The Coronavirus outbreak has been rightly dubbed as a simultaneous health and economic crisis. With millions of Indians under lockdown in the hopes of flattening the curve, the economy has come to a grinding halt.
India was initially quick to respond with the introduction of tax policy measures designed to ease the blow of the lockdown. In March, the Finance Minister rolled out tax compliance relaxations and other similar measures primarily aimed at giving temporary respite to taxpayers and boosting liquidity.
Overall, these steps were generally regarded as appropriate. So far, it also seems that the government has avoided the cardinal sin of permanently distorting our already convoluted tax framework by ensuring that these relaxations apply only in the short term. That said, with the mammoth task of restarting the economy looming over us, it is too soon to count our victories.
The Inherent Limitations of Tax Policies
At the outset, it is necessary to appreciate the conundrum that faces our policymakers. To put it simply, the government is facing a sharp decline in tax collection—which constitutes one of its primary sources of revenue. This is due to a combination of factors including the grant of tax collection waivers and deferrals as mitigation measures, reduction in the consumption of goods and services due to physical containment, and a decline in the rate of profit generation due to suspension of economic activity. In parallel, government expenditure has risen exponentially with the need to finance Coronavirus-19-related expenses such as testing, treatment and cash hand-outs.
By now, it is apparent that despite endeavors to resume economic activity once the lockdown is lifted, international and domestic trade is likely to witness a slow recovery. It is thus imperative to temper our expectations and acknowledge the limitations of tax policies in such situations.
First, tax revenue is dependent on the society’s consumption and income generation capabilities. The purchasing power of households affected by the crisis will be low and consequently goods and services tax (GST) collections will suffer. Similarly, businesses will see small profit margins at best, and income tax earnings will thus be low. Even local taxes such as house/property tax that are linked to the market value of the property, will witness a dry spell. Therefore, tax revenue is not likely to increase significantly in the near future.
Second, tax policies can only directly benefit those under the tax net. Thus the informal sector, which has arguably been hit the hardest by this pandemic, can reap only limited and indirect benefits from changes to tax policies.
Despite these limitations, tax policies play an important role in influencing public behavior and financing public expenditure. In the restoration phase, tax policies and administrative action must be aimed at:
- supporting affected taxpayers;
- increasing consumption;
- incentivizing savings;
- optimizing tax revenue; and
- maintaining stability.
Prolonging the applicability of mitigation measures such as compliance relaxations and tax payment deferrals could be explored as means to support businesses and help affected households regain stability and purchasing power. In the restoration phase however, the coverage of these relaxations must be narrowcast and they must not promote compliance complacency.
Many countries, including the U.K. and Australia, are offering tailored solutions on a case-by-case basis to taxpayers that are especially affected by the ongoing crisis. Adopting a similar system for taxpayers operating in certain identified sectors may be explored in India as well. A special emphasis may also be laid on taxpayers that offer social returns and help build resilience against the impact of the pandemic. Tax authorities must also endeavor to ensure that the terms and conditions of such relaxations are effectively communicated, so as to avoid future litigation.
In order to increase consumption, incentivize savings and optimize tax revenue, tweaks to tax rates may also be considered. Notably, achieving the first two of these aims would call for a reduction in the rate of tax. On the other hand, optimizing tax revenue would ideally entail an increase in the levy of tax. Given the current climate, it is now more important than ever that any alteration in tax rates is underpinned with empirical evidence, cost-benefit analysis and extensive public consultation to determine its impact on the sector as well on behavioral patterns.
Moreover, in deciding whether to impose a new levy, one must also bear in mind our existing administrative capabilities and maintain a buffer for further limitations that may be placed on such capabilities by the ongoing health crisis.
Lastly, any change that imposes a new levy or adds an additional tax burden must comply with the principles of equity and ensure a progressive tax framework.
To optimize tax collection, it is imperative that India invests in leveraging technology to digitize compliance, administration and enforcement processes. Not only would this boost taxpayer morale by making compliance less onerous, but it would also minimize corruption and ensure transparency and consequently maximize tax collection. The introduction of cooperative compliance schemes to foster relationships based on faith, may also be considered.
That said, it is also necessary to ensure that tax authorities resume enforcement action against evaders in the restoration phase. To ensure that such actions do not adversely impact genuine and usually compliant taxpayers that faced financial duress owing to the pandemic, leniency in such specifically identified cases may be allowed. The tax authorities may choose to revisit the compliance risk management approach adopted by them to give effect to such leniency.
Lastly, according to the United Nations Conference on Trade and Development, investment from developing countries during the Coronavirus crisis has been reportedly withdrawn at a faster rate than during the global financial crisis of 2008. Therefore, avoiding shocks and granting businesses a sense of stability and certainty in these tumultuous times should also be a priority for our tax policymakers. Gradually lifting the short-term relaxations granted to taxpayers in the mitigation phase and ensuring that no hasty decisions are taken to impose substantial additional tax burdens would go a long way.
In these uncertain and unprecedented times tax policymakers must actively endeavor to strike a balance between incentivizing economic transactions through tax breaks, while maintaining a steady stream of revenue.
Vidushi Gupta is Team Lead and Senior Resident Fellow (Tax Law) at the Vidhi Center for Legal Policy, India.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.