Indexing the Effectiveness of Tax Administration

Author(s): Sanjay Kumar, A. L. Nagar and Sayan Samanta

Source: Economic and Political Weekly, Vol. 42, No. 50 (Dec. 15 - 21, 2007), pp. 104-110
Published by: Economic and Political Weekly
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Indexing the Effectiveness of Tax Administration

SANJAY

The

KUMAR,

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SAYAN

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104 December 15, 2007 Economic & Political weekly

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: SPECIAL ARTICLE

the tax administration in assigning a role for its employees - taxthere needs to be substantial improvement in order to develop an
enforcer or a tax facilitator.

efficient tax administration. The reason that the taxpayers reg-

This paper examines the effectiveness of direct tax adminis-ister is out of date highlights that the tax administration is not
tration in India through an econometric model, taking into ac-dealing with stop filing taxpayers in a systematic manner, and
count tax collections.3 It constructs a tax enforcement index
needs to design an adequate strategy.
treating enforcement as a latent variable through principal com-

ponent analysis, and attempts policy recommendations for im-1.2 Delinquent Taxpayers

proving the efficiency and effectiveness of tax administration.Priorities are often set for controlling delinquent taxpayers.* Tax

The paper takes tax rates as given. It also does not attempt de-administrations normally have sufficient legal provisions availsigning the tax administration; rather focuses only on the effec-able to take swift and effective action against the delinquent
tiveness of tax administration. Section 1 gives a brief descriptiontaxes. Though many times such non-payments of taxes are not
of the current position of the tax administration, and compares itdue to lack of effort on the part of tax administration, they may also

to some other countries' tax administrations - developing andbe for the reasons that the tax demands may be in dispute before

developed. Section 2 constructs the tax enforcement index.the courts, which sometimes take an inordinately long-time to
Section 3 attempts some key policy issues, which would bring adecide on the tax demands. Also, sometimes the taxpayers file
more effective and efficient tax administration.

appeals the court decisions and take the cover of the tax demand

under dispute as the reason for not paying taxes. That apart,

1 Current Position of Tax Administration

reasons such as raising infructuous demand due to lack of evi-

As stated above, effectiveness of the tax administrationdence,

would collusion between tax enforcers and taxpayers, double
depend on its ability to detect and bring tax offenders to counting
book.
of the tax demand, etc, also cannot be ruled out.
Some of the main areas of tax offences are unWhatever be the reason, delinquent taxes
Table 1: Comparing Stop Filers, Existing

and New
registered taxpayers, stop filers, tax evaders,

and delinquent taxpayers.

Taxpayers (in%)

Year Stop Filers Existing New

Taxpayers Taxpayers

2000-01 12.31 71.91 15.78

2001-02 6.87 71.90 21.23

1.1 Stop Filers

2002-03 17.70 77.46 4.84

In India, the stop filers are around 10 per cent.4

2003-04

16.35 78.18 5.47

2004-05
The figures (in percentage terms) in Table
1

3.39 89.62 6.99

in India have shown a steady rise from

Rs 22,928 crore in 1995-96 to Rs 98,612 crore

in 2005-06, implying a compounded annual

growth rate of 30 per cent. Compared to that,

the percentage collection of these arrear

demands have remained static between 8 and

Source: Income tax department, government of India.

9 per cent - the only rise was in the financial

give a comparative chart of the stop filers, ex-

isting taxpayers and new taxpayers overTable

the

2: Arrear Demand Collection

year 1999-2000 when the government intro-

for Income and Corporate Tax (in Rs crore)

duced a scheme for settling tax arrears. These

last five financial years.

It may also be stated here that these

Financial Arrear Cash Percentage

Year Demand Brought Collection Collection
figoutstanding

ures may not be entirely correct, because the

1995-96
permanent account number (pan)s database

Forward as on Out of Arrear

22,928.61 2,079.01 9.07

1996-97 29,221.49 2,328.41 7.97

arrears, as can be seen, are almost

equal to or a high percentage of the annual

tax collections.

