hence, it is vital to raise tax revenues. 

That, of course, differs from raising tax rates. The point is to collect taxes more efficiently. For this, we need effective analysis of data on economic activity. 

Right now, the government’s approach seems ham-handed, as seen in its mandate for tax collection at source on credit card expenses abroad, for example. 

These spends leave audit trails and card issuers are regulated entities, so this data can be sought and scanned without imposing a burden on the plastic-payment ecosystem and making it difficult for taxpayers to work out their refund-adjusted tax dues. 

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Folks who spend lots of foreign exchange but show disproportionately small incomes in their tax returns deserve scrutiny. Careful analysis of GST data can also help detect tax evasion on earnings. The value added by a company breaks down into gross profits, on one hand, and wages and emoluments on the other. 

Since gross value addition (sales minus input costs) is what GST is ultimately paid on, the rate/s applicable can be used—with some arithmetic—to check if GST payments tally with the stated profits plus payroll records of a business. 

This could reveal if its reported figures are accurate or understated. Such scans can be conducted all along various value chains for discrepancies.

Taxing agricultural income would also help boost collections. The notion that farming is altogether exempt from taxation is faulty. Farm income is not all that hard to assess, though it is for the states to tax rather than the Centre. Let’s not forget that the British Empire ran on land revenue, based on farm earnings. 

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States should be incentivized to tap this source. Big spenders who appear on the radar of tax authorities but claim no liability because their income is derived from agriculture could be referred to the state-level tax apparatus. Reforming India’s tax law is an important aim, but we must also transform our tax administration.