Tax Reforms in India


By

Stuti Gupta
Asst. Professor
Gyan Institute of Management and Technology
Lucknow
 


ABSTRACT

There have been major changes in tax systems in several countries over the last two decades for a variety of reasons. The objective of this paper is to analyze the evolution of the tax system in India. The paper describes and assesses the introduction of new forms of direct and indirect taxes, their revenue and equity implications and the successes achieved in their implementation.

INTRODUCTION

The philosophy of tax reform has undergone significant changes over the years. With the change in the development strategy in favor of market determined resource allocation, the traditional approach of raising revenues to finance a large public sector without much regard to economic effects has been given up. The recent approaches to reform lay emphasis on minimizing distortions in tax policy to keep the economy competitive. Minimizing distortions implies reducing the marginal rates of both direct and indirect taxes. To achieve this, the approach suggests broadening of the tax bases. Thus, over the years, emphasis has shifted from vertical equity in which both direct and indirect taxes are subject to high marginal rates with minute differentiation in rates, to horizontal equity in which, the taxes are broad-based, simple and transparent, and subject to low and less differentiated rates. Equity in general, is taken to mean improving the living conditions of the poor. This has to be achieved mainly through expenditure policy and human resource development rather than reducing the incomes of the rich as was envisaged in the 1950s and 1960s.

The general pattern of these reforms has been to broaden the base of taxes, reduce the tax rates and lower the rate differentiation both in direct and indirect taxes. A broader base requires lower rates to be levied to generate a given amount of revenues. Lower marginal rates not only reduce disincentives to work, save and invest, but also help to improve tax compliance. More importantly, broadening the tax base helps to ensure horizontal equity, is desirable from the political economy point of view as it reduces the influence of special interest groups on tax policy, and reduces administrative costs.

INDIA'S TAX SYSTEM PRIOR TO COMPREHENSIVE REFORMS 1991

The trends in tax revenues present three distinct phases. In the first, from the 1970s to mid-1980s, there has been a steady increase in the tax-GDP ratio in keeping with the buoyant economic conditions and acceleration in the growth rate of the economy. The tax ratio, which was about 11 per cent in 1970-71, increased steadily to 14.6 per cent in 1980-81. The ratio continued to increase steadily during the early 1980s. In addition to the economy attaining a higher growth path, the buoyancy in tax revenues was fuelled by the progressive substitution of quantitative restrictions with tariffs following initial attempts at economic liberalization in the 1980s. The economic recession following the severe drought of 1987 resulted in stagnation in revenues in the second phase until 1992-93. Following the economic crisis of 1991 and the subsequent reforms in the tax system, particularly reduction in tariffs, actually caused a decline in the tax ratio. Overall, it is seen that the tax ratio which reached the peak of about 17 per cent in 1987-88, declined thereafter to 13.9 per cent in 1993-94 and gradually recovered to 14.6 per cent in 1997-98. Overall, the level of tax revenues, although reasonable as compared to the average tax level in developing countries, is clearly inadequate from the viewpoint of resource requirements of the economy.

Level and Composition of Taxes in India
(In percent)


In terms of composition of tax revenue, there has been a steady decline in the share of direct taxes from 21 per cent in 1970-71 to about 14 per cent in 1990-91. After the introduction of tax reforms in 1992, the revenue from direct taxes has grown faster than revenue from other taxes as well as GDP and consequently, the share of direct taxes increased by almost ten percentage points to 24 per cent on 1997-98. An increase was seen in both corporate income and individual income taxes though, taxes on agricultural land and incomes have continued to decline. In fact, although the agricultural sector contributes over 30 per cent of GDP, its contribution to tax revenues is just about half a per cent.

IMPACT OF TAX REFORMS SINCE 1991

Report of the Tax Reform Committee (TRC)

Tax reform since 1991 was initiated as a part of the structural reform process, following the economic crisis of 1991. In keeping with the best practice approaches, the TRC adopted an approach of combining economic principles with conventional wisdom in recommending comprehensive tax system reforms.  The overall thrust of the TRC was to (i) decrease the share of trade taxes in total tax revenue; (ii) increase the share of domestic consumption taxes by transforming the domestic excises into VAT and (iii) increase the relative contribution of direct taxes

The important proposals put forward by the TRC included reduction in the rates of all major taxes, viz. customs, individual and corporate income taxes and excises to reasonable levels, maintain progressivity but not such as to induce evasion. The TRC recommended a number of measures to broaden the base of all taxes by minimizing exemptions and concessions, drastic simplification of laws and procedures, building a proper information system and computerization of tax returns, and a thorough revamping and modernization of the administrative and enforcement machinery. It also recommended that the taxes on domestic production should be fully converted into a value added tax, and this should be extended to the wholesale level in agreement with the states, with additional revenues beyond the post-manufacturing stage passed on to the state governments.

In the case of customs, the TRC recommendations were the weakest. The TRC recommended tariff rates of 5, 10, 15, 20, 25, 30 and 50 to be achieved by 1997-98. The tariff rate was to vary directly with the stage of processing of commodities, and among final consumer goods, with the income elasticity of demand (higher rates on luxuries).

The TRC recommendation also falls much short of developing a co-ordinated domestic trade tax system in the country. This, in a sense, is understandable, as it had no mandate to go into the state level taxes. However, the Committee was aware of the serious problems of avoidance and evasion in respect of sales taxes levied by the states predominantly at the manufacturing stage. Therefore, it did recommend the extension of the central VAT to the wholesale stage with the revenues from the extended levy assigned to the states
 

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Source: E-mail May 25, 2011

          

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