(particularly, for the personal income taxpay1997-98

33,925.47 2,845.04 8.39

The figures show that the arrear demand

1998-99
ers) has not been very accurate. Most of the
tax

45,039.95 3,049.47 6.77

collection has remained flat over as a percent-

1999-2000
districts,6 till late, have been maintaining
an

43,868.78 30,066.60 68.54

2000-01 51,472.55 4,991.91 9.70

age of the total collection during the last nine

individual database manually, and so, if2001-02

any

49,222.85 3,938.89 8.00

years, indicating that there has not been any

2002-03
taxpayer shifted from one tax district to
an-

73,012.85 5,499.25 7.53

perceptive change in the effort of the tax ad-

other, there was no mechanism to verify 2003-04

this,

72,347.88 5,540.23 7.66

unless the taxpayer himself reported doing

so.
2005-06

98,612.00 8,064.00 8.18

2004-05 92,886.00 7,084.00 7.63

tention to tax delinquency can be an expen-

Otherwise, he would be reported as a stopSource:

filerCBDT.
in one district, and a new taxpayer in another.
Table 3:

sive
Collection of Personal Income Tax

Besides this, a number of taxpayers had two

(asor
% of total collection)
Year Pre-assessment Post-assessment
more pans - out of volition or out of confusion.
Collection Collection

This also led to double counting.

ministration towards collecting arrears. But

what needs to be realised is that often lax at-

1995-96 82.6 17.4

source of financing for the government,

and easy and cheap source of finance for the

taxpayer.

It is often seen that a small percentage of

delinquent taxpayers account for a large per-

On the corporate taxpayer's side, companies

1996-97

are mandatorily required to file returns of

centage of delinquent taxes. Statistics from

income as per the income tax laws.? As on

October 31, 2004, 6,61,371 companies were
under registration in the country,8 but the
records of the income tax department show
Source: CBDT.
that only 3,72,483 returns were filed. This

Latin American countries show that 3 to 12 per

1997-98

1998-99

1999-2000

cent of delinquent taxpayers accounted for 65

2000-01

to 90 per cent of delinquent taxes. Such a

pattern of high delinquent taxes being ascribed to a small percentage of taxpayers
exists in India. Quick estimates show that close to 80 per
shows that about 44 per cent of the companies did not file also
corpo2001-02

2002-03

2003-04

cent of the delinquent taxes involve only 200 taxpayers. Such

rate tax returns.

high
concentration of arrears in a few taxpayers requires a set of
While the reasons for high percentage of stop filers or
inacarrear
collection priorities.
curacy of the data above may be debated, it is certainly true
that
Economic

&Political

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December

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2007

105

SPECIAL ARTICLE =

1.3 Tax Audit

But an estimate of the deployment in India, taking into account

It is widely recognised that taxpayers' perception of the

theprobabifact that each tax officer handles 150 cases every year on an
lity of being audited strongly determines their degree average
of complifor audit, with a complement of four staff members on an

ance. Thus, the importance that a tax administrationaverage,

assignsshows
to that each employee handles the audit work of 37.5
the audit function greatly affects the ability of the organisation
cases. If to
we see the number of assessments per employee in

enforce compliance. Even if a tax administration is very

effective
other
countries - developed and developing, we find that there is

in registering taxpayers and detecting stop filers or adelinquent

definite pattern for deployment of employees for tax audit work.
taxpayers, the administration's overall effectiveness In
will
be lowit is 4.58, us 1.16, Canada 4.04, South Africa 29.23,
Australia

Turkey 11.28, Argentina 32.28, Chile 90.18 [oecd 2006]. Thus,

if auditing is not effective in discouraging evasion.

In India, the taxpayer provides information to the tax

admin- countries, typically, have a large number of cases bedeveloping

istration through returns and accompanying documents.

These by each employee. Developed countries' employees,
ing handled
returns contain valuable information on the taxpayer
his hand, handle a lesser number of cases, and so are
on and
the other
activities. All this information is potentially used to able
helptogauge
devote a considerably longer period of time to create
the taxes due from taxpayers. Besides is, information is
also col-through tVe tax audits.
deterrence
lected through various information returns, which
Table 4: Matrix (R) of Correlations between Various Components of Income Tax

are collected from the third parties on various

in- of IT TDS Advance Regular Penalty 1 Penalty 2 Interest Refunds Other
Components
vestments or expenditures. Though a wide variety
of sources of information can be imagined forTDS
colAdvance

lecting such information, the challenge ofRegular

match-

ing this third party information and collatingPenalty

it in a
useful form is certainly a task.

