SABER Research Project Conference on

Efficiency of Economic Policy Formation,

Formation Development and Implementation in
Key South Asian Economies
India International Centre, New Delhi
June 29-
29-30, 2009

Public Finance and Taxation

Reforms
f in India

Dr J V M Sarma
University of Hyderabad
 The Focus

Review of the fiscal developments in India

focusing on the policy changes
and their impact
 Presentation sequence
„ PFM and Development Strategy
„ Land mark Reforms of 90s, paradigm change

„ Trends in the Fiscal Components

„ Analysis of the Tax Policy Evolution

„ The Unfinished Agenda and likely Institutional

hurdles.
Public Finance Management
&D Development
l Strategy
S
 Nature of PFM
„ Development
p strategy
gy options
p ffor India at the time
Independence
„ Market orientation vs government intervention
„ Choice towards
Ch d the
h Mixed
M d economic framework
k
„ With bias towards heavy industry and dominant role for
public sector
„ Pronounced bias against foreign trade
„ Socialistic pattern of development
„ Federal Fiscal Sharing
„ PFM not easy.
easy
 Macro Fiscal Interactions
World
GDP
Population

which inturn, results

Transfers
f is a function
Tax of the accumulated
Nontax capital stock lwhichi caninbe higher
Salaries inverted
band
idiused to
Subsidies
revenue
expenditure.
determine the demand for capital for given level of income.
Yt= f {Kt-1}
Total
The govt capital
HHexp also Kt 1(1 δ) + It
Kt = Kt-1(1- Revenue
entails the O&M exp
Saving
Total
Capital Exp
Revenue
The private sectorRevenue
Capital
GDP is also the base forisown
formation tax and
related to non tax revenues Interest
the
b l
balance
growth of current expenditure other than interest payments
Pvt sector R
basically
t = f {Y
government }
depends
t sector population, the nationalpayments
on thecapital income,
apartexpenditure
Transfers from the
Fiscal
fromrestother via
of the the crowding-
country
variables. also contribute to the
Capital exp
revenue in or crowding-out
revenue. crowding out function O&M
function.
balance Ct= f{Νt, Yt …} The revenue balance,
Debt
along with the demand
to be financed by
for capital,
outstanding
new borrowings.
determines
The demand for the govt capital
Govt sector emanates the
fromFiscal
total Deficit
capital
Capital exp New
requirement in the economy
Borrowings
 Key Requirements for mixed development
strategy to work
„ Need for Private-Public
Private Public Macro Balancing
„ Determining the respective areas of activities to
achieve crowding in,
„ Allocation of resources, avoiding crowding out

„ Efficient government sector management

„ Regulating the Private sector

 Pre--90 Policy Stance: Problems
Pre
„ Development strategy too much centered on direct
intervention of the state
„ in terms of providing direction, controls, regulation and
even direct participation in economic activities.
„ Inefficient,
ff , high
g cost and non-competitive
p industrial
structure;
„ Serious infrastructure bottlenecks
„ Significant constraints on the availability of financial
capital.
capital
The Landmark Reforms of
90s
90
The BoP Crisis of 1991
1991:: The fire
fire--fighting
„ Cutting of Fiscal Deficit through speicial financing
from IMF
„ Trade and Industrial liberalization

„ Tax Reform

„ Crisis – catalytic for a paradigm shift in the tax

policy
li
 Structural reforms since early 90
90’s
’ss
„ Industrial licensingg relaxed
„ Market forces allowed to operate in many economic
sectors
„ Independent regulators in electricity/ insurance/ telecom
„ FDI/ / domestic private
p investment allowed in
electricity/ insurance/ telecom & many other economic
sectors
„ Beginning made in disinvestment of Central/ State
PSUs
 Visible shifts in the ec
economic
onomic Growth
pattern
„ From a modest 3% till 70s to over 5.8%
5 8% in later
decades
annum

10 9.11
8 67
8.67
Percent per a

9 8 52
8.52
Average for the decade
8 7.39
7 5.97
5.8
6 5.7
5 4.02 3.93
4 3.0
3
2
1
0
70s

80s

90s

20000-01

20001-02

20002-03

20003-04

20004-05

20005-06

20006-07
 The Recovery path
„ Real investment growth reaches 40% by 2000-01
2000 01
„ Growth in industrial investment touches > 50%

„ Export growth touches >20%

„ Increase in per capita GDP

„ India the second fastest growing economy today .

