Chapter 9
* Views expressed in the chapter of the author and may not be attributed in any way to the Ministry or the Government of India.
1 The conduct of the fiscal policy in India has been within a federal framework enshrined in the constitution which delimits the powers of the centre and the states in taxation and expenditure. However this chapter does not cover issues relating to the centre-state fiscal transfers or the trends in the state finances for reasons of limitation of scope.
2 Government of India, First Five Year Plan Document.
3 The fiscal situation also impacted the financial sector. In order to contain the debt-service obligations, the government had to tap financial surpluses of the household sector through statutory pre-emption of funds with financial intermediaries.
4 The large increase in the non-debt capital receipts in 2003–04 and 2004–05 was mainly due to recoveries of loans on account of the debt swap scheme, which was introduced for the states and proceeds from the disinvestment in the central public sector undertakings.
5 The basis for classifying the expenditure into revenue and capital and into plan and non-plan has become increasingly questionable. However, this study does not go into accounting the issues relating to the government expenditure.
6 The non-debt creating capital receipts mainly comprise of the recovery of loans and proceeds from disinvestment in the public sector enterprises, the analysis of which has not been possible within the scope of this chapter.
7 Some of the authoritative studies that have analysed the Indian tax system and its weaknesses include—Baghchi and Nayak (1994), Baghchi (1997), Das-Gupta and Mookerjee (1997) and the Report of TRC, 1991, to cite a few.
8 Under the Constitution of India, the taxation of agricultural income is assigned to the state governments. The central government cannot levy tax on such income and the states do not tax agriculture in any significant way.
9 The concerns regarding maintaining stability in the taxes and simplicity in the structure of the taxes are not unique to India. The Meade Committee constituted in UK for enquiring into the direct taxes there, also emphasized on the fact that a good tax system should have stability and fulfil the criterion of simplicity.
10 Economists have often used the four canons (or maxims) of taxation laid down by the classical economists for evaluating the performance of tax systems. The four canons for a tax system are— (1) The subjects ought to contribute, as nearly as possible, in proportion to their respective abilities; that is, in proportion to the revenue which they enjoy; (2) tax, which each individual is bound to pay, ought to be certain and not arbitrary; (3) every tax ought to be levied at the time and manner in which it is convenient for the contributor to pay and (4) the tax should bear as lightly as possible on the subjects (Smith, 1778).
11 From a historical perspective, it is useful to take note of changes in approach to taxation that guided the policy in India. We briefly summarize the observations of Thimmiah (2002), who notes that the Indian tax system passed through five phases since Independence, each following from the recommendations of the different committees. The first phase was guided by the recommendations of the Taxation Enquiry Commission of 1954 (Chairman: John Matthai) which stressed on the need to promote justice in taxation through an increase in the degree of progressiveness of direct taxes, along with the measures for effective enforcement in collection.
The second phase was guided by the recommendations of Nicholas Kaldor’s (from 1957). On his advice, the Government of India introduced a set of integrated direct taxes that included expenditure tax, wealth tax and gifts tax in addition to the already existing income tax, capital-gains tax and estate duty. In practice, the recommendation of Kaldor to reduce the marginal rate of taxes (while introducing a more comprehensive tax system) went unheeded. What followed instead were the high rates of direct taxes with a large number of tax incentives and a complex system of indirect taxes, levied by the central and the state governments.
The third phase was followed with the recommendations of the Direct Taxes Enquiry Committee (1971, also called the Wanchoo Committee). The committee expressed the view that the prevalence of high rates of direct taxes was the foremost reason for tax evasion, and recommended that maximum marginal rate or income tax should be brought down.
Thimmiah observes that tax measures introduced in the first two phases failed to achieve the intended objectives, because they were based on wrong assumptions, viz., that high nominal tax rates would reduce inequalities of income and wealth. While the tax reforms were initiated in the mid-1970s, they did not form a part of the comprehensive package of economic reforms. The yield from the indirect taxes showed buoyancy, the yield from direct taxes became unimpressive.
