23 Dec 2016 16:02 IST

Are Indians hard-wired to evade taxes?

No. Tax evasion isn’t as widespread, or even as deliberate, as we think

Is India a country of inveterate tax cheaters? If you’ve been turned to the news since November 8, this is the disheartening impression you would get.

Ever since the Centre announced its decision to cancel high-value currency notes, a stream of news stories have opened our eyes to the creative ways in which the hoarders of unaccounted cash have been laundering it. The ideas range from depositing ill-gotten wealth into temple hundis, to shipping it via chartered flights to Nagaland where it can be deposited as exempt ‘tribal income’.

The Alladin’s cave of treasures being unearthed from the daily tax raids on obscure businessmen, bankers and bureaucrats also give you the feeling that, if you are paying up the statutory 30 per cent, you are in a minuscule minority.

Not that bad

Sensational headlines spun off due to a recent data release by the Income Tax department have helped fuel this feeling of frustration. The data revealed that only 3.65 crore individuals filed their I-T returns in 2014-15. This was played up with sensational headlines such as “Only 3 per cent of Indians pay taxes”.

But if the thought that 97 per cent of Indians are getting away scot-free is causing you heartburn, you can relax. The problem of tax evasion in India is not as widespread as this number suggests, on three counts.

For one, to find out the actual proportion of tax-evaders in the country, it is necessary to estimate the number of citizens who are gainfully employed. Estimates from the Census suggest that workers who have full-time employment make up just about 30 per cent of India’s population. That points to a potential 39 crore people who are regular income-earners.

We know that agricultural income in India is exempt from taxes and Census statistics tell us that about 40 per cent of the workforce is employed in cultivation. Excluding this set leaves us with a residual population of about 23 crore, which makes up the potential tax base. Some 3.65 crore income taxpayers out of a potential 23 crore isn’t all that dismal, at 16 per cent.

Missing middle

Two, the Indian middle class is not as large or as affluent it is imagined to be. To fall within the income tax net, individuals need to earn a taxable income of at least ₹2.5 lakh a year.

Though this may not seem like a high bar for city-dwellers, the truth is that a majority of Indian households do not earn this level of income. The Census of India does not release data on income distribution. But a past study by McKinsey Global Institute estimated that 78 per cent of India’s households fell below a real income threshold of ₹2 lakh a year in 2015.

The 2016 Economic Survey made the same point in noting that people earning over ₹2 lakh a year make up the top 6 per cent of India’s population by income distribution. This suggests that a majority of the citizens may not be shelling out income tax simply because they aren’t legitimately required to do so!

Three, there are many exemptions and tax breaks that let out high-income earners from the tax net. The blanket exemption to agricultural income, which contributes 15 per cent of the GDP and nearly half of all employment, takes a big bite out of the tax pie. Generous exemptions on equity capital gains, home loans and capital gains bonds — to name just a few — benefit high-income earners as much as others.

All these are good explanations for why India’s tax-to-GDP ratio isn’t as healthy as that of other developing or developed nations.

Then there is the fact that even citizens who do not pay income tax, do cough up the hefty indirect taxes that pad up the government kitty. Put together, excise duty, service tax, import duty and the myriad cesses, all of which are eventually passed on to the consumer, contribute three times as much to the exchequer as personal income tax. In FY16, the Centre raked in ₹7.11 lakh crore from indirect taxes as opposed to ₹2.86 lakh crore from personal income tax.

Simply confused

Yes, after accounting for all this, there is still scope for doubling India’s personal tax base from current levels. But doing so requires both the Centre and the IT department to better understand the psychology of the tax evader.

Not all of the citizens or businesses who keep away from the income tax net, do so out of criminal intent. There are a couple of other identifiable reasons as well.

India’s tax rules are both complex and constantly changing, making it quite difficult for citizens to assess even if their incomes are assessable to tax.

Vaguely framed tax rules perpetuate the confusion. One good example of this is the taxation of services. Services contribute nearly 60 per cent of India’s GDP. Yet the taxation of this big chunk of the economy relies on a ‘negative list’ — that is, all ‘services’ that aren’t mentioned in the list are presumed to be taxable!

And then, there’s red tape

Even citizens quite willing to pay tax find themselves unable to cope with the red tape that dealing with the IT department entails. Despite various attempts at simplification, even today, an individual seeking to file an IT return has as many as ten different forms to choose from, depending on the sources of income. Filling the seven-page ‘Sahaj’ — the simplest of the lot — requires a nodding acquaintance with as many as 20 different sections of the IT Act. Given the levels of financial literacy in India, this is a tall order.

In fact, a good number of Indian citizens seem to be willing to pay taxes via TDS, if only they can be exempted from the chore of filing IT returns.

Data from the tax department reveals that apart from the 3.91 crore taxpayers who filed their returns in 2014-15, there were 1.61 crore citizens who actually paid taxes but did not file a return!

In short, shock-and-awe measures such as tax raids are fine. But to expand the tax base, they need to be accompanied by concrete measures to make tax compliance less of a hardship for the ordinary citizen.

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