Trends in Fiscal Components
 Continued Fiscal Downtrends: A Road
Block to Development
„ Narrow tax base
„ Low, stagnant tax/GDP ratio

„ Impact of the Pay Commission

„ Rising interest burden

„ Growing revenue deficit

„ Growing fiscal deficit

„ Declining capital expenditure

 High fiscal deficits (Centre & States)

4%
Fiscal balance Revenue balance Primary balance
2%

0%

-2%

-4%

-6%

-8%

-10%
1960-61

1965-66

1970-71

1975-76

1980-81

1985-86

1990-91

1995-96

2000-01

2005-06

2006-07
 The Quality of Fiscal Deficit: A cause for
worry
„ Firstly
Firstly, the fiscal deficit driven by revenue deficits.
deficits
4%
Fiscal balance
2% Revenue balance

0%

-2%

-4%

-6%

-8%

-10%
1965-66

1975-76

1985-86

1995-96

2000-01
1960-61

1970-71

1980-81

1990-91

2005-06

2006-07
 The Quality of Fiscal Deficit: A cause for
worry
„ Secondly
Secondly, a significant increase in debt service
4% liability Fiscal balance
Primary balance
2%

0%

-2%
2%

-4%

-6%
6%

-8%

-10%
1965-66

1975-76

1985-86

1995-96

2000-01
1960-61

1970-71

1980-81

1990-91

2005-06

2006-07
 Financing of Fiscal Deficit
12
Other liabilities
External financing
Market borrowing
10
Budgetary
d surplus
l /d
deficit
fi i

0
2000-01

2001-02

20007-08b
1990-91

2002-03

2003-04

2004-05

2005-06

22006-07r
-2

-4
The Tax Policy Evolution
 General
„ Tax structure gguided byy the economic and ppolitical
structures and choices
„ 90s mark a bigg changeg in the growth
g strategy.
gy We
touch upon
„ Pre-90 tax policy stance
„ Tax Reforms of 90s
„ Post Millennium tax reform experience
„ Future reform priorities
„ Likely institutional bindings.
 Tax policy constraints in pre-
pre-90
90ss
„ Need for raising resources for the public investment
and government current expenditure requirements
„ Adoption of socialistic pattern means need to
maintain high
g progressivity
p g y
„ Anti- foreign trade regime – high foreign trade
related taxes
 The Resultant weaknesses
„ Anti- fforeign
g trade regime
g – high g customs and export
p
duties
„ High
g progressivity
p g y – ppersonal income tax
„ High tax rate differentiation – corporate tax, union
excise, customs
„ Plethora of exemptions, concessions, deductions, rebates
and preferences
„ Federal
d l fiscall sharing
h further
h complicates
l
„ Resulting tax complexity, difficult to manage
 Pre--90
Pre 90ss Tax Reform under systemic
constraints
Constrained due to the nature off the development
p paradigm
p g – onlyy
mild Reforms
„ The TEC (1954) – first comprehensive attempt after
Independence
„ Kaldor Committee (1956) – Expenditure tax and move towards
integrated taxation
„ DTEC (1971) – Reduction in income tax rates, and slabs
„ ITEC (1977) – Moves in the direction of VAT introduction at
the Central level
„ The LTFP (1985) – advocated reduction of customs, rationalize
excise – partially implented.
The Landmark Tax
Rf
Reforms off 90
90ss
 The TRC (1991
1991))
„ Three reports –
„ Broad principles for taxes on income and
wealth tariffs and taxes on domestic
wealth,
consumption in the Interim Report
„ Tax administration and enforcement aspects -
Part I of the Final report ,
„ Restructuring the tariffs
t riffs - Part
P rt II of the Final
Fin l
Report
 Basic principles underlying the
recommendations
„ Base broadening,
„ Lowering of marginal tax rates,
„ Reducing rate differentiation,
differentiation
„ Simplifying the tax structure and
„ Measures for more effective tax administration
„ Revenue neutralityy in the short term
„ Revenue productivity in the medium and long
term.
 Major concrete recommendations
„ Simple
p three-tier ppersonal income tax structure,,
„ with an entry rate of 20 per cent and a top rate of 40 per
cent.
„ Phased reduction of the corporate tax rate to 40 per
cent,
„ Abolition
Ab l off the
h distinction
d between
b widely-held
d l h ld andd
closely-held companies,
„ Abolition
Ab liti off wealth lth tax
t on allll assets
t
„ except certain ‘unproductive’ assets.
 Major concrete recommendations
„ Phased reduction of the high import duties (many
above 200 per cent in 1991) to a range of 15 to
30 per cent for manufactures and 50 per cent for
certain agricultural items by 1997-98.
„ Restructuring
R t t in off central
nt l excise
i tto cover
v allll
manufactures,
„ Reduction of multiple excist tax rates to three in
the range of 10 to 20 per cent
 Major concrete recommendations
„ Extension off MODVAT credit to all inputs p includingg
machinery.
„ Selective excises at higher rates on luxury consumption
items.
„ Elimination of the numerous prevailing exemptions and
tax preferences in both direct and indirect taxes
„ Far-reaching reforms of tax administration, including the
p y
deployment off modern information
f technology
gy and online
linkage of new tax identification numbers to a national
network.
 Implementation
„ In different
ff phases
p byy different
ff governments
g – Broad
Thrust kept in tact
„ PIT rates lowered
„ Import duties cut
„ Corporate
p distinction –widelyy held closelyy held
abolished.
„ Single CENVAT rate
„ Service tax introduced
„ Reduction in the exemptions and incentives
 The Aftermath of TRC Tax Reforms
„ MAT
„ Further lowering of CENVAT and customs

