24 January 2008

My Experiences with the Income Tax Department -- 11
[A single-page version of this blog can be seen here]

The reader may be surprised that, far from having embittered me, my five-year-old-and-continuing encounter with the income tax has actually been a source of some amusement to me. But it wasn't always so.

When the encounter began I was convinced that the department was full of crooks to the extent that "an honest income tax officer is a contradiction in terms". I never expected to win an appeal as long as the process was still within the confines of the department. It was therefore quite a surprise when I won at the stage of Commissioner of Income Tax (Appeals). I now believe that the system leaves some scope for an honest tax payer to fight and win. You do not have to succumb. And no matter the number of bad eggs in the IT Department you must remember that at some stage it passes out of the control of the department. I am thus in some ways more of an optimist than I was five years ago.

But I think there is a bigger philosophical issue, the issue of "moral hazard" (thanks to Niranjan Rajadhyaksha for jogging my memory on this term).

Here is what Wikipedia says about the subject: "Moral hazard is the prospect that a party insulated from risk may behave differently from the way it would behave if it were fully exposed to the risk. Moral hazard arises because an individual or institution does not bear the full consequences of its actions, and therefore has a tendency to act less carefully than it otherwise would, leaving another party to bear some responsibility for the consequences of those actions."

This is what I meant when I wrote at the time: "If I win the case after fighting it out for two years [oh, the optimist in me!] it will be at the cost of much time, money and mental tension, all of which could have been devoted to earning more money for myself and indirectly for the exchequer. The income-tax department too will have to spend a lot of resources to fight me. The only winner in the case will be Mr Sebastian. If the IT department loses the case he loses nothing. But he stands to gain Rs 10 lakh or more (I estimate that is the order of the bribe he expects) at zero risk to himself."

The chapter headings of the Income Tax Officerís Concise Manual on Harassing the Tax Payer read as below:
1. Pass an adverse assessment order, never mind that it wonít stand scrutiny at any stage.
2. Donít bother to present a cogent defence when the tax payer files an appeal.
3. When the tax payer wins the appeal file an appeal against the verdict.
4. Donít bother to present a cogent defence when the appeal comes up for hearing
5. When the tax payer wins the appeal file an appeal against the verdict.
6. Donít bother to present a cogent defence when the appeal comes up for hearing.
7. When the tax payer wins the appeal file an appeal against the verdict

See the problem? No higher authority bothers to ask the assessing officer or the officers who file appeals why they acted as they did. They run no risk whatsoever. And it doesnít take much effort to file an appeal. All it takes is a clerk who can type out a single page. But the tax payer has to hire consultants and lawyers to fight it out for another year or two. The pain is all on one side.

As it stands the only way an income tax officer can be prosecuted today is if he is caught red handed accepting a bribe. And the department has long gone beyond the stage when it can be caught in such a simple-minded fashion. These days I am told the tax payer is asked to leave money in a magazine in the officerís bathroom. "Hey, I just picked up the magazine with the intention of returning it to the owner. Never looked into it."

On the issue of moral hazard Wikipedia goes further to say: "A special case of moral hazard is called a principal-agent problem, where one party, called an agent, acts on behalf of another party, called the principal. The agent usually has more information about his actions or intentions than the principal does, because the principal usually cannot perfectly monitor the agent. The agent may have an incentive to act inappropriately (from the view of the principal) if the interests of the agent and the principal are not aligned."

In this case the principal is the government. And as long as the government is interested merely in total tax collections and will not act in any way whatsoever against the kind of crook who writes foolish assessment orders (take a look at this case) or files stupid appeals the tax payer can only expect to be harassed while the tax official amasses tens of crores of rupees. Remember the scandal a few years ago when someone in the finance ministry was caught accepting bribes to post income tax officials to Mumbai?

The system can improve only if some risk is placed on the income tax officials. Imagine that a crook of the kind mentioned above is summoned by a very high-level judicial officer. The conversation may proceed somewhat as follows: "You are allowed to plead temporary insanity at the time of writing the assessement order/filing the appeal. Tests will also be conducted to verify that you are indeed above the idiot class. If you fail the tests you will be acquitted of all charges and your job. If you pass the test and do not plead insanity you will have to present a defence of your assessment order/appeal."

I am not optimistic enough to expect something like the above to happen anytime soon. Until it happens the crooked tax official will have a field day. The only way out at present is to make the crook think twice by making public the utterly foolish assessment reports he writes or the utterly foolish nature of the appeals he files. In terms of moral hazard, there needs to be a change in the zero-risk nature of the actions he takes.

Category: Income-Tax


Philip George
Debunker of Keynesian, monetarist and Austrian economics

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