An Alternative to Direct Taxation System Outline of a

Proposal
S Krishnamurthy, Shyamal Roy, Sankarshan Basu1

INTRODUCTION
There are several ways through which a government can raise revenues to meet
its various expenses. It can impose taxes on income and income related assets
(direct taxes) and, on goods and services (indirect taxes); it can resort to non-tax
revenues through levies, fees, and penalties on various items and from dividends,
interest and profits received out of its various investments; it can also raise nondebt receipts through public sector disinvestments.
In India the principal source of government revenue is taxes. Of the total revenue
of the government, tax revenue accounts for about 80% and non-tax revenue,
about 20%. The contribution of non-debt capital receipts, as of now, is
inconsequential, though it is projected to grow in the coming years.
Within tax revenue, the share of direct taxes has grown over time. At the end of
2008-09, they contributed to 55% of total tax revenue. Clearly, direct taxes being
progressive, as GDP growth gathers momentum, government will rely increasingly
on direct tax collection to finance its activities.
However, everything is not right with direct taxes in India.
First, the direct tax-GDP ratio of about 6.5% in India is not only the lowest among
the BRIC countries, but it is also erratic. This could mean a) that the distribution of
income is highly skewed in favour of rich which, in turn, means that tax rates must
increase to bring about a better tax-GDP ratio and/or, b) there are a large number
of people who should be paying taxes are not doing so.
Second, while tax administration has improved over time, persistent arrears
indicate that this has not gone far enough. According to the CAG data2,
uncollected amount of taxes at the end of 2007-08 amounted to Rs 37,415 crores
or, 12% of total direct tax collection in that year.

Visiting Professor, Professor and Associate Professor, respectively at Indian Institute of

Management Bangalore
2

www.nic.cag Ch.II, page 1 Union Audit Report- Compliance Audit (Direct Taxes) Report No.21 CA
of 2009 of CAG

Third, despite attempts at simplification of collection procedures and, certain

amount of success in that direction, the tax system, essentially, remains a
complicated one. The number of income tax cases pending scrutiny has increased.
As per CAG Report No.21 CA of 2009 referred to, the number has increased from
57.89 lakh cases(21.16%) in 2003-04 to 191 lakh cases (45.48%) in 2007-08. As per
this report only Rs.8,612.62 crore dues could be recoverd in 2007-08 against the
certified dues of Rs.36,057.56 crores. Clearly, this situation leaves ample room for
rent seeking.
Finally, any possibility of rent seeking in the tax system adversely impacts
economic efficiency by imposing higher tax burden on honest tax payers.
Thus, the direct tax system, as it exists in India, is found wanting on all
dimensions, e.g., revenue collection, allocative efficiency, equity and tax
administration.
AN ALTERNATIVE SYSTEM
We are calling the alternative system as Automatic Tax Collection through Bank
Credit Deduction System or, ABCD System.
Under the proposed ABCD system, as and when any credit in any account in any
branch of any bank takes place, automatically, say Rs.2/- per Rs.1000 ( 0.2%) is
debited to the account and transferred to the government revenue. On a day-today, hour-to-hour basis, the government will receive its revenue as and when any
credit to any savings/current account takes place in any bank under its
jurisdiction, without any distinction of individual or corporate. ABCD will apply
to: a) deposit of cash in favour of the account holder; b) cheques deposited in
favor of the account holder; c) direct transfer from one account holder to
another account holder in the same branch of the bank; and, d) transfer from one
bank to another bank in favour of the account holder. And, it will exclude: a)
Opening credit balances taken from time to time e.g. Monthly/quarterly etc. b)
credits arising out of inter-branch transfer of the same bank of the same account
holder; c )time Deposit Credits (Fixed/recurring /time deposits) till they mature
and get credited to the current account or savings account of the accountholder; d) Inter-branch transfers of the same bank ( e.g.: SBI Mumbai
transferring funds to SBI Chennai to their own account); e) day-to-day callmoney market under the RBI control; and, f) forex credits which has already
been subject to ABCD, later being converted in to INR and credited to the same
account- holder.
The above is based on several well founded premises: a) Indian banking system is
well regulated; b) it is almost impossible for a citizen or business entity to be
without a Bank Account c) banks are computerized - as per RBI report, 95%
2