The fourth phase started in the mid-1980s, with the new economic policy of V.P. Singh, the then Finance Minister. Through the Union Budget for 1985–86, he announced a Long-Term Fiscal Policy outlining a reduction in the corporate tax and rationalization of the other taxes in the following years. He accepted the recommendations of the Indirect Taxation Enquiry Committee of 1977 ( Jha Committee), reduced the rates of central excise duties and introduced MODVAT, in place of the central excise duties on some selected commodities. But the Long Term Fiscal Policy measures could not be fully implemented because of the political developments that pushed the economic reforms to the background. The fifth phase began in the aftermath of the foreign exchange crisis of 1991 that paved the way for comprehensive economic reforms. In the realm of taxation, the fifth phase has been guided by the recommendations of the Tax Reforms Committee of 1991–93 (headed by Professor Raja Chelliah).
12 The motivation for tax reforms has been diverse, and has also been changing over time. In many developing countries, the tax policy was directed to correct fiscal imbalances (Ahmad and Stern, 1991). In East European economies that made a transition from centralized planning, the tax reforms were made to replace the revenues from public enterprise with taxes. With an increasing openness consequent to the emergence of the WTO, there was a general tendency across the world to reduce the tariffs, and at the same time to find new domestic sources of tax revenue and to focus on reducing the compliance cost of the tax system.
13 In order to capture the perquisites, the budget for 2005–06 identified a range of expenses that provide indirect benefits to the employees. These benefits were sought to be taxed through a fringe benefits tax.
14 From the overall perspective of the tax policy and its structure in the country, a major reform initiative during the post-2000 period was the introduction of the state value added tax, in replacement of the cascading type sales tax in 2005. This reform measure is however not covered in this chapter.
15 Without implication, I am grateful to Dr. Archana Mathur, Director Planning Commission for providing these estimates computed at four-digit level by her.
16 Except for a few specified services assigned to the states, such as the entertainment tax, passengers and goods tax and electricity duty.
17 A two-pronged approach to debt relief to the states was recommended by the Twelfth Finance Commission (1) a general debt relief to all States and (2) a write-off of debt linked to fiscal performance to provide an incentive for the achievement of a revenue balance by 2008–09. Both were subject to the states enacting fiscal responsibility legislation. Under the debt relief scheme, all central loans to the states contracted till 31 March 2004 and outstanding on 31 March 2005 were consolidated and interest rate fixed at 7.5 per cent, with a uniform tenor of 20 years. Under the debt write-off scheme, repayments due from 2005–06 to 2009–10, on the central loans contracted up to 31 March 2004, and recommendations to be consolidated and rescheduled were made eligible for write-off; with the quantum of write-off linked to the absolute amount, by which the revenue deficit was reduced in each successive year during the award period and the fiscal deficit of the state being contained at the 2004–05 level. The implementation of these measures, in turn, led to a drop in the interest receipts of the central government.
18 However the portfolio of the banks continued to be dominated by a high share of government securities through the 1990s due to various reasons, in particular, a lack of demand credit from the corporate sector coupled with a certain degree of risk aversion by the banks.
19 The states too were allowed a relaxation in their fiscal and revenue deficit targets.
20 In 1999–2000 the central government decided to pass on the states’ share of the proceeds, the National Small savings, to a public account as a result of which they do not figure as a part of centre’s fiscal deficit thereafter.
21 Identifying specific measures of reform depends on reliable information on financial flows. It is now recognized that the classification of government expenditure does not often reflect the end use. In comparison to the expenditure, data the classification of government revenues is relatively simple and standardized. In this context, a committee set up by the government to look into the classification of the government expenditure observed that the distribution of government expenditure into the revenue and capital, shown by the accounts, cannot always be taken as a measure of the developmental expenditure undertaken by the government (Government of India, 2004).