It has been reported that the government proposes to raise import duties on 35 items, in a bid to slash imports and contain the current account deficit. This is the path to economic inefficiency, lost revenue and a thriving underworld that prospers on smuggling. The forthcoming Budget is an occasion to show boldness in vision and policy and regain India’s lost growth momentum. That means lower, simplified, preferably uniform rates of import duty and low, enforceable rates of tax on income in the hands of earners and sophisticated mining of data generated by the Goods and Services Tax (GST), to widen the tax base.
High import duties on goods make the businesses that use those goods as inputs relatively inefficient and non-competitive.
Taxes on gold and cigarettes illustrate the folly of high taxes. Gold smuggling was a brisk business that produced organised crime, anti-heroes on the silver screen and a corresponding hawala trade (informal cross-border money transfers at rates of exchange different from the overvalued official rate) in pre-liberal India. Liberalisation and the lowering of the import duty on gold to Rs 300 per 10 gm practically killed the incentive to smuggle gold.
But then, the import duty was gradually raised, first to two percent ad valorem, later to 10 percent in 2013, when the current account deficit had ballooned. It was reduced to 7.5 percent later, but in July of 2022, it was jacked up again. Right now, the total incidence of duty is 12 percent customs and a cess of 3 percent. On top of this, the consumer has to bear GST at the rate of 3 percent. The net result is that gold smuggling is once again a brisk business, and when gold is smuggled in, to pay for the gold, a hawala operation also comes into being. The government loses import duty on the smuggled gold and, since jewellery made out of smuggled gold would be hard put to show any legitimate source of purchase, the tendency would be to evade GST on the products made out of the smuggled gold as well.
The government would receive a big boost in revenues, both customs and GST, by slashing the import duty on gold to a level that makes smuggling totally unattractive.
A similar logic applies in the case of cigarettes also. Including import duties and excise duties and cess, the tax on cigarettes is something like 73 percent. This makes smuggling of cigarettes a lucrative business. And the government loses both import duty and excise duty on the smuggled cigarettes. Such loss is estimated to be as high as Rs 13,000 core, although this estimate has been made by the tobacco lobby. Sensible rates of duty on cigarettes would reduce the incentive to smuggle.
Taxing Incomes
The present government claims to believe in simplifying the tax regime and easy compliance. It has, in practice, raised the number of tax slabs to 11, with a top rate of 42.74 percent.
Data from the Home Ministry’s Bureau of Immigration says that in January-November 2022, 7.2 million Indians left the country to take residency abroad. Indians do not gain residency abroad on the strength of refugee status or any other debility; rather, they gain residency on the strength of competence and skill. It would not be inconceivable that some of the millions fleeing the country are persuaded by the high rates of tax in India on successful individuals. It is not just that the rates of tax are high, the visible return to the citizen in terms of state services does not appear proportionate to those subjected to high rates of tax.
It makes sense to not drive successful, skilled people away with onerous tax rates. The businesses they start in India would generate additional incomes within the country, generate jobs and yield taxes.
Few individuals are motivated to pay their taxes, as honest discharge of their civic duty. They pay because they cannot get away with paying less. But those in business can find assorted ways to conceal their income in shell companies, corporate expenses on their behalf and other tricks of accounting. If the cost of non-compliance (including the expected value of probable penalty, legal expenses, accounting expenses and the like) is significantly lower than the cost of compliance with tax demands, non-compliance will come out on top. It makes sense to bring down the effective tax rate and, thus, the cost of compliance, while raising the cost of non-compliance through predictable detection and certainty of stiff penalties.
But India needs to raise tax revenues also. The Centre and the states together collect taxes worth about 17 percent of GDP. This is about half the proportion collected by countries of the OECD. Tax collections go up by smart taxation, not by jacking up the rates of taxation. India has had an income tax rate as high as 97 percent on the highest slab, but this served more to signal the government’s anti-rich, and, implicitly, pro-poor disposition, than to raise tax revenues.
Follow The Trail
The way to raise tax revenue is to follow up on the audit trails generated by GST. Small-scale producers who evade taxes can be identified by following up on the downstream chain of bulk raw materials sold to large distributors, all of whom pay GST on their purchases and sell their product to smaller buyers collecting GST. Identify their customers, and these customers’ customers, till all the bulk raw material is accounted for. Input-output norms make it easy to estimate how much of final product should be made out of the bulk raw materials.
Diligent follow-up of GST audit trails and big-data analytics of the massive amount of data people generate, including on social media, will help the authorities unearth income that has been escaping tax. Locating this is the basic task of revenue mobilisation, not raising tax rates.
In fact, the government stands to raise additional taxes by moderating its import duties on goods amenable to smuggling and by simplifying the income tax structure and lowering the tax rates, while stiffening tax administration to secure compliance.
TK Arun is a senior journalist. Views are personal and do not represent the stand of this publication.
