India's tax compliance remains notably low, with a tax-to-GDP ratio below 12%, significantly trailing behind OECD nations. In the realm of Direct Taxation, this ratio hovers around 5%, which is insufficient and inadequate. The accompanying chart illustrates the disparity between the Direct tax-to-GDP rate and the GDP Growth rate, highlighting the widening gap between the two. This suggests that a substantial portion of the population is outside the tax net and not contributing to the nation despite the evident economic growth.
Figure: 1 Direct tax to GDP rate Vs GDP Growth Rate Figure: 2 Year-wise Number of Filers and Percentage Change
The relationship between economic growth and tax collection is mutually reinforcing. Over the past 30 years, India has experienced consistent and organic growth in its gross domestic product. However, direct tax collection does not accurately reflect this GDP growth. The tax-to-GDP growth rate has remained largely flat, indicating a lack of buoyancy in collection over the years. While many attribute this lack of buoyancy to skewed income distribution, it is evident that the country must also tackle compliance gaps.
The World Bank suggests that an ideal tax-to-GDP ratio is approximately 15%. This ratio plays a crucial role in fostering economic growth and development, facilitating a country's transition from low-income to middle-income status. It enhances the government's capacity to invest in essential public services such as education and healthcare. Additionally, a robust tax-to-GDP ratio helps mitigate economic volatility and address income inequality, allowing countries to avoid reliance on borrowed funds for development initiatives(Taxing for Growth: Revisiting the 15 Percent Threshold, 2024).
India has significantly under-invested in critical areas like health, education, skill training, and infrastructure. This raises serious doubts about the State’s ability to generate resources through effective taxation. India still has 30% of its people living in poverty.
Figure: 3 India’s Public Investment in Key Nation-Building Sectors(% of GDP)
It is inevitable for the country to mop up the resources through the right taxation of the right people. Traditional enforcement models, which rely on search and seizure operations (often referred to as raids), audits, and hefty penalties, fail to address the behavioral factors that drive tax compliance. There is a pressing need to integrate behavioral insights into tax administration to enhance voluntary compliance, reduce evasion, and improve revenue collection.
b. The intervention and its theoretical basis
Various psychological factors contribute to the challenges of tax compliance among individuals. A primary issue is the complexity of tax laws, which can discourage taxpayers and reduce their willingness to comply. Individuals often assess their knowledge of tax regulations, impacting their compliance intentions. Additionally, misconceptions about taxation frequently lead to non-compliance. Negative attitudes toward taxation, influenced by cultural, social, and personal beliefs, can also lower compliance rates. Social norms—such as the perception that others evade taxes—can further encourage tax evasion.
When individuals perceive the tax system as unfair, whether regarding tax distribution (who pays what), collection procedures, or penalties, they may be more inclined to evade taxes. It is widely acknowledged that the intrinsic desire to pay taxes, or tax morale, varies among individuals and societies. Low tax morale can result in increased evasion. Furthermore, cognitive shortcuts, or heuristics, such as misperceptions of risk and the effect of framing, can influence decisions about tax compliance. For example, if taxpayers mistakenly believe that audits are rare or penalties are lenient, they may engage in riskier behavior.
Finally, the manner in which tax authorities interact with taxpayers plays a crucial role in compliance. An enforcement-oriented approach (e.g., heavy fines, audits) can provoke resistance, while a service-oriented approach (e.g., facilitation, transparency) can foster trust and promote voluntary compliance (Kirchler, 2007).
In light of the above, let us explore the "slippery slope model," which suggests that tax compliance relies on a balance between trust in authorities and the authorities' power to enforce compliance. When trust is low, the use of enforcement measures may backfire, leading to even greater tax evasion.
The Slippery Slope Framework (SSF) focuses on the relationship between trust in tax authorities and their power. It distinguishes between voluntary compliance, based on trust, and enforced compliance, based on authority. Trust in tax authorities is fostered through transparency, fairness, and effective tax administration. High levels of trust encourage voluntary compliance, with taxpayers willingly paying taxes as a contribution to society. Strong institutions, equitable tax policies, and public confidence in the government are likely to yield higher levels of voluntary compliance.
Power, on the other hand, refers to the ability of tax authorities to observe, audit, and penalize tax evaders. When power is high, it leads to enforced compliance, where taxpayers comply out of fear of being caught and punished. Relying too heavily on enforcement can create resentment and ultimately undermine voluntary compliance over time. The interaction between power and trust should be mutually reinforcing. Optimal tax compliance is achieved through a balance of both factors. When trust is high, enforcement is minimal, fostering a cooperative environment among taxpayers. Conversely, when trust is low, tax authorities must increase enforcement, creating an adversarial atmosphere that encourages resistance. A slippery slope scenario arises when both trust and power are low, resulting in widespread tax evasion.
Slippery Slope Framework
Figure 4: Pictorial representation of Slippery Slope Framework, Source: https://www.mdpi.com/
Research shows that trust in tax institutions significantly affects overall tax compliance more than enforcement measures do. While enforced compliance can be effective, it risks damaging long-term trust and voluntary compliance. Therefore, policy approaches should aim to build trust by treating taxpayers fairly while also maintaining an effective enforcement system(Lisi & University of Cassino, 2019).
