Personal income tax collection is a success story for 2000-01. Budget estimates were for such revenue to increase from Rs. 26,684 crores to Rs. 31,590 crores. Collections till January indicate a 35 percent increase which if sustained should mean a Rs. 36,000 crore collection by March 2001 i.e. almost a Rs. 5000 crore increase over the best estimates of the Revenue Department.

What is going on ? Is this jumbo increase due to an increase in compliance or the cumulative effect of the two surcharges announced by the Finance Minister, Mr. Yashwant Sinha, for the fiscal years 1999-00 and 2000-01. Given the alacrity with which the government imposed an earthquake surcharge a few weeks ago, it seems that they are convinced that the jumbo tax gains are due to the surcharges.

This reasoning also perhaps led to the Kargil surcharge - it seems the government is only too keen for disaster to strike so it can raise "additional" revenue to finance the largesse of the pay commission that led to large, unwarranted increases in expenditure in the first place. Let us see - announce pay commission rewards, cut other expenditure, and don't raise tax rates because that would be politically unpopular. (However, there are several old fashioned economists who believe that direct taxes at a 30 percent peak rate are too "low"). Instead, pray for calamity to strike so tax rates can be raised through the disaster surcharge door. Kafka, did you say ?

What makes it worse is that surcharges most likely lead to a decline in gross revenue collected. So the government manages to axe its feet by imposing surcharges. Besides gratifying the confused economists, nee moralists, that the "rich" are being taxed heavily for their obviously misbegotten gains, there is little to justify the income tax surcharges that the knee-jerkers seem to implement so wantonly. This is documented below.

It is important to establish the source of tax revenue changes. There are three possible reasons why tax revenue changes from year to year - changes in income, changes in tax rates, and changes in compliance. There is no debate that various efforts have been made to increase compliance - more people in the net, a lowering of tax rates, etc. So, ceteris paribus, income tax revenues should be increasing at a healthy rate - which they have. What is of interest, however, is the effect of tax rates, and in particular tax surcharges, on compliance and therefore tax collection. This is what has been attempted at Oxus over the last few months, an effort that has been aided by the excellent study done by Mr. Parthasarthi Shome and associates for the Planning Commission.

The data requirements for assessing the compliance vs. surcharge question are straightforward. One needs an estimate of income distribution, and the tax schedule. The former was provided by NCAER in the form of the various MISH (Market Information on Survey Households) surveys. The average number of earners according to NCAER survey for 1997-98 is 1.4 per household, and there are approximately 175 million households. Thus, the number of earners in India in 1997-98 is estimated to be about 250 million. The earners income distribution obtained from the NCAER household data is then (roughly) benchmarked with the NCAER household distribution for the same year. Thus, one is able to obtain, for each year since 1994-1995, the income, deductions, tax rate, and (potential) taxes paid by each percentile of the income earners population. An aggregation of the taxes paid yields the theoretical tax revenue that would be collected with a 100 percent compliance rate.

Obviously, the potential revenue level calculations have little bearing with reality. What is of concern are the calculations pertaining to the growth in revenue - these growth rates can be compared with actual growth rates to identify the separate contributions of changes in compliance with changes in tax regimes. In other words, differences in the growth rates are entirely the result of differences in compliance from year to year.

Some basic results which emerge - only the top 25 percent of the earners population is eligible to pay tax and that is approximately 60 million individuals. Of these, approximately a fourth are in rural/agricultural pursuits, which are either too difficult or illegal to tax. Thus there are 45 million potential taxpayers, of which 18 million are estimated to be on the rolls today, giving an overall 40 percent tax coverage ratio. Not as bad as some people had assumed, but not that good either. The percentage of potential tax collected is in the neighborhood of 20 to 25 percent. Still a lot of room for tax collection, if not messed up by higher tax rates.

The table documents various data pertaining to direct income tax collection, and compliance. The large fall in potential revenue in 1997-98 - minus 25 percent - is the positive compliance effect of Mr. Chidambaram's tax reform. In that year, tax rates were streamlined, and the maximum tax rate reduced to 30 percent. The expectation was that without increase in compliance, tax revenues would fall by a whopping 25 percent. Tax revenues (excluding VDIS) stayed constant at around Rs. 18000 crores. Thus, compliance must have increased by a large amount.

Note now the effects of the surcharge on compliance. A surcharge of 10 percent was introduced by Mr. Sinha for 1999-00. In Feb. 2000, Mr. Sinha increased the surcharge from 10 percent to 15 percent for the top income (greater than Rs. 1.5 lakh) group. And how much extra revenue has been gained in the process? Note the negative compliance effect for the two years, 1999-00 and 2000-01. Tax revenues are lower by at least 3 percent than they would have been if there had been no surcharge. Since 1998-99, actual tax revenues likely increased by 69 percent, while potential tax revenue increased by 73 percent. If it is assumed that the compliance effect of the 1997-98 tax cuts lingered on beyond a year, (a very reasonable assumption) then total revenues collected since 1997-98 should have increased by 118 percent. The actual increase was only 92 percent (increase of 36,000 over Rs. 18750 crores). The gap between the two is 26 percent, which on an average base collection of Rs. 28,000 crores, 1998-99 to 2000-01, comes to Rs. 7280 crores - or about half the amount needed for Gujarat.

Thus, one obtains two estimates of the effect of the recent surcharges on tax collection - either a Rs. 800 crore decline or a reduction of Rs. 7000 crores. At a minimum, there is no evidence that the tax surcharges have helped generate additional revenue, and all the evidence exists that such surcharges hurt revenue collection.

Not only should another surcharge not be levied, but the existing surcharges should be removed - to help revenue collection. What is most refreshing is that Mr. Yashwant Sinha apparently sees it the same way. He is on record as stating that he feels the "old" Chidambaram tax rates are fine. Let us hope the new Sinha wins the day, both for himself and Mr. Vajpayee (a team to beat the Rao-Singh combine?), and most importantly for the Indian economy.