Tax System and Reform in India
V N Alok
Indian Institute of Public Administration
vnalok@gmail.com
Outline of Presentation
• BRIC
• India,s Economic Structure
• India’s Economic Development
• Tax Assignment in Indian Federation
• Tax Reforms in India
• Move towards Goods and Service Tax
Rise of BRIC
India's Export Relation With BRC
10.0
8.0
Per cent
6.0
4.0
2.0
0.0
2000- 2001- 2002- 2003- 2004- 2005- 2006- 2007-
01 02 03 04 05 06 07 08
Year
Brazil China Russia BRC Total
Inidia's Import Relation With BRC
14.0
12.0
10.0
Per cent
8.0
6.0
4.0
2.0
0.0
2000- 2001- 2002- 2003- 2004- 2005- 2006- 2007-
01 02 03 04 05 06 07 08
Year
Brazil China Russia BRC total
Unity in diversity in India
•Many Ethnic Groups
•Many Languages
•Many Religions
Diversity in India
• Population 1150 m; Area 3.285 m sq km
• Area 1/3 of the US/China
• Density around 1/3 of Bangladesh
• 22 languages; 1576 mother tongues
• 5+200 religions; 2500-3700 castes
• Scheduled Castes and Scheduled Tribes
• Choices of people vary from one region to
another
Religious Diversity (%)
Hindu Sikh Buddist Muslim Christian
1951 10.4 2.3
1961 84.4 1.83 0.7 10.7 2.4
1971 83.5 1.92 0.7 11.2 2.6
1981 82.6 1.96 0.71 11.7 2.4
1991 82.4 2.00 0.81 12.6 2.3
2001 81.6 1.93 0.82 13.4 2.3
Source: P K Chaubey (2009)
British India vs Modern India
Indian Federation: the setting
• Union Government
• 28 States
Special Category States
Non-special category states
• Union territories
• Rural local governments
• Urban local governments
National Income – Sectoral Shares
Year Agriculture Industry Services
1994-95 30.4 21.7 47.9
1995-96 28.1 22.8 49.1
1996-97 28.6 22.7 48.7
1997-98 26.7 22.7 50.6
1999-00 25.5 22.1 52.3
2007-08 19.4 25.4 54.2
Governance and Policy Making
• Constitution
• President
•„Legislature
Lok Sabha (House of the People)
Rajya Sabha (House of the States)
•Executive
Prime Minister & Cabinet
Chief Ministers of States
•Finance Commission
•Planning Commission
•Inter State Council
•National Development Council
•State Finance Commissions
Parliament
What made Govt. to initiate
structural reforms in 1991?
•Twin chronic imbalances -
–fiscal & external trade
•Fiscal deficit was more than 8% of GDP
•An annual inflation rate was 12%
•Foreign exchange reserve of US $ 1 B
•Low growth of the economy 1.5%
Components of Structural
Adjustment Programme
•Fiscal Reform
–Tax Reform
•Trade Policy Reform
•Monetary Policy Reform
•Financial Sector Reform
•Devaluation
•Exchange Controls
•Privatization
•Labour Deregulation
•Administrative Reforms
Macro Economic Highlights of
the 1990s
• External Sector Reforms
–Devaluation, Convertibility of Rs,
FDI, Low tariff, Removal of QRs
• Financial Sector Reforms
– Free interest rates, Pvt.banks
• Growth rate picked up
• Inflation was contained
• Many measures to improve fiscal sector
Growth of the GDP
Year Growth Rate (%)
1991-92 1.5
1992-93 4.5
1993-94 6.0
1994-95 7.0
1995-96 7.3
1999-00 6.4
2004-05 8.3
2005-06 9,3
2006-07 9.7
2007-08 9.1
2008-09 6.1
Deficits of Centre and States
Year Fiscal Deficit Revenue Deficit
Centre States Combined Centre States Combined
1990-01 9.4 4.2
1995-96 5.1 2.6 6.4 2.5 0.7 3.3
1999-00 5.6 4.7 9.8 3.8 3.0 6.8
2004-05 4.0 3.4 7.5 2.5 1.2 3.6
2006-07 3.5 1.9 5.6 1.9 -0.6 1.4
2007-08 3.1 2.3 5.3 1.4 -0.5 0.9
Tax GDP Ratios
Year Total Tax Rev. Union Taxes States Own
(All India) (gross) Taxes
1950-51 6.69 4.32 2.37
1960-61 8.33 5.52 2.81
1970-71 11.01 7.43 3.58
1980-81 14.59 9.69 4.90
1990-91 16.38 10.75 5.63
2000-01 14.52 8.97 5.55
2004-05 15.81 9.75 6.06
2005-06 16.41 10.23 6.19
2007-08 (BE) 18.14 11.63 6.51
Quick Review of Tax Assignment in the
Indian Federation
• Tax Powers of the Union and States are specified
by law
• Seventh Schedule to the Indian Constitution