„ VAT at the States level

„ The FRBM

„ Advisory Group on Tax Policy 2001

„ The Kelkar Task Force Committee on Direct and

Indirect taxes
 Economic performance in the 21 century
„ Striking till the Crises
„ The Crises and their impact

„ Rise in Petroleum price and other commodities –

rising inflation
„ The Financial Crisis

„ Series of monetary and fiscal measures

 Combined Receipts and Disbursements of the
Central andd State governments (% of GDP)
1960- 1970- 1980- 1990- 2000- 2001- 2002- 2003- 2004- 2005- 2006- 2007-
61 71 81 91 01 02 03 04 05 06 07r 08b
I Total Disbursements 15.4 17.7 24.9 26.8 26.1 26.5 26.7 27.1 26.1 25.9 27.0 27.3
1995-96 1996-97 1997-98 1998-99 1999-00 2000-01
A Revenenu expenditure 9.9 12.5 16.5 21.6 23.0 23.5 23.8 23.6 22.1 21.9 22.6 21.9
Interest payments 1.3 1.6 2.1 4.4 5.8 6.1 6.2 6.3 6.0 5.6 5.4 5.2
Defence 1.4 2.3 2.5 1.9 1.8 1.7 1.7 1.6 1.4 1.3 1.2 1.1
Subsidies 0.0 0.0 0.6 1.2 1.0 1.1 1.3 1.3 1.1 1.0 1.0 0.9
B Capital expenditure 5.7 4.7 7.7 5.3 5.3 5.5 4.5 5.8 5.7 6.4 7.0 8.0
II Total Receipts 10 0 12.8
10.0 12 8 16.4
16 4 17.6
17 6 17.0
17 0 16.5
16 5 17.3
17 3 17.9
17 9 18.4
18 4 19.2
19 2 20.320 3 20.5
20 5
A Revenue receipts 10.0 12.8 16.4 17.6 17.0 16.5 17.3 17.9 18.4 19.2 20.3 20.5
(i
) Tax 7.9 10.4 13.8 15.4 14.6 13.8 14.5 15.0 15.7 16.4 17.7 18.1
Direct 2.3 2.2 2.3 2.2 3.4 3.2 3.5 4.0 4.4 4.7 5.6 5.7
Indirect 5.5 8.2 11.5 13.6 11.2 10.6 11.1 11.3 11.6 12.2 12.5 11.4
(i
i) Nontax 2.2 2.4 2.6 2.2 2.4 2.7 2.8 2.8 2.7 2.8 2.6 2.4
Interest receipts 0.0 0.0 1.2 1.1 0.8 0.7 0.7 0.7 0.6 0.6 0.4 0.4
PSU di
dividends
id d etc t 04
0.4 02
0.2 02
0.2 -0.1
01 05
0.5 07
0.7 08
0.8 08
0.8 05
0.5 07
0.7 07
0.7 07
0.7
Others 1.8 2.2 1.3 1.2 1.0 1.3 1.3 1.3 1.7 1.5 1.4 1.3
Nondebt capital
B receipts
III Gross fiscal deficit -5.3 -4.9 -8.4 -9.2 -9.1 -10.0 -9.4 -9.2 -7.6 -6.8 -6.7 -6.8
 Tax Composition
Other indirect taxes
20
Service
Se v ce ta
tax
18 Sales tax 2.4
Union excise 2.4
16 2.4
Customs 1.8
2.1 2.2 1.2
14 O h direct
Other di taxes 2.2 11
1.1
0.3 2.0 2.2 0.7
1.8 0.2 2.1 0.5 4.1
12 Corporate tax 0.0 0.3 4.0
3.2 0.2 3.8
Income tax 3.5 3.6 3.7
2.8 3.4
10 1.5 3.4
00
0.0 2.8 2.8
8 1.7 4.3 3.1 3.1
1.2 3.3 3.4 3.3
0.0 4.5 3.2 2.0 2.1
6 1.0
3.8 1.8 1.8 0.2 0.1
2.4 2.3 1.8 1.8 0.2
4 3.6 1.8 0.2 0.2
24
2.4 02
0.2 00.22 35
3.5 3.6
1.0 1.1 0.2 2.3 2.6 2.8
2 0.7 0.4 0.3 0.3 1.7 1.6 1.9
0.6 0.8 0.9 0.9
1.5 1.4 1.5 1.5 1.6 1.7 1.9 2.0
1.0 1.0 1.0 0.9
0
1960-661