Penalty

tax

assessment

0.8884

0.9510

1.0000

Interest recoveries 0.7837 0.8101 0.6510 0.6579 0.6037 1.0000

If we see the collection of personal income

tax
Refunds
Other receipts -0.0629 0.1547 0.2737 -0.1250 -0.2598 -0.1545 0.6578 1.0000
- pre-assessment and post-assessment, as percentage of total collection, we find that there has not
Table 5: Matrix
been any significant change in the tax collection

(R) of Correlations between Various Components of Corporate Tax

Components of CT TDS Advance Regular Penalty 1 Penalty 2 Interest R

- pre-assessment or post-assessment; in fact it has

remained stagnant. This shows that despite the

TDS

Advance
tax
emphasis of the tax administration on improving
Regular assessment
the collection of information, the effectiveness
of
Penaltyl
Penalty
the use of information has not seen any significant

Interest
improvement. Maybe the audit programmes,
which

0.8682

0.9774

1.0000

recoveries 0.2220 0.5480 0.5318 0.1393 0.3635 1.0000

Refunds

are reported to be auditing 2-3 per cent of the

tax
Other

receipts

-0.1165

-0.0646

returns are not able to control the underreporting

of taxes!

A comparison with some of the Organisation for

Table 6: Arithmetic Mean and Standard Deviations of Observations on Variables

TDS Advance Regular Penaltyl Penalty 2 Interest Refun

Economic Cooperation and Development (oecd)

tax administrations shows that the Indian tax

FF

'

Mear

administration is collecting significantly higherStandard deviation gx 97237562 26096827 6482895 140906 718
post-assessment taxes as percentage of total collec-

"~

Meanx

tions. But there is no reason for complacency onStandard deviation gx 75686343 1.35E+08 35989010 93511.5
this score as the oecd has better socio-economic

conditions, social security systems, and better

Table 7: Eigenvalues (Aj) for Income Tax and Corporate Tax

governance systems, which result in higher voluntary tax compliance.

(^)

CM

(^)

(Xj

IT 4.2573 1.9068 1.0486 0.3854 0.2638 0.1186 0.0131 0.0064

CT 4.2198 4459 0.9836 0.6552 624 53 23 0.0007

A good indicator of the emphasis on the audit

function is the number of employees engaged in

audit work in any tax administration. In oecd countries, audit, An overview of the tax audit programme of developing couninvestigation and other verification functions are, on an average,
tries shows that these countries typically experience some imcarried out by more than 25 per cent of the employees. Australian
provement in compliance and collection in the short-term but

tax administration has 33.8 per cent employees in audit, investi-they tend to reach plateau within a few years after the first drastic
gation and other verification functions; Belgium 50 per cent, the
changes are introduced and do not show any significant advances
us 18 per cent, Japan 68.4 per cent, Turkey 10.7 per cent and uk
subsequently. This means that the tax administration needs to
13.9 per cent [oecd 2006]. In non-OECD countries like Argentina,focus on its audit efforts by improving its information collecthe ratio of employees employed in audit and other verification
tion, collation, and dissemination in a concerted manner. But

functions is reported to be 34.4 per cent, Chile 60.2 per cent,

the dilemma of whether the tax administration should engage its
such percentage deployment in India is not known.

employees as tax enforcers or tax facilitators continues to affect

December 1 5, 2007 Economic & Political weekly

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= SPECIAL ARTICLE

such efforts. In fact, in many countries, it has been seen that the Any excess payment of taxes results in refund of the taxes.

auditing has decreased in importance over a period of time rela-

All tax payments are mandatory. But for convenience, one

may classify them as, "voluntary" and "involuntary" payments.

tive to other tax administration functions, as shown by the reduc-

tds and advance tax payments can be largely regarded as "voltion in the number of staff assigned to auditing as well as by the
untary", as they are paid by taxpayers before they submit any

decrease in the percentage of taxpayers who are audited.

return of income.10 "Involuntary" payments are those arising out

2 Voluntary Compliance and Enforcement Measures

of regular assessment (such as, penalties 1 and 2, interest recov-

eries, refunds and other receipts, including taxes paid on regular

Given the above perspective, it would be in order to examine the
effectiveness of tax administration and attempt to construct anassessments).
index to estimate the contribution of voluntary compliance and
the enforcement measure.

