India’s taxman has a problem. Under three per cent of the country’s citizens pay income tax, while the government continues to run a significant budget deficit. Bolstering tax collection thus assumes particular importance in the country. Prime Minister Narendra Modi’s widely criticised demonetisation programme, which I wrote about in an earlier column piece, was to a great degree motivated by the aim of increasing tax revenue. The government points to the programme as being responsible for a 12 per cent increase in collection.
But with the vast majority of Indians working in the informal economy – typically small businesses, self-employment and other such enterprises that are chronically not tax compliant – and many more making too little to pay a meaningful sum of tax, the government has made a concerted effort to boost collection in other tax categories as well. India’s rapidly expanding real estate market has been a prime target. The government levies a stamp duty, proportional to the value of the property, on both the buyer and seller. This stamp duty varies from state by state, and is typically around five per cent.
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The issue with this approach is that tax avoidance is quite simple. When the property is being registered, those seeking to avoid the duty can simply declare a value far below the market price of the property and cover the difference in a cash transaction. Thus, not only is tax avoided, but also people who have “black money” – undeclared income that is often the proceeds of corruption or criminal activity – can conveniently legitimise their gains.
With this in mind, local governments across India have instituted what they label “circle rates” for the sale of property. These are government appraised values per square metre of the property, below which the property cannot be sold. Typically, properties will be categorised within one of a number of circle rate categories depending on a variety of valuation factors.
The circle rate has long been plagued with issues, and perversely, circle rates have in many instances served only to exacerbate evasion. To begin with, valuations are not reassessed anywhere near as frequently as they need to be. During property booms, the actual market value of the real estate has frequently been far north of the value assessed using the circle rate. This has encouraged black money transactions. With the government-defined value being below the market rate for a property, it is straightforward to under-declare the sale price with even less risk of raising suspicion of wrongdoing than under a system without a circle rate.
Furthermore, there is risk of a norm forming, even for generally law abiding citizens, of paying only the minimum tax and settling the rest in cash. This is particularly likely, and even more pernicious, in a country like India, which does not have a general culture of tax compliance – in no small part because citizens have historically had limited faith in the government’s ability to deploy tax money effectively and without corruption.
When there is a slump in the market, as occurred in many cities in 2016, the circle rate typically exceeds the market value. In this scenario, the market grinds to a halt. Buyers are unwilling to pay the excessive duties that result from the essentially inflated circle rate. This is clearly not an ideal outcome for any party involved.
A potentially robust solution could be to replace the stamp duties with a somewhat increased annual property tax. The lower immediate tax hit should reduce the incentive for evasion and will ensure that even if appraised values are not entirely in sync with market values, the impact to the taxpayer or government will be of a lesser magnitude until the appraisal is revised. Under this scheme, mutually beneficial property sales will take place regardless of market conditions, and a norm of tax non-compliance is less likely.
Privatised appraisal by companies specialising in that particular field – as opposed to bureaucrats in municipal offices – should also help make the determination of property values more accurate: expanding beyond, for example, the relatively arbitrary eight categories used in New Delhi, and therefore bringing the appraised value closer to the actual market value.
Of course, one of the functions of a stamp duty is to penalise harmful speculation in the property market, but this issue can be dealt with by implementing stamp duties solely when a home has been resold within, say, three months or years of its acquisition.
In the long run, there will likely be some interesting developments for the government – and tax evaders – to consider. Demonetisation was partly also a push by the Indian government to move toward a “cashless economy”, on the grounds that electronic transfers are simpler to assess for tax purposes and make it harder to conceal ill-gotten gains. Luckily for Indian government, the economy will probably continue moving in that direction anyway.
But bureaucrats should not rejoice just yet. Circumventing the banking system, which significantly enables tax evasion, is aided with the use of online platforms like bitcoin, which operates on an anonymised blockchain. Unless regulation keeps up with such “off-the-record” transactions, taxation could become a major headache. China, for one, has simply banned bitcoin. More nuanced policies may be possible, and desirable, but that is a discussion for another time.