2009 Reports

Tax System Reform in India

Rao, M. Govinda; Rao, R. Kavita

Many developing countries have embarked on tax reforms in recent years. Such reforms were motivated both by local factors as well as by rapid internationalization of economic activities. The need to correct fiscal imbalances and the transition from a centralized plan to a market economy were the important local factors hastening tax reforms. Difficulties in compressing expenditures necessitated that tax system reform take an important role in fiscal adjustment strategy. The transition from plan to market required the substitution of administered prices with market determined prices, the replacement of physical controls with financial controls, and the substitution of public enterprise profits with tax revenues. The Indian tax system too had to be reformed in response to changes in development strategy. In the initial years, tax policy was used as an instrument to achieve a variety of diverse goals which included increasing the level of saving and correcting for inequalities arising from an oligopolistic market structure created by a centralized planning regime, including a licensing system, exchange control, and administered prices (Bagchi and Nayak 1994). While the history of taxation in India is peppered with efforts for tax reform, especially in the form of various expert committees, the fiscal crisis of 1991 provided the first major window of opportunity for a serious rethink, followed by action. This paper analyzes both the structure and the operations of the Indian tax system. The first section discusses the evolution of the Indian tax system and tax collections and the impact of historical and institutional factors in shaping Indian tax policy. Next, we provide a critical analysis of some key features of the tax regime and its reform options. An analysis of the observed trends in tax revenue is presented in the following section, highlighting the possible efficiency and equity implications of the tax system. The final section pulls together the various suggestions for consolidation of tax reforms in India.