2.2 Tax Enforcement Index

In this section, we propose to construct a tax enforcement index

2.1 Tax Enforcement

(enf) for corporate tax (ct) and income tax (it) as a weighted

average
In common parlance, involuntary payment of taxes is linked
toof various tax components, based on the time series data
(1985-86 to 2003-04) on various tax components available from
tax enforcement. But enforcement acts through two channels;
published
sources, such as The Statistical Abstract of India.
directly, as involuntary collections are enforced by
tax
It should be noted that the tax components (i) to
Table

8:

Eigenvectors

(a,)

(a2)

(a3)

for

Income

(a4)

Tax

and

Corporate

Tax

(<*s)

if 0465 39 :236 -0.1226 -0.1355 -0.0785 0.6819 0.4717

0.4728 -0.1054 -0.0423 -0.1834 -0.1622 -0.0733 0.1612 -0.8199
0.4399 -0.2046 -0.0759 -0.3367 -0.1061 0.5820 -0.4918 0.2315
0.1882 0.2667 0.8069 0.0919 0.2066 0.3609 0.2466 -0.0126
0.3719 0.1925 -0.3611 0.4605 0.6791 0.0479 -0.1241 -0.0577
0.4250 0.1914 0.3038 0.0732 -0.1910 -0.6504 -0.4311 0.1996
0.1100 -0.6137 0.1175 0.7050 -0.2968 0.0939 0.0459 0.0379
0.0156 -0.6516 0.2217 -0.3392 0.5618 -0.2922 0.0551 0.0831

CT -0.4371 -0.1764 -0.3755 -0.0361 0.0469 -0.3885 -0.0312 0.6939

-0.4758 -0.0378 0.1111 -0.0612 0.0217 0.6537 0.5564 0.1371

-0.4794 -0.0604 0.0731 -0.0329 0.0332 0.3342 -0.7940 -0.1303
0.0073 0.6390 -0.2676 -0.7189 0.0190 0.0438 -0.0298 0.0067
-0.2955 0.2048 0.4791 -0.0393 -0.7374 -0.3059 0.0483 0.0039
-0.2582 0.3579 0.5021 0.1239 0.6581 -0.3165 0.0661 -0.0122

I4383 I1668 ^03785 -0.0463 0.0283 -0.3165 0.2263 -0.6946

087 ^5980 386 ^6767 35 -0.1196 53 -0.0053

(vii) are not mutually uncorrelated. Pair-wise

correlations between them are given in Tables 4
and 5 (p 106).
We observe that corr (tds, advance taxes) is of

the order of 0.9545 for it and it is 0.8352 for ct.

The correlation between tds and regular assessment is of the order of 0.8884 for it and it is
0.8682 for ct; and so on. It is, therefore, not appro-

priate to pick one of the components (say tds or

regular assessment, etc) and analyse the effect of
changes in them on the enforcement or performance of tax collection. There is need to compute a

"composite index of enforcement" by combining

various tax components in a suitable way (assign-

ing appropriate weights to different components) and relate it to

administration, and indirectly, as voluntary compliant tax paythe
ments, induced by fear of enforcement actions. Efficient enforce- tax productivity of the economy.

