Indian Tax System: Compliance by Design

Abstract

            Taxes matter.  They are required to finance social goods which the markets fail to provide.  Since taxes are compulsory payments, it is important to evolve the design and implementation features to ensure effective compliance with the tax to ensure both horizontal and vertical equity. Tax compliance is a multiplicative function of the rate of tax, probability of detection, and penalty rate.  The best practice approach to tax policy and reform is to evolve the system with a broad base, and low and less differentiated rates. Such a simple system with reasonable rates minimises the three costs associated with taxes namely, the collection cost to the government, compliance cost to the taxpayer, and distortion cost to the economy. Avoiding multiple objectives makes the tax system simple and broad-based and requires low tax rates to collect a given amount of revenue.  A strong technology platform for administering the tax increases the probability of detection and enhances voluntary compliance.  The paper discusses the important aspects of tax compliance in terms of design and the importance of technology in the administration of taxes in India.