In the 2019 Union budget, finance minister Nirmala Sitharaman increased tax rates for the super-rich. She is hoping that increasing tax rates would proportionately increase tax revenue. According to supply-side economist Arthur Laffer, increased taxation does not always lead to higher tax revenue because above a certain threshold tax rate, the incentive to produce more diminishes, thereby reducing the tax revenue the government receives.
Those in the higher tax bracket, more so self-employed individuals, have the resources to find innovative ways to protect their capital from taxation. The high-tax system will also give people an incentive to do something that they would not have chosen to do at a lower tax rate. So, an individual’s willingness to pay the tax—tax compliance—is as important or more important a factor in improving tax collections than tax rates themselves.
How do we improve an individual’s willingness to pay taxes? To inculcate a positive attitude towards tax payment, we need to change the narrative around taxation. In recent times, thanks to the work of economists focusing on distributional issues like Thomas Piketty, MIT’s Nobel Prize winning economist Peter Diamond and Berkeley’s Emmanuel Saez, intellectual arguments have been developed to propose higher rates for the rich than what exist today. Their main argument is that a large amount of capital today is concentrated in the hands of a small number of super-rich, increasing the inequality in society.
This narrative portrays the super-rich as selfish people who do a disservice to the nation by usurping national resources for their personal wealth creation. This narrative forces the government to don the image of Robin Hood, one who forcefully extracts money from the rich and redistributes it to the poor. Looking at it from this point of view, taxation is an ideal tool to bring about a semblance of equality in a society.
However, this narrative about the rich ignores the fact many individuals who have become rich, to paraphrase American poet H.W. Longfellow, are those who “while their companions slept, were toiling upward in the night". These individuals took risks others were scared of taking. They have provided jobs to hundreds. The rich made their millions while helping several others and the nation as a whole, to become richer. One of the unfortunate fallouts of years of socialist thinking is that becoming rich is considered a sin. As a first step towards building a tax-compliant culture, we should remove this negative bias towards rich people. We should build a culture that respects those who become rich and, in that process, pay high taxes.
Income tax has always remained in the private world between the individual and the tax authorities. This has to change. Paying taxes should become a facet of one’s social behaviour. The government should design several interventions to develop tax compliance as a prestigious social norm. An exclusive line at the airport for those who have paid more than ₹1 crore in taxes in a year will surely provide social recognition to the taxpayer and act as an incentive for many more to join that line.
From an economic utility point of view, one cannot deny that paying tax will always be considered a loss of one’s hard-earned money. Human aversion to losses will always make tax compliance a perennial behavioural problem. To create a tax-compliant culture, the government needs to find ways to compensate for this sense of loss. The solution could lie in a recent discovery about human brain. Learning from cognitive neuroscience reminds us that the real currency of human mind are emotions. All human decisions are influenced by the emotional utility of those decisions.
In a World Values Survey done across 56 countries, the vast majority of respondents stated that “cheating on taxes if you have a chance" is never justifiable. Several other studies have also shown that the vast majority of humans are inherently honest. All that is required is to have the right stimuli to trigger the inherent honesty that resides in most humans.
In the paper Income Tax And The Motivation To Work published in the Journal Of Behavioural Decision Making, Scott Rick, Gabriele Paolacci and Katherine Burton show that the motivation of individuals to pay taxes is closely related to their attitude towards income redistribution. Individuals will have a positive attitude towards paying taxes when they know that the tax they paid was used to make a significant positive impact on society.
When people are not told where their tax money has gone, their imagination runs wild. Many might assume that their hard-earned money has been wasted on useless projects. This feeling tends to create a further negative attitude towards tax compliance and becomes a valid excuse to resort to tax evasion. A communication from the government that the tax that was paid by the individual is equivalent to the cost of building a few kilometres of rural road, will help the taxpayer better visualize where his money is going. The emotional utility could be further increased if individual stories of those who benefitted from the tax income are included in the communication. Presently, all the communication to the taxpayer is from the income tax department, a faceless, emotionless entity. Instead, if the communication to the individual tax payer is from the finance minister, the communication will be far more relatable and so emotionally more rewarding to the tax payer.
At present, tax payment is an independent year-on-year exercise. The loyalty programmes of service providers such as airlines have shown that creating some sort of mechanism to accumulate one’s past behaviours tend to create stronger loyalty to that particular behaviour. Similarly, mechanisms to accumulate the emotional utility of tax-compliant behaviours of previous years could go a long way in reinforcing that behaviour.
The more we look at tax compliance as a behavioural issue, the better our ability to solve it.
Biju Dominic is chief executive officer of Final Mile Consulting, a behaviour architecture firm