Division of Commodity Taxes
between Union and States
UNION LIST STATE LIST
Cen- VAT State-VAT/ Sales tax
Custom Duty Motor vehicles tax
Central Sales Tax Passengers and goods
tax
Tax on services Octroi/Entry Tax
State Excise
Entertainment tax
Electricity Duty
Category of Tax Arrangement
• Service Tax – Levied by the Union but
appropriated by both, not part of divisible pool
• Taxes levied by the Union but appropriated by
the States
• Taxes levied by Union but shared with States
• Taxes of States collected by Union and passed to
States
Own source revenue of each level
of Government (% Share)
Year Rural State Union
Local Govt
90-91 0.36 33.21 63.42
98-99 0.48 37.01 59.65
00-01 0.45 37.05 59.87
02-03 0.45 38.43 59.11
Source: Alok (2006) in Anwar Shah (ed.), The World Bank
Infirmities
• Considerable Decentralization of Public
Expenditure
• Centralization of Revenue Collection
• Sharp Imbalance between the Taxing
Powers and Spending Responsibilities
• Tax Exporting and Tax Competition
Shares of Central Taxes
Vertical Distribution
Commission States’ share in net proceeds of
Income Tax Union Excise
1st 55% 40%
2nd 60% 25%
3rd 66.66% 20%
4th 75% 20%
5th 75% 20%
6th 80% 20%
7th 85% 40%
8th 85% 45%
9th 85% 45%
10th 77.5% 47.5% (29% from 1.4.96 )
11th 29.5 % of global taxes
12th 30.5 % of global taxes
Objectives of Tax Reform
Low import tariffs towards ASEAN level.
Broad based, moderately progressive
personal income tax
Corporate tax, a single rate tax, at par with
personal income tax.
A broad based consumption tax in the form
of VAT.
Reforms in Direct Taxes
Trends up to Nineties
• Taxation Enquiry Commission 1953-54:
– Higher tax rates for mobilizing resources
• Kaldor 1956 integrated approach along with
wealth tax, gift tax, expenditure tax.
Indira Gandhi Budget Speech in 1970
“ Taxation is also a major instrument in all
modern societies to achieve greater equality
of incomes and wealth. ….The marginal
rates will be increased progressively on all
incomes. With the addition of the surcharge
at 10 per cent, the maximum rate (will be)
93.5 per cent.”
Reforms in Direct Taxes (contd.)
Tax reforms in the 1990s
• Tax Reforms Committee 1991-93
– Three rate structure of income tax (20,30,40%)
– Removal of exemptions under income tax.
– Wealth tax exemption raised and financial
assets excluded.
Opening up of the Economy
• Reduction in the custom duty was mainly
recommended by TRC.
• Commenced in 1990-91. Peak rate was
• 110 % in 1992-93;
• 85% in 1993-94;
• 65% in 1994-95;
• 50% in 1995-96……..
• 15% in 2005-06
• 10% in 2007-08
Custom Duty Structure
• Basic Duty – Peak Rate 10%
Many Items above rates e.g car, alcohol
• Additional Custom Duty
• Special Custom Duty
• Education Cess
Basic Features of Indirect Tax
System
Multiplicity of rates
Plethora of exemptions
Taxation of inputs and cascading
Complex laws & archaic administration
High cost of compliance
Lack of Harmony
Reform in Union Excise duties
• Jha Committee 1978- Recommendations of
Manvat implemented partly in 1986 in the
form of modvat.
• Tax Reform Committee 1993 further gave a
fillip.
• Covered all commodities.
• Converted into a Cenvat by 2001.
• Tax rate 16%.
Reform in Union Excise duties
(contd.)
• Input credit can be taken immediately, 50%
for capital goods in the same year.
• Exemption notifications reduced.
• specific rates are converted into ad valorem
rates.
• Simplified tax structure and resulted in
transparency of the tax burden.
Reform in Union Excise duties
(contd.)
• Some additional duties continue:
– Additional excise on some items- 8% mainly
final goods.
– ADILSAT on sugar, tobacco, textiles.
– Additional excise on textiles and tobacco.
– Education Cess.
Reform of State Domestic Trade
Taxes
• Variety of taxes.