Slippery Slope Matrix
Figure 5: Slippery Slope Framework Matrix
c. Details of its implementation
It is evident from the discussion supra that more trust in tax authorities coupled with fair enforcement will yield more compliance. The implementation must combine behavioral insights to increase voluntary tax compliance, transcending the classical enforcement paradigm. Some of the most important behavioral-based recommendations are highlighted below:
1. Social Sanctions & Recognition – Publicizing payment of taxes or rewarding compliant taxpayers affects behavior by social norms. When people notice others paying taxes, they tend to comply themselves. Some countries have implemented "honor lists" for high taxpayers, thus generating positive reinforcement, while others apply mild social sanctions for non-compliance(Dom et al., 2022). In India, regular high-income taxpayers are awarded while middle-income taxpayers are not recognised. All layers of taxpayers must be rewarded, including free-lounge facilities in airports, free insurance coverages, priority access in airports, preferred seat allocation in railways, reduced toll rates, etc.
2. Trust-Based Compliance – Taxpayers are more compliant when they feel the tax system is equitable, fair, and accountable. Governments must show transparency in tax collection and expenditure to create trust, decrease corruption perceptions and enhance voluntary compliance(Dom et al., 2022). Strengthening anti-corruption institutions, speedy trials in corrupt cases, barring corrupt politicians from contesting elections, breaking the bureaucratic-politico nexus through transparency and increasing accountability through public audits, etc.
3. Simplified Tax Processes – If tax procedures are too complicated, taxpayers are likely to hide taxes because they are confused, or compliance is costly. Simplification of tax reporting processes, making digital platforms available, and the availability of unambiguous tax policy promote compliance through minimizing the compliance effort(Dom et al., 2022). The tax department has continuously taken steps to simplify the tax filing process, including E-filing, compliance through online, simplified tax forms, etc. The recent simplification of provisions in the Income Tax Act is an example. Still, a lot can be done to make it less complex. Simplification of TDS provisions and processes, relief from mandatory tax audits in the thriving sectors such as MSME, renewable energy, prompt refunds, etc.
4. Behaviorally Designed Letters – Research indicates that tailored tax reminders with behavioral nudges, for example, highlighting social norms ("9 out of 10 individuals pay their taxes on time"), applying loss aversion (alerting taxpayers to possible penalties), or making moral appeals, strongly enhance tax compliance(Das Biswas, 2024). We should make tax filers feel privileged and of a high moral status worthy of publishing to all.
5. Pre-filled Tax Returns – Compliance rises when the process is simple. Pre-populating tax returns using third-party information minimizes errors, saves time, and enhances taxpayer trust, resulting in greater compliance(Das Biswas, 2024). The use of AI and data analytics could help pre-populate the relevant data for tax filing, where a taxpayer has to just give his consent or otherwise. This requires substantial investment in building infrastructure for the integration of bank transaction details, movable and immovable property details, and other relevant information to get it populated.
6. Public Goods Communication—Governments can enhance tax morale by connecting tax payments with observable public goods, like infrastructure and healthcare. This reinforces the perception that taxes directly fund citizens' welfare (Dom et al., 2022). Visibility of how tax money is used will have a huge impact on taxpayers' morale.
Figure 6: Strategic communication to nudge the common people to contribute to building the nation.
When supplemented by conventional deterrence mechanisms, these behavioural interventions provide a more efficient and trust-based tax system.
d. The final/expected results
Behavioral considerations, such as psychological and social influences, are important for enhancing tax compliance rather than mere enforcement. The Slippery Slope Framework (SSF) postulates that tax compliance is affected by two key variables: trust in tax agencies and perceived enforcement authority. By using behavioral nudges that raise trust levels and tax morale, governments can move compliance from enforcement-based to voluntary, which is more sustainable in the long term.
One crucial method is ensuring transparency and equity in tax administration, as this fosters trust and encourages voluntary compliance. When taxpayers perceive tax policies as fair and believe the government acts responsibly, they are more inclined to comply willingly. Additionally, social norms and peer influence can serve as powerful motivators; research shows that informing individuals about high compliance rates among their peers significantly increases the likelihood of tax payment.
Another effective nudge involves positive reinforcement. Studies suggest that recognising and rewarding cooperative taxpayers—whether through acknowledgment or modest incentives—promotes positive behavior and strengthens tax morale. Conversely, relying solely on deterrent measures such as audits and penalties may yield temporary compliance but can undermine long-term trust and foster a confrontational dynamic of "cops vs. robbers." By thoughtfully implementing behavioral nudges such as personalized messaging, simplifying tax preparation, and fostering trust, governments can cultivate a synergistic tax environment where high compliance can be achieved even in the absence of strong enforcement. Ultimately, voluntary compliance is far more effective and sustainable in the long run than compelled compliance. Through these initiatives, tax buoyancy will be enhanced, allowing for the necessary resources to support the development sector and other areas.
e. Examples from China
A Chinese field experiment tested deterrence and non-deterrence nudges to tax compliance by reminding 7,377 taxpayers. Deterrence nudges, such as credit penalties and fines for late payment, boosted compliance by more than 6%, whereas non-deterrence nudges, such as appeals to tax morale, had no influence. The effect was transitory—credit fines affected behavior for up to six months, whereas other deterrence nudges decayed more quickly. Private-sector employees, high-income earners, and men were more responsive, while government employees, entrepreneurs, and the super-wealthy displayed minimal change(Yang et al., 2024).
The research highlights that while simple nudges are beneficial, achieving lasting compliance requires both effective enforcement measures and the fostering of trust within the community. These elements are essential for promoting positive and sustainable behaviors.
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