While constructing the enf as a weighted average of various

ment should have minimum actions, which can lead to a higher
tax components, it is crucial to determine weights to be assigned
share of voluntary compliance relative to potential or theoretical
to each of these components. We propose a method of determaximum tax collections. This would also mean that voluntary

mining the weights that take into account the variation in tax
compliant taxes should have a high share in the total tax collecover the entire period of observations, viz, 1985-86
tions. A less efficient system would be one where a high sharecomponents
of
Table 9: Proportion of Variation Accounted
2003-04.
collections requires strong enforcement actions. It also needstoto
for by Successive Principal Components
We
regard
enf
as
a
latent
be mentioned here that the efficiency of tax enforcement actions

Variance of P, Proportion Cumulative

variable, which cannot be

is not a stand-alone parameter; rather it also depends on the synmeasured in a straight forergistic relationships with other institutions in the economy, such

of Variance Proportion of

Accounted (%). Variance

ward manner but is sup-IT

as the responsiveness of the legal structure, trust in rule of law,
posed to be linearly deterand other social institutions.

4,2573

1.9068 23.8350

mined by various tax comThe term "tax enforcement" implies tax collection as per the

1.0486

ponents. Supposing that

statute of the tax laws. Taxes are to be paid according to the
rules and provisions of the law, which are administered by we
the have an adequate set of

0.3854

0.2638
0.1186

tax components (detertax administration. Penalties are imposed for any lapses (either

0.0131

of enf), we can
late payment or detection of undisclosed income) on the part minants
of
assume that the total variataxpayers. Various components of tax collection include (i) taxes

tion in enf over years is

deducted at source (tds); (ii) advance tax payments; (iii) taxes

accounted for by the variapaid on regular assessments; (iv) penalty 1 for detection of untion in various tax compodisclosed income, under Section 27i(i)(c) of the Income Tax Act
nents and error variance is
1961; (v) penalty 2 - other than those under (iv); (vi) interest

negligible. We exploit the

recoveries either for less payment or late payment of taxes; and
total variation in all tax
(vii) other receipts, in the nature of residuary receipts.

0.0064

CT
4.2198

1.4459
0.9836
0.6552
0.6241
0.0503

0.0203
0.0007

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107

SPECIAL ARTICLE

components to arrive at the enf index.

Thus, the first principal component for it is:

/ TDst - 99991727 \ /at,- 43944471 \
For this purpose, we construct principal components (defined
Pit

as normalised linear combinations) of various tax components,

which have the property that the first principal component (PJ

accounts for the largest proportion of total variation in all tax+

/ RAt- 9439298 oo /PENI, -55652.59

V 6482895 \ 140906 )

O.4399

components, the second principal component (P2) accounts for

the second largest proportion of total variation in all tax compo-

/PEN2t-7l8993.4\ ( iRt- 699472

0.3719

V 2764113 / V 2466368 1

nents, and so on. If we compute as many principal components as

the number of tax components, the total variation in all tax com-

0.4651

v 97237562 \ 26096827 /

/REFt- 45808282 \ / ORt- 243487.I \

+

0.1100

v 47585682 ; v 472320.8 /

ponents is accounted for by all principal components together.

It is also true that the corr (Pj, Pj) = o, ie, the principal compoFor CT, it is:

51657666 \ /ATt-1.44E+O8 \

nents are mutually orthogonal.11

A weighted average of the principal components

FDSt- 75686343
/

( RAt - 37865022 \ / PENtl - 59162.58 \

Xl?i + -.. + kkPk

enf

v 1.35E+08 1

O.4794

v 35989010 / v 93511.47 /

*, + ... + **
In the present case, k = 8 and \ > l^ > > Xg are successive

/ PEN2t - 120306 \ / IRt - 3837706 \

-

O.2955

V 162499.6 / V 6500979 /

eigenvalues of the 8x8 correlation matrix of observations on

various tax components. We have arranged them in descending

' - 8239OI6O \ / ORt - 166036.2 \

I.36E+O8 . Q- ) \ 2534

order of magnitude.

' . Q- ) +O.O817

It can be shown that Var ?x = \, > Var P, = X8.

We assign largest weight \/I, \ to ?l because it accounts for

the largest proportion of total variation in all tax components.
Similarly P2 has been assigned the second largest weight ^/I X{
because it accounts for the second largest proportion of the total
variation in all the tax components, and so on.

By a little rearrangement of terms, the enf index can be expressed as a weighted sum of various tax components which provides weights (share) of individual tax components.

2.3 Computation of ENF Index

Since we are using an aggregated database, the magnitudes of

The normalisation is such that the sum

cients is 1.

