Independent tax policy body needed

The satirical refrain “Kijiye meeting meeting...” from the Panchayat series humorously captures bureaucracies’ tendency to hold endless meetings with little progress. This mirrors the common perception of government operations, where new committees or commissions are often formed in response to issues, sometimes seen as delaying tactics rather than solutions. While this can indeed be seen as bureaucratic inertia, certain situations do necessitate the creation of new entities for effective problem-solving.

Theoretical frameworks explain this bureaucratic behaviour. Max Weber’s theory of bureaucracy points to rigid structures causing organisational inertia, while Parkinson’s Law suggests administrative tasks expand unnecessarily. Public Choice Theory highlights how officials may form committees to advance personal interests, and the Garbage Can Model shows how solutions like committees are often attached to problems without clear outcomes.

Despite the scepticism surrounding bureaucratic expansion, there are instances where the formation of specialised bodies is essential for effective governance. One such example is the establishment of an independent Tax Policy Unit, which would focus on long-term revenue estimation, mobilisation, and rationalisation.

This unit would bridge the gap between existing tax authorities, such as the CBIC and CBDT, which often operate in silos, and provide cohesive, forward-looking policy recommendations. The unit could enhance fiscal planning, improve tax efficiency, and support sustainable economic growth.

Staffing issues

While the Tax Policy Research Unit (TPRU) was established in 2016 to address the structural issues highlighted by the Tax Administration Reform Commission (TARC), it needs to be more adequately staffed.

The TARC, in its First Report, emphasised the need for a more integrated and coherent approach to handling tax policy and legislation. It pointed out that the current structure creates fragmentation, limiting the capacity for multidisciplinary inputs and strategic consistency.

Apart from this, there are several reasons why setting up a new body that subsumes TPRU or strengthens TPRU is essential. Tax bodies like CBIC and CBDT are primarily focused on short-term revenue collection. This emphasis on immediate goals creates a conflict of interest that hinders structural reforms in the tax system.

The principal-agent problem arises when tax bodies prioritise short-term revenue targets over the government’s long-term policy goals. This misalignment is inherent when the agent (tax bodies) follows its objectives rather than the principal’s (government’s) objectives.

By creating an independent Tax Policy Unit, the focus could shift towards sustainable reforms, addressing this fundamental conflict and aligning tax policy with broader economic goals.

An independent Tax Policy Unit would mitigate the risk of regulatory capture and ensure tax policies are designed with public welfare in mind rather than catering to narrow interests.

A Tax Policy Unit could focus more on the macroeconomic fundamentals of the economy and incorporate these factors using advanced models like DSGE (Dynamic Stochastic General Equilibrium) and VAR (Vector Autoregression), providing more accurate long-term revenue forecasts. This would enable better fiscal planning, accounting for immediate and future economic changes.

Using dynamic scoring techniques could enhance revenue projections. This approach accounts for behavioural changes in response to tax policies, such as shifts in labour supply or consumption patterns, offering a more realistic estimation of the long-term impact of tax reforms.

CBIC and CBDT often work in silos, resulting in inefficiencies like conflicting exemptions between direct and indirect taxes. An independent body could apply Optimal Tax Theory to design a coherent tax system that balances equity and efficiency. A unified and rational tax structure would reduce distortions, optimise revenue collection, and improve compliance. This would also mean that exemptions would go, and the net effective tax rate would come down.

Compliance issues

India’s tax system faces persistent compliance issues, and existing enforcement mechanisms do not fully account for behavioural insights into taxpayer actions. Game theory models could be used to design better strategies for increasing compliance.

Additionally, leveraging advanced data analytics and AI could help identify patterns of non-compliance, improving enforcement efficiency and reducing tax evasion. Current tax bodies focus primarily on immediate revenue collection, often neglecting long-term fiscal stability.

An independent Tax Policy Unit could apply Fiscal Reaction Functions (FRFs) to ensure that tax policies are designed to stabilise public debt and manage fiscal deficits over time. This would prevent fiscal policies from being excessively procyclical, which could exacerbate economic fluctuations. Moreover, the use of Overlapping Generations (OLG) models could ensure that tax policies do not disproportionately burden future generations, promoting intergenerational equity. This long-term perspective is crucial for ensuring that today’s fiscal policies do not create unsustainable future obligations.

By separating operational tax collection from policy formulation, an independent Tax Policy Unit would avoid the risks associated with having the same bodies perform both functions. This separation would lead to more objective, transparent, and efficient policy recommendations, free from the day-to-day pressures CBIC and CBDT face. The global economy introduces new challenges, such as Base Erosion and Profit Shifting (BEPS). An independent unit could specialise in addressing these cross-border tax issues, ensuring that India’s tax policies remain competitive and aligned with international standards.

An independent body would be better equipped to use endogenous growth models to assess how tax changes impact innovation, investment, and human capital. This dynamic evaluation process would ensure that tax policies support long-term economic growth.

In conclusion, an independent Tax Policy Unit would provide India with a more objective, strategic, and long-term approach to tax policy, ensuring that the system is sustainable, equitable, and growth-friendly.

The writer is Officer on Special Duty, Research, Economic Advisory Council to the Prime Minister. Views expressed are personal

CBIC and CBDT are primarily focused on short-term revenue collection. This hinders structural reforms in the tax system