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Tax System Reforms in India:The Centre-State Dimension

M. Govinda Rao

Director, National Institute of PublicFinance and Policy

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Coordinating Tax System Reform

In Indian Federalism Introduction Major problems with Indian Indirect tax system.

Coordinated calibration indirect taxes. Recent reforms in indirect taxes. Transitional steps to evolve VAT. An assessment of design and implementation of

State VAT in India. The idea of GST: desirability, feasibility and

transitional steps. An agenda for tax reforms in a globalising

environment.

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Introduction

Need for a paradigm shift in tax policy in a marketeconomy. Compensating revenue loss from customs. Minimising the three costs of taxation. Enhancing revenue productivity of the tax system. Re-look at fiscal assignments.

History of Indirect taxation: The assignments Evolution: From clearance based excise duties to account

based CENVAT. Service taxation and its coordination with taxation of goods Reform of the sales tax system to move towards a state VAT

Characteristics of indirect system: narrow base, high anddifferentiated rates, complicated structure, poor

information system. Negotiated tax system.

Low revenue productivity and high degree of distortions andinequity.

Several committees and study reports on tax system reformduring the last five years. Many of the reform issues havebeen identified.

A major issue relates to evolving a coordinated consumptiontax system in the country. This presentation deals with this

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Major Problems with Indirect TaxSystem

Major Problems with Indian Indirect tax System Low revenue productivity despite reforms. Declining revenues mainly due to the inability of domestic

trade taxes to compensate revenue loss from reduction inimport duties.

Disproportionate distribution of burden between sectors; Poor information system and low tax compliance; Customs duties: large exemption list; rate differentiation

based on the stage of production; Octroi: problems Small is beautiful: excessive concession to small scale

industries from excise duties; Area based exemptions; Special economic Zones. Taxes on inter-regional transactions several tariff zones

within the country. Multiple objectives: selectivity and discretion in exemptions,

rate structure and input tax credit.

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Tax - GDP Ratio in Different Countries

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0 10000 20000 30000 40000 50000 60000

Per Capita PPP

TotaTaxGDP

rat

io

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Tax - GDP Ratios in Different Contries (According to Per Capita GDP)

0

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0 5000 10000 15000 20000 25000 30000 35000 40000 45000

Per capita GDP

TotalTaxGDPRatio

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Trends in Tax Revenue in India

(Per cent of GDP)Centre States Total

Direct Indirect Total Direct Indirect Total Direct Indirect Total

1991-92 2.4 8.0 10.3 0.2 5.3 5.5 2.6 13.3 15.8

1995-96 2.8 6.5 9.4 0.2 5.2 5.4 3.0 11.7 14.82000-01 3.3 5.8 9.0 0.2 5.4 5.6 3.4 11.2 14.6

2001-02 3.0 5.2 8.2 0.2 5.4 5.6 3.2 10.6 13.8

2002-03 3.4 5.4 8.8 0.2 5.7 5.9 3.5 11.1 14.6

2003-04* 3.8 5.4 9.2 0.2 5.8 6.0 4.0 11.2 15.2

2004-05# 4.3 5.6 9.9 Na na na na na na

Note: * Actual for the centre and revised estimate for States. #Revised estimates for Centre.

n.a: not available.

Source: Public Finance Statistics, 2003-04. Ministry of Finance, Government of India.

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Trends in Direct and Indirect Taxes

0.0

2.0

4.0

6.0

8.0

10.0

12.0

14.0

16.0

18.0

1980

-81

1982

-83

1984

-85

1986

-87

1988

-89

1990

-91

1992

-93

1994

-95

1996

-97

1998

-99

2000

-01

2002

-03

Years

Direct Taxes

Indirect Taxes

Total Taxes

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Coordinated Calibration of IndirectTaxes

Problems with domestic trade taxes

Reform of Union excise duties; towards a

MANVAT. Taxation of Services; Issues of reform;

Integration with taxation of goods;

Reforming the sales tax system towards a

destination based VAT Need to have a coordinated calibration to limit

the tax burden.

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Introduction of VAT inStates

Progress in VAT introduction Revenue implications Problems of design Implementation issues Further reforms:

Phasing out the CST Concurrent tax on services Integration of other taxes

Correcting the design Strengthening the information system Risk-weighted sample selection for detailed auditing Speeding up the appellate system.

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GST: Desirability, Feasibility and

Transitional Steps Kelkar reforms and a blueprint for dual VAT.

Kelkar II reforms and the idea of GST.

Why is GST important: Tax harmonisation vsfiscal autonomy.

Steps involved: Concurrent tax powers; From CENVAT to GST at the centre VAT of goods and services at the state level Merger of the two: Should there be separate tax

administrations or Piggybacking arrangement? Substitution of Octroi with a local turnover tax at the

last point of sale.

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Critical Issues in Tax System Reform

Need to have reforms for improving the

revenue productivity, minimize distortions andimprove equity;

Tax reforms are needed at Central, state aswell as local levels.

Need to ensure a common market; Tax harmonisation with sub-national fiscal

autonomy. Integration of tax on goods with services.

Tax Administration is tax policy: Importance ofinformation system and information exchange;Strengthening TIN.

Need to reduce selectivity and discretion in tax

policy and administration;