From THE HINDU group of publications
Sunday, February 25, 2001


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The `compounding' way to counter evasion

D. Sampathkumar

THE public and the Government alike have always suspected there is tax evasion.

But now comes confirmation from the industry itself. The other day, the President of the South India Mills Association (SIMA) said there is rampant evasion of excise duty by the cotton yarn industry. In his view, the duty evasion in 1999-2000 could have been Rs 750 crore, or nearly one-and-a-half times what was actually collected that year. A representative of the North India Textile Mills Association made much the same point, though in a somewhat oblique fashion. He said that a duty reduction in yarn manufacture would result in better tax compliance by large mills in the organised sector.

While the SIMA President's figure of tax evasion is but an estimate, the fact that it has come from somebody representing the industry makes it all the more significant. It is one thing for economists, academicians and retired civil servants to talk of the problem of tax evasion by the industry, but quite a different matter when a representative of the industrial community himself admits it.

When aired by the former, we somehow lull ourselves into believing that the issue is only academic -- something that could provides sound-bytes on television talk shows and academic seminars. Or, even if it is considered as a real issue, the matter could still be dismissed as not serious enough to warrant drastic remedial measures. But when it comes from someone who could normally be expected to look the other way where tax evasion is involved, the issue can no longer be ducked.

The current system of excise duty collections depends excessively on human commitment for effective enforcement. Where clearances of dutiable goods depend on an excise official's authorisation, his connivance can easily be procured for a consideration. Even a system of record-based clearances -- that is, one where physical sanction by an excise official of each and every despatch is not involved -- evasion does not pose much of a problem. Records can be doctored, and the corresponding transactions of consumption of inputs, too, similarly masked. But the problem is not restricted to excise duty. Nor is it confined to the Centre.

It has spread to other instruments of taxation and across States. In normal circumstances, the oversight mechanism at the political level would act as a deterrent against any deviant behaviour by officials. But, over the years, an unholy alliance has evolved between civil servants in charge of revenue administration and politicians with ministerial responsibilities.

It is not uncommon to hear of officials in charge of key instruments of taxation having to arrange for lumpsum amounts to be given to their political masters for the privilege of continued involvement in tax collection. This reduces the structure of a particular tax from one that is transaction-based (be it, ad valorem or a specific duty) to one that is partly transaction-based and partly a compounding levy. The compounding levy -- a lumpsum payment based on productive capacity, in this case -- is diverted for personal gains, while the levy based on transactions goes to the exchequer.

The SIMA President's suggestion is that there should be an arrangement for set-off of the duty paid on yarn against the duty payable by those manufacturing readymade garments. This does not represent any real reform of the structure of taxation. Nor is it likely to make a major impact on revenue collection. Most units in the garments sector are too small to attract any excise duty, in the first place. The facility of offsetting taxes on inputs is of little consequence. At best, it might make those complying with tax laws improve their profit margins. The competitive edge of those supplying yarn to units in the organised sector after evading taxes, gets blunted somewhat.

The worrying aspect for policy-makers would be when today's whistle-blowers decide that the game is no longer worth the candle, as the expression goes, and decide to enter into a tacit understanding with tax administrators for similar duty evasion. This might already be happening.

The net capital stock in the economy generates a pittance of tax revenue for the Centre and the States put together. A sum of Rs 100 in capital stock in 1998-99 in the economy generated a mere Rs 5.7 in total tax revenue. There has been no change in this ratio since 1993-94. Either the assets are under-utilised or a proportion of the output/income goes unreported.

What is the way out? Clearly, we need to seriously reexamine our existing system of tax collection, which is transaction- or volume-centric. That is to say, a system that depends on the measurement of output or quantum of income, or some such parameter, for determining the amount to be charged as taxes. This system has been adopted because it is seen as more equitable.

The liability to pay depends on quantum of output or income, as the case may be. That may be so. But the problem with this system is that it leaves scope for manipulating the taxable outcome as alleged by the SIMA President. Also, it involves a continuous measurement process as output or incomes of each day are reckoned for tax purposes.

In contrast, a compounding levy based on production capacity is administratively more convenient as only a one-time determination of production capacity needs to be made. Thereafter, incremental addition to capacity based on capital expenditure can be taken into account for determination of tax liability.

In other words, the tax administration switches over from a production mode to a project mode. Indians always excel under a project mode but fail to deliver when the level of performance has to be repeated day after day. The administration that can handle the civic challenge of a Kumbh Mela can quite easily slip up when it comes to delivering that level of output on a continuous basis, across the numerous cities and towns.

The argument for a compounding levy has long since been settled. The secondary steel producers have already been brought under a compounding scheme because of suspicions of rampant evasion of excise duty. It can be done for yarn. Come to think of it, the whole manufacturing sector can be brought within its scope.

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