1970-71

1980-81

1990-91

2002-003

2003-004

2004-005

2005-006

2006-07r
2000-001

2001-002

2007-088b
 Shortfalls in Central Tax Collections
„ Tax collections below targets
„ The drop affecting the flow of tax devolution to the
St t
States
 Tax buoyancy: Centre & States
„ Stagnation in tax/GDP ratio even prior to the
present recession.

1.14 1.15 1.12

0.96 1.04 0.96
0.94 0.93 0.88

1980-81
1980 81 to 1989-90
1989 90 1990-91
1990 91 to 1999-00
1999 00 2000-01
2000 01 to 2006
2006-07
07
Centre and States combined Central taxes States own taxes
 Stagnant Non-
Non-tax revenues
„ Non-tax revenues of the Centre increased during the 90s,
„ but not adequate to neutralize the fall in tax revenue.
„ Non-tax revenues of the States declined.
„ The upward trend in 1994
1994-95
95 and 1995
1995-96
96 was short-lived.
short lived.
Centre States Total Nontax Revenue

2.8 3.0 3.0 2.8

2.7 2.7 2.7
2.6 2.5 2.5 2.5 2.5
22
2.2 23
2.3 24
2.4
2.2
1.7 1.9 1.7
% of GDP

1.5 1.4 1.5

1.3 1.2
1.0 1.1 1.0 1.1
0.6 0.7 0.7
02
0.2
0.0

-0.3 -0.2 -0.2

1990-991

1991-992

1992-993

1993-994

1994-995

1995-996

1996-997

1997-998

1998-999

1999-000

2000-001

2001-002

2002-003

2003-004

2004-005

2005-006

2006-007

2007-008
 Components of Non-
Non-tax Revenue: Centre
b_1 (Net Contribution of Public Undertakings) b_2 (Interest Receipts)
b 3 (Fiscal Services)
b_3 b 4 (General Services
b_4 Services,excluding
excluding Defence Receipts)***
Receipts)
b_5 (Social & Community Services) b_6 (Economic Services) !
3.0% b_7 (External Grants)

2.5%

2.0%

1.5%

1.0%

0.5%

0.0%

-0.5%

2001-022be
1974--75

1975--76

1980--81

1985--86

1990--91

1995--96

2000-011re
 Components of Non-
Non-tax Revenue: States
b_1 (Net Contribution of Public Undertakings) b_2 (Interest Receipts)
b 3 (General Services)
b_3 b 4 (Social & Community Services)
b_4
b_5 (Economic Services) #
3.0%

2.5%

2.0%

1.5%

1.0%

0.5%

0.0%

-0.5%

2be
1974--75

1975--76

1980--81

1985--86

1990--91

1995--96

1re
2000-01

2001-02
 Factors Contributing to rising Central
Government Expenditure
d
„ Rising interest expenditure
„ Increases in defense expenditure
„ Impact of 5th Pay Commission

„ Rising fertilizer/ food subsidies

 Pattern of Financing the Fiscal Deficit in the
late 90
90ss
„ Indebtedness of the Centre and the States > 65%
of GDP in 2000-01
10

„ More important is its unsustainability (growth of

9
8

debt > GDP ggrowth))

7
of GDP

6
Pecent o

5
4
3
2
1
0
1995-96 1996-97 1997-98 1998-99 1999-00 2000-01

Market Borrowings (net)