• Efforts have been made to reform sales tax,
stamp duty and registration fee, and octroi.
• A model law for stamp duty and registration
fee is prepared. Rates rationalized, efforts
on for reform of administrative procedures.
Reform of sales tax
• Deliberation spanning over one decade.
• Report led by Amaresh Bagchi
• Committee of State Finance Ministers 1995, and
1998.
• Chief Ministers Committee of 1999.
• Conference of Chief Ministers and Finance
Minister 16 November 1999.
• Setting up of the Empowered Committee
Design of State VAT
• Three-rate structure: 0, 4, 12.5%.
• Exceptions of 1% for gold, silver, precious and
semi-precious stones and 20% for liquor.
• Petroleum products out of VAT.
• 0% for
– (a) natural and unprocessed products (such as betel
leaves, earthen pot etc.),
– (b) items which are legally barred from taxation on sale
(such as newspaper, national flag etc.), and
– (c) items which have social implications (such as books,
periodicals, slate, slate-pencils etc.).
Design of State VAT (contd.)
• Four percent applicable to essential
commodities (such as branded bread, bulk
drugs, paper etc.), declared goods (such as iron
& steel, hide & skins etc.) and industrial and
agricultural basic inputs (such as printing ink,
coir, beedi leaves, fibres, seeds etc.), and capital
goods.
• For all other goods there will be a floor rate of
12.5%.
Issues in design of State VAT
• Special treatment of small dealers-
Composition scheme for dealers in turnover
bracket of 5 to 5 million.
• The model VAT Law of 1998: 0.5 to 2.5
million
• Floor rate versus the rate- the issue of
autonomy.
Issues in Taxation of Interstate
Trade
• Present scheme of CST at the rate of 4% or
10% in vogue since 1956.
• Causes interaction and corruption.
• CST inconsistent with destination based
VAT
Tax Buoyancies - of Centre and State
Period Total Tax Revenue Centre’s Gross Tax States’ Own Tax
( Combined) Revenue Revenue
1950 - 60 1.38 1.38 1.39
1960 - 70 1.16 1.15 1.17
1970 - 80 1.30 1.27 1.35
1980 - 90 1.13 1.14 1.11
1991 - 02 0.93 0.89 1.02
“…I will reinforce the Central Government’s
catalytic role to facilitate the introduction of GST by
1st April, 2010 after due consultations with all
stakeholders.’’
- Part of the Union Budget Speech 2009-10
Quick Review of Developments - Leading to
Policy Announcement
• Progress Towards Comprehensive GST
• Dual VAT System
• Independent Central VAT
• Independent State VAT
• Three Rate Structure of 0, 4, 12.5
• Phasing out Central Sales Tax
• Discontinue Fiscal Incentives
GST Options for India
A. Federal GST with Tax Sharing
B. Autonomous State- GSTs
C. Dual GST
Federal GST with Tax Sharing
Merits
• Levied and administered by the Union
• Replaces both Cen-VAT & State-VAT
• Tax rates unified across the country
• Covers all transactions from manufacture to retail
• Attractive to many particularly trade and industry
• Conducive to common market
• No inter-state border control
Federal GST with Tax Sharing
Drawbacks
• States to surrender autonomy of tax power
• States to surrender buoyant source of
revenue
• Damage the federal fabric
• More dependency on the Union
• Sales tax establishments will be abandoned
• Fiscal decentralisation be affected adversely
• Politically it will not be accepted
Autonomous State-GSTs
• Centre to withdraw from the field of domestic trade
taxes except sumptuary items and taxation of services
• Levied, administered, collected and retained by the
States
• Common market will be distorted
• Arrangements required for inter- State transactions
• Implications for federal transfers: revenue equalizing
role gets affected
Dual GST
• Converting Cen -VAT to Cen-GST
• States convert sales taxes/state VATs into State-GST
• Fine blend of the fiscal autonomy of States and
harmonization
• Harmonization in fixing tax base, legislations and
administrative procedures
• Harmonization of tax rates can also be achieved
• Conducive to common market
• Inter-State sales need to be attended to
• Federal fiscal equations do not go through basic changes
• Article 307 needs to be invoked.
Steps for Dual GST
• Combination of Union and State GSTs
• Single State rates or vary within agreed bands
• Requires constitutional change
• Concurrent taxation powers on goods and services
• Harmonization of tax base, legislation and admn
• Major overhaul in institutional and administrative
infrastructure
• Agreement on place of supply rules (trade matrix)
• Union State tax collection agreement
Thank You!