computerization of Banks has been achieved by 31.3.20093 d) all the banks have
unique account number for each of the account holder; e) they also follow the
Basle II KYC (Know Your Customer) parameters before opening any bank account
i.e. whenever any money is received by the Bank on behalf of a customer, the
same is credited to the specific account with the unique identifying account
number.
The basic postulate is that the volume of bank transactions is several times more
than the so called taxable income of the tax-payer in a year. The new system,
thus, even at a modest rate, will bring more revenue to the government, besides
being easy to administer. Specifically:
1. Governments revenue target will be easily achieved
2. Tax payer will not be required to file returns and undergo assessments and all
their accompanying hassles.
3. The rate of tax will be just, equitable and broad based.
4. The method of collection will be simple and sustainable over a long period of
time.
5. The Government will receive tax on a daily basis while the tax-payer will pay
tax only on receipts and not on accruals.

THE DIRECT TAX SYSTEM vs. ABCD SYSTEM

Direct Tax System
The main features of the direct tax system in India are as follows4:
a. The number of tax payers was 3.36 crores in 2007-08 out of a
population of 120 crores
b. Direct tax collection in 2007-08 amounted to Rs 312,213 crores.
c. Direct tax-GDP ratio at 6.6% in 2007-08. Trend is upward but erratic
d. Growth rate of direct tax revenue estimated at 30.4% per annum between
2003-04 and 2007-08. Plan is to maintain this growth rate.

www.rbi.org RBI report dated 22.10.09 Appendix Table IV.35Computerisation of Public Sector
Banks

www.finmin.nic.in Indian Public Finance Statistics 2008-09 published in Aug 2009by Economics
Division, MEA, Ministry of Finance

e. Cost of collection of Central income tax estimated at Rs 4102 crores in

2007-08
ABCD System
The main features of ABCD system, as we see it, will be as follows:
a. As on 31.3.2008, there are more than 68 crores bank accounts spread over
78,000 branches. Additionally, there are 18 crores postal savings
accounts5
b. Estimates based on data published by RBI (11.1.2010) show that the total
volume of bank transactions consisting of cheque clearances6, large value
gross settlement systems7, other electronic settlement systems8, exportimport9 and forex inward remittances10 per year amount to Rs.
161,924,592 crores.11 On this amount alone, the ABCD at 0.2% works out
to tax revenue of Rs.323, 849 crores.
c. The above data does not include the daily cash deposits in each branch of
a bank and the fund transfers within the branch from one account holder
to another. Data is not readily available on this, but it is possible to get an
order of magnitude.
d. For example. The former chairman of State Bank of India, Mr. Bhatt is on
record (http://www.cga.nic.in/pdf/Statebankofindia/pdf) to have said that
there were 35 million transactions a day on behalf of their 200 million
clients on 21.10. 2008. Based on this figure it will perhaps be safe to
assume daily transactions of around 250 million for the entire banking
system on this account. Even assuming a low figure of Rs.10,000 per
transaction per day, the total volume of intra branch transactions will
amount to Rs.2,500,000 million a day or Rs2,50,000 crores a day. ABCD at
0.2% on this works out to Rs.500 crores a day annualized to Rs150,000
crores at least. And, it will grow overtime with the growth of the economy.
e. Clearly, the total collection through ABCD system of Rs. 323,849 (from b
above) + 150,000 (from d above) of Rs 473,849 crores far exceeds the

www.rbi.org RBI Table No.2.1. Population Group & Bank grouping as on 31.3.2008 dated
2.11.09
6
www.rbi.org RBI Current Statistics dt 11.01.2010 Table 8
7
Op cit, Table 9B
8
Op cit, Table 9A
9
Op cit ,Table 39A
10
Op cit, Table 44
11
The breakdown, in crores, is: Cheque clearances Rs10,264,610; Retail electronic payment
system Rs662,345; Large value clearing and settlement system Rs145,851,860; Foreign trade Rs
1,964,414; and Other forex inward remittances Rs 3,181,365