The values of principal components, for ct and it for different

years, are obtained by substituting the corresponding values of
the indicators of tax enforcement.

The variance of successive principal components (equal to the

eigenvalues), proportion of total variation accounted for by them

and cumulative proportion of variation explained are given in

Table 9 (p 107).

From Table 9,
we observe that

Table 1 Ot Tax Enforcement Indtx of IT and CT

Income Tax Corporate Tax

Year Index Revised Year Index Revised

53.21 per cent of1999-00

2.51 102.51 2003-04 3.70 103.7

observations on different components are very high (or, very

the total variation 2002-03 2.13 102.13 2002-03 1.36 101.36

low). For example, for it, tds in 2003-04 is Rs 3,01,57,77,64,000,

in all tax com-

2003-04 1.50 101.5 2001-02 1.15 101.15

2000-01 1.18 101.18 1998-99 0.34 100.34

advance tax in this year is Rs 97,09,51,01,000 and penalty 1 is

ponents of it 2001-02
is

Rs 2,16,42,000, etc. It is advisable to make the observations scale

accounted for by

free. We transform the variables into their standardised form by

the first principal

1994-95

-0.37 99.63 1996-97 -0.01 99.99

subtracting respective arithmetic means (am) from each obser-

1995-96
component alone;

-0.38 99.62 1995-96 -0.05 99.95

vation and dividing them by the standard deviation (sd). The

77.05 per cent of

arithmetic means and standard deviations of observations on the

the variation is ac1992-93 -0.68 99.32 1991-92 -0.61 99.39

tax components are given in Table 6 (p 106).

1989-90 -0.72 99.28 1992-93 -0.61 99.39

counted for by the
1990-91 -0.76 99.24 1990-91 -0.74 99.26
first and second

The covariance matrix of standardised variables is, in fact, the cor-

relation matrix between the components as given in Tables 4 and 5.

We compute the eigenvalues shown in Table 7 (p 106), of the

correlation matrix r for it and ct by solving the determinant

equation |R-M| =0.

Corresponding to each eigenvalue (A.j), we solve the matrix
equation (R- A^I) oq = o to obtain the 8x1 eigenvector
<*i.

1.11 101.11 2000-01 0.23 100.23

1998-99 0.07 100.07 1999-2000 0.20 100.2

1996-97 -0.11 99.89 1997-98 0.10 100.1

1997-98 -0.47 99.53 1994-95 -0.33 99.67

1993-94 -0.56 99.44 1993-94 -0.42 99.58

principal components and so on.

1991-92 -0.76 99.24 .1988-89 -0.75 99.25

1988-89 -0.85 99.15 1989-90 -0.76 99.24

1987-88 -0.93 99.07 1987-88 -0.86 99.14

Similarly, 52.75 1985-86

-0.95 99.05 1986-87 -0.90 99.1

1986-87 -0.97 99.03 1985-86 -1.02 98.98

per cent of the to-The revised index is obtained by choosing 100 for the zero value of the index.
tal variation in all
tax components of ct is accounted for by the first principal com-

ponent; 70.82 per cent of the total variation is accounted for by

a i = as shown in Table 8 (p 107).

the first and second principal components, etc.

All eight principal components account for 100 per cent of the

total variation in all tax components. Table 10 provides the estimated tax enforcement index calculated as

The principal components of tax components are obtained as

normalised linear functions of standardised variables, where the
coefficients are elements of successive characteristic vectors.

y>1 + ... + X8Ps

ENF =

\ + ... + Kg
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SPECIAL ARTICLE

Rearranging terms in enf, we obtain the coefficients of indi-

vidual tax components as given below:

Given the above and the fact that the tax enforcement index

have hovered around the same level, the deviation being low, it

For it: 0.21 tds +0.21 at + 0.16 Reg asst 4- 0.29 Penalty 1 + 0.24 is important that the tax administration improves each of the
Penalty 2 + 0.30 Int recovery- 0.05 Refund - 0.12 other receipts. key components of tax enforcement - voluntary as well as invol-

