Tax Research Cell of National Institute of Public Finance and Policy (NIPFP) has released a report on ” Development of an Analytical Model for Widening of Taxpayer’s Base”.  This study was undertaken for the Central Board of Direct Taxes to analyse and develop an Analytical Model for the number of taxpayers in the personal income tax system. The Terms of Reference of the study is reproduced below.

  1. Time series analysis of evolution of number of tax payers in relation to macro-economic and policy variables
  2. Cross section analysis: quantifying the number of non-filers using taxpayer data and income distribution data
  3. Profiling of non-filers from data available from income tax returns and income or consumer expenditure surveys.
  4. Using the salient facts from a, b and c above to construct an analytical model on number of tax payers in the tax system
  5. Policy suggestions on how to expand the set of people filing returns.

The focus of this study was on the number of personal income tax payers. Two ideas implicit in the conception of this study are: first, that the number of filers in the system is smaller than the number that “should be” filing; and second, the number of filers should be increasing over time.. Economic growth and other related variables should drive changes in the number of filers. These two ideas have been used to formulate the structure of analysis for the present study.

Conclusion of Study Report

Chapter 1 of the study examines and compares the available data sources. In view of the limitations of such data sources as discussed in detail, the study carries out the time series analysis using CAG data on number of assesses while the cross section analysis has been carried out using the Indian Human Development Survey for individuals and the NSS Survey on Unincorporated Non-agricultural Enterprises (Excluding Construction) in India.

The time series analysis of the total number of taxpayers in the categories of firms and individuals, in chapter 2 reveals that:

  1. Both for individuals and firms, the growth in the number of taxpayers has plateaued. While for the individuals, the break comes after 1998, for firms the break comes somewhat earlier by 1991. Interestingly, the change in trend for these two types of entities was in opposite directions – while the number of firms filing return stagnated, the number of individuals filing returns had dramatically increased till 1998.
  2. The study indicates that both tax policy and other economic variables are important for determining the trends in number of effective assessees in individuals and firms.
  3. While policy and administrative measures pulled up the number of individual taxpayers, once the administrative measures were withdrawn, the total number of assessees has not dropped off.
  4. Economic growth and changes in the economy to bring in more assessees into the system may not be as effective as alternative administrative measures which could be faster in achieving the same goal.

While the time series analysis reveals that the total number of taxpayers has increased and that there are variables which explain the change in these numbers, it is also important to understand the underlying distribution. In chapter 3 we compared alternate sources of information and arrived at a broad conclusion that the number of taxpayers as calculated is higher than that reported by the income tax department. But the difference is not very large for individuals but is substantial for firms.

To examine whether there is close correspondence between income tax data and the data from the survey across income and activity classification, chapter 3 presents results on profiling of taxpayers. These results suggest that while in lower income groups the survey shows much larger numbers than the income tax department data on returns, the differences disappear and even reverse themselves in the higher income categories. This holds both for individuals and firms. For the individuals, the differences are concentrated in the categories with incomes less than 4 lakh per annum while for firms, these are concentrated in the income groups with income less than Rs 10 lakh. This result suggests that while the overall number of taxpayers might not be at wide variance, there is considerable scope to increase the numbers in the lower income categories.

In the activity wise profiling, with the caveat that significant number of returns do not contain information on activity code, the composition indicates that in the survey some manufacturing sectors and food and beverage services show up more prominently than in the returns. Similarly, in the case of individuals, in manufacturing, trading, building and estate agents and services sector, the share in the survey is higher than the share in the ITD returns. Sectors like professionals and commission agents are not that common in the survey. These results too indicate that there could be some scope for expanding the number of taxpayers. However, more focused identification of sectors has been hampered by the non-availability of data.

Chapter 4 provides some models for predicting the number of effective assessees. This is followed by an economic model to understand the conditions under which individuals might prefer not to file a return. The results from this chapter can be summarised as follows:

  1. The predicted number of effective assessees. The same is 35.79 million in 2013-14. This number is sensitive to the share of trade in GDP and the ratio of imports and exports to GDP.
  2. In terms of the difference between the potential and actual returns filed in the country, the cross section model suggests that the number of potential returns can be higher by about 18 percent over the actual numbers for 2011-12 if one third of the households have two earners. In other words, the differences are not very large. The results however do indicate that sharp increases in the exemption threshold seem to have eroded the tax base in terms of number of people within the tax regime. If the exemption threshold had remained unchanged from 2004-05, for instance, the number of people filing a return would have been as high as 10.5 percent, i.e., 4.8 times the number filing a return at present.
  3. The economic model suggests that there can exist conditions where even with incomes above the exemption threshold, people might prefer to not file a return. The range of incomes for which non-filing is a preferred option decline with a decrease in the tax rate and with an increase in the penalty rate. Further, an increase in the probability of detection too has a similar result.
  1. The results in the time series analysis and the economic model both suggest that a reduction in the tax rate will bring in more people into the tax regime.

Using the results we have obtained in the study so far, chapter 5 presents some suggestions on how to bring in the non-filing taxpayers into the system. These suggestions are grouped into three categories. To begin with, it is essential to have a clear policy perspective on whether the tax department wants to concentrate on revenues alone and hence concentrate on revenue yielding tax payers who also happen to be from higher income groups, or whether the marginal taxpayer too needs to be brought in to improve the culture of compliance. Once a decision in favour of the latter is taken, there are a series of policy and administrative decisions that can aid in reducing non-filing. The policy measures can be summarized as

  • Refraining from increasing the exemption threshold too frequently – while every government has the right to decide on the exemption threshold, increases in the exemption threshold tends to erode the tax base in terms of number of tax payers Some countries even desist from correcting the exemption threshold for inflation on a regular basis.
  • Limiting the benefits from tax policy incentives to individuals/agents who comply with the tax laws like filing of returns.
  • Incentivizing the move away from cash to other financial instruments: it is often remarked that India continues to be a cash based economy which undermines compliance with tax laws. Taking from the Korean experiments, the chapter proposes some incentives that can be given to encourage this move.

In addition the chapter also proposes some administrative measures. These can further be divided into two categories – those that could further augment the cause of “enforced compliance” and those that could aid “voluntary compliance” as formulated in the literature on slippery slope. To begin with measures suggested to augment “enforced compliance” are:

  • Third Party Information: there is substantial literature to suggest that compliance and filing improves with increase in information with the government. The chapter therefore proposes a change in the system of collection of information away from the present institutional arrangement of CIB to an augmented list for AIRs.
  • Form 60/61: It has been argued that some of the success from the effort to collect information is defeated by the option of filing forms 60 and 61. It is therefore proposed that the department should do away with these forms and PAN be made mandatory for all income earning individuals in the economy, irrespective of what their source of income is.

Turning to measures to support voluntary compliance, the study has identified the following measures:

  • Prepopulated returns: these can be a mechanism of aiding the taxpayers’ efforts at return filing by informing the taxpayer of certain details that are already with the department. It can therefore be treated as a service to the tax payer. In the case of delinquent taxpayers, such services might make the department more visible and hence induce compliance. It is understood that the department is already considering this issue.
  • Information Dissemination: Tax departments tend to face a lot of bad publicity for their efforts to bring in the evading taxpayer. It would be useful to address this issue by periodically putting out information on the extent of interface of the tax department with the average tax payer. Such information could work towards increasing confidence of the taxpayer on the department.

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