IRS, Former Principal Chief Commissioner of Income-Tax
After the announcement of demonetisation on November 8 2016, tax experts were of the view that if unaccounted cash was deposited in one’s account and declared as the current year’s income, one only needed to pay tax at normal rates to make the cash white. This view was based on the newly inserted Section 270AA of the Income-Tax Act, which granted immunity from prosecution and penalty if all taxes were duly paid.
However, in the second week after demonetisation, the government made several announcements indicating that it would deal strictly with persons finding ways around demonetisation and on November 28, a bill proposing the Pradhan Mantri Garib Kalyan Yojana, 2016 (PMGKY) was introduced in the Lok Sabha.
This bill negated the provisions of Section 270AA by taxing unexplained credits, investments, cash and other assets at a rate of 60 percent with a surcharge of 25 percent of the tax i.e. total tax surcharge amounted to 75 percent of the income. Additionally, the Assessing Officer could levy a penalty amounting to 10 percent of the income. To escape penalty and the high rate of tax, a tax evader could pay tax, surcharge and penalty aggregating to 50 percent of his income and deposit 25 percent in an interest free deposit for four years under PMGKY. This Bill became law on December 18, 2016.
As the PMGKY draws to a close, it is becoming increasingly clear that the response to the scheme has not been up to the government’s expectations. Tax of Rs 50,000 crore to Rs 100,000 crore was expected under the PMGKY and PMGKY was expected to provide a fillip to tax collection.
However, according to reliable sources collection under PMGKY is still far short of Rs 10,000 crore and the income-tax budget (even after including collection under IDS and PMGKY) is far short of the target.
In these circumstances, the question naturally arises: Why is a scheme so assiduously promoted by the government staring at an ignominious failure? A number of reasons come to mind. Firstly, the current year has seen the Finance Ministry roll out four major schemes viz. Income Declaration Scheme 2016, Dispute Resolution Scheme 2016, Demonetisation and finally the Pradhan Mantri Garib Kalyan Yojana 2016.
The target group of all the schemes was black money holders who were to be persuaded to whiten their money by paying appropriate taxes. However, it soon became clear that persuasion was not working and the Income-Tax Department had to resort to mass surveys and searches. One reason for the lack of response of the tax payers could be that black money is earned over a period of many years but taxes are to be paid out of current resources. With demonetisation hitting hard at business, few taxpayers had the wherewithal to contribute to both the IDS and PMGKY. Psychologically, tax payers felt a sense of déjà vu when PMGKY was announced by the Government just after IDS.
Secondly, the rate of tax under PMGKY is extortionate. No person would pay tax if he is not convinced that the tax is fairly levied and he would be in an advantageous position if he pays the tax. In fact, the entire theory of modern taxation is based on the postulate that no tax revenue will be raised at the extreme tax rates of 0 percent and 100 percent and that there must be at least one rate which maximises government taxation revenue.
The Laffer curve portrays this theory. The optimal rate of income tax for India has been found to be 30% and for this reason from 1991 onwards Governments of all hues have persisted with this rate. It is also a matter of record that income-tax collection has increased more than 20 times in the last 25 years, far outpacing both inflation and GDP growth.
One implication of the Laffer curve theory is that increasing tax rates beyond a certain point would be counter-productive for raising further tax revenue. Simply put, no prudent businessman would pay 50% of tax upfront and immobilise 25% of his income. Rather, the taxpayer would prefer not participate in any such scheme and would fight tax demands to the bitter end.
Another reason for the tepid response to PMGKY was that PMGKY was the aftermath of demonetisation. Though the exact value of the banned notes deposited in banks has not been disclosed but it is clear that almost all banned notes have reached the banks. Thus one may safely conclude that all money — black and white — has been accounted for. This has left little scope for PMGKY because everyone who has deposited banned notes has some explanation ready for the source of the money.
On its part, the Income-Tax Department has identified 18 lakh suspect bank accounts and has sent questionnaires to all the 18 lakh depositors but less than half have been replied to and that too in a sketchy manner.
The Income-tax Department scrutinises only 4 lakh income-tax returns every year, therefore, scrutinising all suspect accounts is well nigh impossible given the additional fact that an Assessing Officer gets time of only 17 months to scrutinise a return. Moreover, the I-T Department is desperately short of manpower and to expect that it would do its regular work and also run assorted yojanas successfully is asking for too much.
If the government had acted in a planned way, it would have run demonetisation and IDS concurrently. This would have obviated the need for PMGKY. Under IDS/demonetisation black money holders could have deposited 45 percent of banned notes in the income-tax account and 55 percent in their own. I am sure that this would have avoided the large scale corruption unleashed by demonetisation. Instead of adopting dubious methods to exchange banned notes, people would have opted to be law abiding. Even if the government had announced PMGKY and demonetisation at the same time then PMGKY would have been far more effective and corruption related to demonetisation would have been much less.
Finally, there is a very simple reason for the failure of PMGKY. The scheme was held out as an alternative to something much worse that would befall the taxpayer if he did not come clean. Thus, there was a significant element of coercion in the promotion of PMGKY. It is human nature that such situations bring out the fighting spirit in the intended victims. Also, the fact that the government kept changing its position every second day convinced taxpayers that they were not safe regardless of whatever they did. This lack of trust engendered a confrontationist attitude guaranteeing the failure of PMGKY.
Hypothetically, if there had been no PMGKY and the suspect 18 lakh people had been allowed to whiten their money by paying tax at normal rates then tax collection would have gone up by Rs 100,000 crore assuming an average deposit of only Rs 16 lakh in each suspect account. This would, of course, have denied an opportunity to tax officials to ride roughshod over the public.
However, there are some important takeaways from the failure of PMGKY.
Firstly, all schemes affecting large chunks of the population should be launched only after due deliberation. Secondly, the maxim that there is no equity in tax laws is valid even today. If some scheme aims at eliminating black money then some incentive should be given to the black money holder to come clean.
If the government wants to eliminate black money by coercion and penalties, then the black money holder will never co-operate. A case in the point is the Indonesian tax amnesty scheme which concluded on February 28, 2017. Due to moderate tax rates, Indonesia garnered declaration of income and assets to the tune of USD 330 billion in its tax amnesty scheme as against the less than USD 10 billion in IDS and USD 2 billion in PMGKY. Even Argentina did much better, garnering USD 80 billion in income declarations in its amnesty scheme.
Thirdly, and most importantly, tax collection being a consensual process, in the short run, the government should never deviate from its stated position. The trust of the public is worth much more than billions of rupees in tax revenue.
We can only hope that the government has learned its lesson and would not launch such disruptive schemes in the future and would rather rely on structural and legislative reforms to fight black money.