For ct: 0.31 tds + 0.24 at + 0.25 Reg asst - 0.03 Penalty 1 + 0.12 untary. Since the two components of tax enforcement have a
Penalty 2 - 0.05 Int recovery + 0.31 Refund + 0.06 other receipts. feedback effect on each other, one cannot be improved at the

The sum of the coefficients in enf for it is 1.24. Therefore, expense of the other. Each aspect of the tax administration, like

weight (share) of tds for it is obtained as Table

detecting
11: Weights (Share) of Individual Tax
(%)

stop-filers, penalising tax evaders,

(0.21/1.24) x 100 = 16.94 per cent and so on Components

and making delinquent taxpayers pay arrears,

for other tax components of it. Similarly, TDS 16.94 25.62 ~

bringing unregistered taxpayers to the tax fold

Tax Components IT CT

sum of coefficients in enf for ct is 1.21. There-

fore, weight (share) of tds for ct is (0.31/1.21)

x 100 = 25.62 per cent, etc.

Table 11 gives weights (shares) of individual
tax components.
The above results show that tds and ad-

Ad

are important for creating an efficient and

Tax

Regular

effective tax administration. But as already

assessment

Penalty

Penalty
Interest

stated, it is also important that the tax depart-

ment focuses on facilitating voluntary compli-

recovery

ance through the provision of quality taxpay-

Refunds
Other

ers' service. Important obstacles to taxpayers'

receipts

Total

vance tax, broadly considered 'Voluntary" tax

Table

payments, contribute 33.88 per cent and 45.45

Components

voluntary compliance are the perceived in-

12:
(%)

per cent of the tax enforcement in it and ct,Tax

re- Components IT CT

Weights

(Sha

equity of the tax system, complexity of tax

laws, lack of fairness of the penalty system,

TDS 27.64 26.97 ~

spectively. "Involuntary" compliance resulting

and weak taxpayer education programmes.

Advtax
out of regular assessment, levy of penalty, inter-

Lack of adequate training of the staff, the tax

Regular assessment 20.50

ests recoveries, etc, constitute the remainder.

Penalty

While for personal income tax, the pen-

Interest

and weak tax audit programmes act as impedi-

Refunds
alty under Section 271(1) (c) is really a threat
Other

against the taxpayer - with 23.39 per cent of

administration's inability to ensure adequate

follow-up action during the appeal process,

recovery

receipts

ments to the enforced compliance. Well-

Total

designed preventive actions, such as the estab-

the weight share in the enforcement index, it is

lishment of withholding schemes and development of prevennot a very effective enforcement measure against the corporates.
tive
It should be observed that the magnitude of penalty 1 has
re- audit programmes which will demonstrate to a significant
number
mained rather low for all years except 1999-2000 (showing
a of taxpayers that the tax administration will use relevant
information from third parties to detect evasion, may also foster
peak). For ct, the year 1985-86 was really an outlier with respect
voluntary
compliance.
to penalty 1, as also 1998-99 showing a high value of penalties
1
One key strategy to improving the effectiveness of administrabesides 1999-2000 showing the peak.

tion would be to build a proper information system, and a data

As involuntary compliance results mainly from regular assess-

base. A major aspect of poor tax administration has been the

ment, the relationship between penalty 1 and regular assessment
is important. From Table 2 (p 105) we see that for ct thevirtual
cor- absence of data, and if there is data, it is inadequately
collated for meaningful analysis. This has not only rendered the
relation between regular assessment and penalty 1 is negative
proper analysis of taxes to provide an adequate analytical back(equal to -0.07). In fact, this is insignificant correlation.

ground to calibrate changes in the tax structure but it has also

If we combine penalties 1 and 2 the weight shares are as shown
in Table 12.

