Can governments increase revenues by lowering taxes? A study of competing policies to reduce tax evasion during house purchase in India

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Governments and urban local bodies struggle the world over to raise revenues to pay for providing quality services to its residents. This problem is more acute in developing countries where rampant corruption and tax evasion reduces their ability to raise such revenues. This study examines two competing policies that local governments follow in India to raise revenues from property-related transactions.

In most countries, property-related taxes are a significant source of government revenues. Aside from the property tax that is levied periodically, governments also raise revenues through stamp and registration duties on immovable properties when they exchange hands. In India, the latter is a larger source of revenue because property taxes are mostly based on imputed rental values which are considerably lower than sale values.

To assess stamp duties, the government must know at what price the property was transacted at. India has an opaque property market where buyers often report a price that is far less than the actual transaction price. While under-reporting helps evade stamp duties, it also facilitates generation and storing of unaccounted wealth (“black money”) as the difference between the actual price and the reported price is transacted in unaccounted cash. Governments, therefore, have a compelling incentive to reduce under-reporting in property transactions.

Governments in India have started using another approach where 'guidance values,' or government’s own estimate of market values, are used instead of reported values. The guidance value represents the minimum value for the transaction and stamp duties would be levied on the higher of guidance value and reported value.

By introducing this floor price for the property transaction, the government has reduced the incentives to under-report for evading taxes. Not only would this raise government revenues but it may also curb generation of black money if the guidance value becomes the de-facto value of the property irrespective of what has been reported. In fact, that is exactly what is happening in India as reported values are now being disregarded by most institutions such as tax authorities and banks in favour of guidance values as the value of the property.

This study examines these two approaches to raise revenues and reduce tax evasion in the State of Karnataka. Our results will provide insights to the governments, especially in developing countries, on innovative policy tools for raising revenues despite constraints such as corruption and weak enforcement.