Tax System Reforms in India: The Centre-State Dimension

M. Govinda Rao Director, National Institute of Public Finance and Policy

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.

Introduction

Need for a paradigm shift in tax policy in a market economy.

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 and differentiated rates, complicated structure, poor information system. Negotiated tax system.

Low revenue productivity and high degree of distortions and inequity. Several committees and study reports on tax system reform during the last five years. Many of the reform issues have been identified. A major issue relates to evolving a coordinated consumption tax system in the country. This presentation deals with this

Major Problems with Indirect Tax System

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 in import 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.

Tax - GDP Ratio in Different Countries 50 45 40 35 Tota Tax GDP ratio 30 25 20 15 10 5 0 0 10000 20000 30000 Per Capita PPP 40000 50000 60000

Tax - GDP Ratios in Different Contries (According to Per Capita GDP) 50 45 40 35 Total Tax GDP Ratio 30 25 20 15 10 5 0 0 5000 10000 15000 20000 25000 30000 35000 40000 45000 Per capita GDP

Trends in Tax Revenue in India (Per cent of GDP)

1991-92 1995-96 2000-01 2001-02 2002-03 2003-04* 2004-05# Centre Direct Indirect 2.4 8.0 2.8 6.5 3.3 5.8 3.0 5.2 3.4 5.4 3.8 5.4 4.3 5.6 Total 10.3 9.4 9.0 8.2 8.8 9.2 9.9 Direct 0.2 0.2 0.2 0.2 0.2 0.2 Na States Indirect 5.3 5.2 5.4 5.4 5.7 5.8 na Total 5.5 5.4 5.6 5.6 5.9 6.0 na Direct 2.6 3.0 3.4 3.2 3.5 4.0 na Total Indirect 13.3 11.7 11.2 10.6 11.1 11.2 na Total 15.8 14.8 14.6 13.8 14.6 15.2 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.

Trends in Direct and Indirect Taxes

18.0 16.0 14.0 12.0 10.0 8.0 6.0 4.0 Direct Taxes 2.0 0.0 Total Taxes

Indirect Taxes

-81 0 98

-83 2 98

-85 -87 -89 -91 -93 -95 -97 -99 -01 -03 4 8 4 6 0 2 6 8 0 2 198 198 198 199 199 199 199 199 200 200
Years

Coordinated Calibration of Indirect Taxes

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.

Introduction of VAT in States

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.

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 vs fiscal 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.

Critical Issues in Tax System Reform

Need to have reforms for improving the revenue productivity, minimize distortions and improve equity; Tax reforms are needed at Central, state as well 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 of information system and information exchange; Strengthening TIN. Need to reduce selectivity and discretion in tax policy and administration;