2007-08 direct tax collection of Rs 312,213 crores or, even Rs 380,000,

targeted for 2009-10.
TEST OF FEASIBILITY, SUSTAINABLITY AND EQUITY OF ABCD SYSTEM

The table below lists out the comparison between the existing system and the
proposed system on various parameters:

Under the Present System

Under the Proposed System

Tax Collections:
1

From 338 lakh assessees

From 6800 lakh bank accounts

Tax burden on each assessee

even after availing the
various deductions is high as
the Govt. has to collect the
required tax only from the
338 lakh assessees.
Exemption of Income Tax of
less
than
Rs.1,50,000
taxable income

Tax burden on each assessee will be

much less than under the present
system, as the revenue collection base is
much broader 6800 lakh accounts.

5
6

No exemptions. If the total credit in a

bank account is less than Rs.1,00,000 in
a year, the government will refund (max
Rs.200 per a/c)

Slabs of 10%, 20%, 30% after No slabs. 0.2% of any credit in banks. No
computation of
taxable computation(Rs.2.per Rs.1,000)
income
Capital Gains Computation
Nil
0.2% of forex is Governments

Government does not earn

forex
Loans, Deposits, Capital
raising is not part of income
tax
Tax depends on profit

On accrual based

On actual receipt based

10

Government gets payments Government gets payment every hour

monthly/ Quarterly/ Annually of every day.

11

Payment defaults

12

Counter trade cannot escape Can escape but difficult & impractical
taxes

Any amount received is covered. No

distinction
No concept of Taxable Profits. Tax is on
receipts.

No default

Administration:
13
14
15
16
17

18
19

Returns to be filed by the No Returns to be filed

assessees
TDS
No TDS
Monthly TDS returns by the
Payer
Quarterly calculation of advance
tax & return
Computation of Depreciation,
Investment Allowance, Area
issues.
Deductions,
exemptions
&
computations
No finality of Assessment:
Appeals & Litigation

No Monthly Returns
No calculation & returns
Nil. No concept of zero tax
companies
Nil
No Assessments, No appeals &
litigation

20

Difficult to fine-tune due to Easy to fine-tune annually during

different
sections/
rules/ the Budget sessions or in intervals of
procedures
time

21

Difficult to collect Statistics

Very easy

22

MAT, DTAA, PE issues

Nil

23

Computer technology used for Simple implementation

complicated calculation and computer technology
statistical compilation
Bank computerization is not used Fully used

24
25
26

27
28

29

due

Capital a/c and revenue a/c Nil

distinction
PAN system & bank a/c opening No PAN system. Bank A/Cs are
difficult
encouraged. Unique Identity No. of
Bank Account
Bank A/C opening is made Made easy. Encourage bank A/C
difficult
Finance consultants make lots of They have to re-engineer to
business on tax consultancy
different areas
People avoid bank transaction

People will prefer bank transaction

Cost of Collection:
30

to

Rs.5000 crores spent by the No computation and no expense

assessees to compute taxable
6

income
CBDT after 338 lakh assessees, CBDT to redeploy to monitor 79,000
spending Rs. 4,000 crores
+ bank branches

31

32
33

Savings and investments based Nil

on tax
Incentive to suppress & hoard
Nil

34

Discretion leading to corruption

35

Very narrow based (goes against VERY broad based

Chelliah Committee
recommendation)
Informer system to unearth tax Nil. Not necessary
evasion
Economic value of transaction True economic value
calculated on tax structure

36
37

Nil

The benefits of a switch from the existing system to the ABCD system can be
summarized as follows:

To start with, it will result in the government getting tax every day,
instead of monthly or quarterly. At the end of the year, if the ABCD rate
requires tweaking of the percentage, this can be done as the annual
budget exercise under alternative assumptions with respect to ABCD
percentage. With this system we can do away with the Income tax Act,
Rules, and Procedures etc.