made enforcement difficult. Changes in the tax structure have

often been made in an ad hoc manner [Rao and Rao 2005]. High

3 Conclusions

compliance costs combined with the poor state of computerisa-

tion andisinformation systems have led to a continued interface of

From the above analysis we find that the voluntary compliance

taxpayers
not more than 50 per cent in it or ct. Close to one-fifth
of the and tax officials, with compliance costs but low levels

ofon
tax
compliance [Das-Gupta 2004]. An important indication of
enforcement comes from regular assessment. Penalties
indithe is
poor
vidual taxpayers do act as a deterrent but such an effect
notstate of information system is that even as the coverage

of TDS
very perceptible in the case of corporate taxpayers. Since
re-was extended over the years, there was virtually no
funds, in the case of corporate taxpayers, are large due to the
Figure:

high volume and magnitude of the disputed amount against

Fluctuation

them, the enforcement index presents it as an important factor in

raising tax collection. In fact, it is said that till some years ago the

interest rates on refunds were high and many corporate taxpayers were finding an opportunity for arbitrage on the interest rates

and therefore, were making higher instalment payments, only to

collect them later as refunds. Since such refunds are not so high
in personal income tax, they show up having negative effect on
the tax enforcement index.

Economic & Political weekly December 15, 2007 109

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SPECIAL ARTICLE ~

information system to check whether those deducting the taxes

tax atshould not be a reason for complacency if the effective-

source file the returns and pay tax. As the cag report forness
2003of the tax administration is to be improved. In fact, in04 states that of the 6,26,000 returns to be filed by tds assesses,
creased effectiveness of the tax administration would actually be

only 4,99,000 returns were filed (ibid). In other words,reflected

more in the increased voluntary compliance. Penalising tax
than 20 per cent of the tds assesses did not file the returns.
evaders and pursuing delinquent taxpayers to collect tax arrears
The recent initiative of the Central Board of Direct Taxes on
cannot be the main objectives of an effective tax administration;

building the computerised information system may facilitate rather it should be to encourage voluntary compliance so that if
compiling information on taxpayers. This would improve match- marginal non-compliance is detected, the same is effectively

ing and cross-checking of information from banks and other punished. There is, therefore, a need to manage the tax adminisources, and may improve voluntary compliance. The online taxstration with a view to achieving a proper balance between the
accounting system operationalised in July 2004, may be one such service to the taxpayer and enforcement of the tax laws to prostep in that direction. The current high growth rate in the direct mote voluntary compliance.

NOTES

3 This paper deals

with
only
direc
variation
in ENF is expressed
as a sumthe
of (i) variation
income tax and corporate
which
due to tax components and (ii) tax,
error variance.
How-

1 A tax policy is only as good as it is administered and therethe income tax department, governme
ever, as corr (Pj, Pj) =0, the tax components are not
fore, it is important to design the tax system keeping
4 the
Stop filers are those taxpayers, who

necessarily mutually uncorrelated.

administrative capacity in mind [Bird and Zolt 2005].
es for one or more years stop filing th
2 Revenue productivity is a ratio of the effective tax
rate many counties, the ratio of stop-fil
In
to statutory tax rate. For example, statutory corporate
REFERENCES
the total registered
taxpayers is in th

tax (CT) rate in India in 2001 was 35.9 per cent40

and

per

the effective CT rate was 3.5 per cent, so the revenue

5 PAN
productivity was 9.7 = (3#5/359) x 100. Ratio of corpo-

cent.

is

Bird,

taxpayer's
via

Richard

an

identification
nu
Taxation:
The
L

6 Commissioner's Tax
jurisdiction
is calle
in
Developing
rate tax to GDP is used for calculating effective CT rate.
7 See Section i39(i)(a)
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the income
Policy
Geo
For comparison with other countries, see the table below.
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Productivity

(%)

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Tax Rate (%) Tax Rate (%) Productivity

France

8.9

33.3

26.73

Germany

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Das-Gupta,
Arindam
of
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of

sonal

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Estimates,
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wh

Policy.
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for various reasons,
creating
Poirson, Helene (2006):
Making Tax Policy Pro-growth,arrears.
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10 The income tax
has

even

OECD (2006):
Tax Administration
in OECD and Selected
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ad

ries, 2006, Centre for Tax Policy and Administration.

11 We can draw an analogy with the classical regres-

UK

US

average

site.

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Korea

Source:

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web

to

Italy

Japan

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9.6

Helene

Rao, M Govinda and R Kavita Rao (2005): Trends and

sion model. If the dependent variable (ENF) could
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Poirson
(2006).
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optimal coefficient estimates. The total

Economic&PoliticalwEEKLY
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