Curbing tax avoidance

Businessmen will start routing their payments through hundis, which will serve as an alternate currency.

The prime ministerial candidate of the BJP, Narendra Modi has agreed to consider the proposal of wholly doing away with income tax, excise duties, VAT and local taxes and replacing all of these with a Bank Transaction Tax (BTT) which will be collected as a small percentage, say 2 per cent, of all transactions passing through the banking system.

Simultaneously all notes above Rs 100 denomination may be demonetised. This will make it difficult for people to undertake large transactions in cash. All transactions will be routed through the banks and BTT could be collected. The question is whether BTT will lead to a reduction or an increase in corruption.

The assumption underlying the proposal is that businesses will be happy to pay a small transaction tax if they could get peace of mind. I am a Marwari and belong to the business family. I do not think this is the correct reading. Businessmen will always want to avoid paying taxes even if it be small. They would be happy if the present 30-odd per cent taxation would be reduced to a 2 per cent BTT; but they would continue to try to avoid paying even that 2 per cent. There are many ways they could take to avoid the BTT. The most likely way would be to institute a system of promissory notes or Hundi.

Businessmen will start routing their payments through such hundis instead of through the banks. Tatas, Birlas and Premjis will issue hundis which will serve as an alternate currency. Payments will be made across the country without entering the banking system. Any attempt to stamp out this practice will spawn another cat-and-mouse game between the evaders and tax collectors. That will be worse than the present system because it will be more diffused. Presently excise duties are collected at the point of manufacturing. Once an item enters the white stream, it leaves a trail and to the collection of VAT and other taxes.

The hundi system will leave no such trail and make it difficult to collect taxes. The problem will extend to retail outlets. Say there is a TV manufacturer who is presently paying excise duties. The retail shop has to pay VAT because it has purchased excise-duty paid goods in its books. This check at the point of manufacture will be dismantled in the proposed BTT system. The manufacturer will be free to ship TVs to the retailer. He will only be required to pay BTT on monies received through the banks. The retailer can, in turn, sell the TV in cash to the consumer even if that be illegal. The consumer would be mighty happy doing so. He would save BTT of Rs 800 on a purchase of Rs 20k. And the money can be remitted by the retailer to the manufacturer by hundi.

Parallel cash economy

Thus a parallel cash economy will be created which will be very difficult to control because it will be very diffused. Presently all retail shops are forced to pay VAT because every piece of TV comes in the white stream. In contrast, evasion of BTT will have to be checked at every retail shop.

Another way to avoid would be to transport truck loads of cash in small denominations. A rough collection indicates that a payment of Rs 5 crore in cash would require 20 suitcases of notes of 50 rupee denomination. The cost of transporting these 20 suitcases from Delhi to Mumbai with an armoured carrier and guards would be, say, Rs 1 lakh. Against this one would have to pay Rs 10 lakh as BTT. Any attempt to penalise such cash transactions would involve setting up of a police system and, in turn, create a huge source of corruption.

Such was the experience of Ghana in the eighties. A World Bank report tells us that the problems “were compounded by a series of measures which shook the confidence of the public in the banking system. These measures included the demonetisation of 50 cedi notes, the freezing of bank deposit accounts in excess of 50,000 cedis.

BTT will also deprive the economy of the benefits of trade. Today the goods pass through large number of points—consignment agents, wholesalers and retailer. The goods are evaluated, sorted and distributed at each step. At present this does not involve additional taxation because VAT is collected only on the incremental value. In contrast, BTT will be collected at each point. Five transactions in the chain would lead to an imposition of BTT of 10 per cent.

Businesses will try to avoid this by selling directly to consumers; or traders may collect cheques from consumers and pass them to the manufacturer to deposit in its account. This will lead to a huge waste of time and energy. BTT is, therefore, simply not going to make life easy. Instead it will create a bigger source of corruption. Yet we need to simplify the tax regime. The way forward would be to reduce personal income tax. Maybe the lowest slab could be raised to 10 or even 25 lakhs. The consequent loss of revenue can be collected by imposing progressive excise duties on items of luxury consumption. Heavy excise duties and VAT may be imposed on luxury cars and air-conditioners.

The Goods and Services Tax should similarly be implemented with a progressive orientation that is by providing for higher rate of GST on Harley Davidson motorcycles and lower rate on bicycles. The collection of Income Tax should be simplified. Yashwant Sinha had introduced Saral forms which has been discontinued. It can be reintroduced. We should not be under an illusion that tax collection will come easily. Kautilya had suggested that a spy system should be created to watch on tax collectors; and another to watch the spies. Progressive taxation, simplification and tough implementation are the way to go.