Instead of 338 lakh assessees paying income tax now, under the ABCD
system, 6,800 lakh bank accounts will be paying tax. And every adult
Indian can proudly say that he is a tax payer.

The government can, in fact, generously refund to each savings bank

account where the total tax collections are less than Rs.200 per account
(i.e. total credit is less than Rs.1,00,000) in a year. The government can as
well abolish the PAN system & replace it with the Unique National Identity
Card. This will automatically reveal identity of persons having more than
one bank account! Incidentally, one person having more than one bank
account does not affect the proposed ABCD systems effectiveness.

Under the ABCD system any forex coming into India to anyones credit is
also subject to 0.2% tax, Hence, the government will also earn forex. There
will be no concept of NRI remittances etc from tax point of view. Any
credit to any account in any currency will be subject to ABCD. This means
out of nearly annual receipt of around 20 Billion U$ received, the
government will get a revenue of 4 million U$ in forex. Needless to say,
such ABCD forex when converted to INR and credited to the same account
holder will not suffer tax again.
7

If the ABCD percentage is fixed at a very low level (0 .2% recommended, or

less) there will be no incentive to hoard cash or gold as the cost of
hoarding will be more than the tax on bank credits. Thus, under the
proposed ABCD system one would rather deposit the money in banks and
pay 0.2. % tax.

The entire staff of more than 60,000 personnel in the income tax
department can now be re-deployed to monitor 78,000+ bank branches.
Since the entire system is automated, they will not have much of problem
of monitoring the collection of ABCD tax.

When the tax collection is on daily, actual cash basis, the government
requirement of borrowing and paying high interest will also come down
(and also the litigation).

Question of erroneous credits/wrong credits in the banks do arise. In

banks, this is neutralized by what is called Contra - entries. This is where
the IT department personnel deputed to banks step in. They would verify
whether it is a genuine Contra -entry or not. If it is genuine, then the
ABCD tax paid is automatically refunded through electronic system.
Similarly, they will also check that opening/closing balances from time to
time is not taxed erroneously.

IT deputees also will ensure that credits arising out of branch transfer in
the same bank by the same account holder is not taxed and also that the
inter-branch transfers of the same bank to their own account and also the
money market transactions are not taxed.

The last issue of the IT department is to administer the laws of FEMA,

Foreign Contribution Act, and Money laundering etc for which they are the
most suitable.

SUMMING UP ON ABCD

Imagine a world where no one has to file Income tax return, claim breaks,
deductions, refunds etc and at the same time he is able to proudly claim that he
is a tax payer. Imagine a world where there is no requirement of income tax
consultant, auditor, inspector or IRS official running after or chasing a citizen for
tax. Also imagine a world where governments are able to get revenue as
required for meeting the various needs of the people, be it defense, social
security, health care or whatever. It is now possible to make it a reality through
the introduction of ABCD system. If not immediate implementation, there is at
least an immediate need to generate a debate on the suggested system.
Question may, of course, arise that if the benefits of ABCD system are so obvious
why it was not adopted earlier? The answer is that automated banking system,
well regulated by federal authorities, was not in place earlier to think in this
direction. Thanks to the Information Technology revolution and fairly well
8

regulated banking system, it is now possible. Also, practically, nobody can be

without a bank account: be it current A/C, Savings A/C, credit card, debit card,
checking account whatever the name be. Time and again, world over it has been
proved beyond doubt that the people do not mind paying tax, if it is a small
percentage and easier to pay. Now with Banking system well regulated and
automated, it is time to bring down the rate drastically and in a simple citizen
friendly way. Once this system is proved as an effective alternate for the income
tax, the government should repeal and bury all the income tax laws and similar
laws.
TRULY, THE FAMOUS STATEMENT BY CHANAKYA (KAUTILYAS , ARTHASASTRA)
THAT THE TAX COLLECTION BY THE GOVERNMENT SHOULD BE LIKE THAT OF A
BEE COLLECTING HONEY FROM THE FLOWER ,CAN BE ACHIEVED, UNDER THIS
ABCD SYSTEM.