( ) S
Small S
Savings ((net)) S
State Provident Funds (net)
( )
Budget Deficit Others External Financing
 Variations In Fiscal
Performance
P f Across
A SStates
 Structural Weakness of State Finances
„ Uncertaintyy and Variabilityy in the ffederal resource
transfers.
„ Large electricity/irrigation/transport subsidies
„ Inadequate generation of own resources
„ Inefficiencies in expenditure
„ Rising expenditures mainly due to rising wages and
salaries, pensions, subsidies and interest payments.
„ Constraint on investments in
education, health, infrastructure, social security and welfare
Increased Growth Dispersion Across States
(average % per annum) during
d 80
80ss andd 90s
90s
Andhra Pradesh
10
West Bengal Bihar
8
Uttar Pradesh Gujarat
6

4
Tamil Nadu Haryana
2

Rajasthan Karnataka

80s
90s
Punjab Kerala

Orissa Madhya Pradesh

Maharashtra
Trends in the Fiscal Deficit/GSDP
Deficit/GSDP ratio in
14 Major States
Andhra Pradesh
7%
West Bengal Bihar
6%
5%
Uttar Pradesh Gujarat
4%
3%
2%
Tamil Nadu Haryana
1%
0%

Rajasthan Karnataka

1995
Punjab Kerala
2000

Orissa Madhya Pradesh

Maharashtra
 Percapita income vs fiscal deficit/GSDP
deficit/GSDP ratio
in 14 major States of India
d
12
O rissa

10
W est Bengal
Bihar
R j th
Rajasthan
8
Fiscal deficiit/ GSDP (%)

Uttar Pradesh
G ujarat
6 Punjab
Kerala
Karnataka M aharashtra
M adhya Pradesh
Haryana
Tam il Nadu
4 Andhra Pradesh

0
0 2,000 4,000 6,000 8,000 10,000 12,000 14,000 16,000
Percapita incom e (INR)
 Own revenue/ Total expenditure & Fiscal
d / GSDP in 14 major States in India
deficit/ d
70

Haryana
Karnataka Maharashtra
60
Tamil Nadu Gujarat

Punjab
Kerala
%)

50
otal expenditure (%

Madhya Pradesh
Andhra Pradesh
40 Rajasthan
Own resources/ To

West Bengal
30 Uttar Pradesh
Bihar
Orissa

20
O

10

0
0 2 4 6 8 10 12
Fiscal deficit/ GSDP (%)
 Share of developmental expenditure in total:
The Shrinking Trendd in the in 14 major States
Andhra Pradesh

W t Bengal
West B l Bih
Bihar
75%

Uttar Pradesh 70% Gujarat

65%

60%
Tamil Nadu Haryana
55%

50%

Rajasthan Karnataka

Late 80s
Early 90s
Punjab Kerala Late 90s

O i
Orissa M dh Pradesh
Madhya P d h

Maharashtra
States Efforts to overcome
fi l constraints
fiscal i
Fiscal restructuring at the States’ level to focus
on
„ Revenue mobilization, through better tax collection and
rationalizing taxes
„ Revising user charges specially for power, water and transport
„ Better expenditure management
„ for example, downsizing
d the Government by abolition/freezing
/ of
posts
„ Enhance expenditure efficiency
„ Compressing non-Plan revenue expenditures
„ PSU reforms: Closure/ disinvestment
„ Infrastructure development
„ Sector reforms: Competition/ Regulation
Priorities for Further Reforms
 Revenue side reforms
„ Coordination of central excises (CENVAT) with a
state level VAT
„ Implement comprehensive taxation of services at the
earliest.
 Expenditure side reforms
„ Reduce non
non-Plan
Pl n expenditures through containment
cont inment of
wage bill
„ Reform the subsidies (reduction in size,
size making them of
finite duration, making them transparent and proper
targeting.)
g g)
„ Review user charges in
agriculture, irrigation, industries, power and transport.
„ Use the proceeds of disinvestment in public enterprise to
amortize public debt.
Thank You!
 References
„ 1) Raja J Chelliah (1999) Economic Reform
Strategy for the Next Decade Considerations for
D t i i th
Determining the Directions
Di ti off
Reforms, EPW, September 4.
„ 2) Bagchi, Amaresh et al (1994): Reform of
Domestic Trade Taxes in India: Issues and
Options, National Institute of Public Finance and
Policy New Delhi.
Policy, Delhi
„ 3) Acharya, Shankar (2005) Thirty Years of
 References
„ 6) Stephen Howes and Rinku Murgai
()Subsidies And Salaries: Issues In The
R t t i Of G
Restructuring Governmentt EExpenditure
p dit IIn
India
„ 8) Sarma E A S and Sarma J V M (2002)
Financing government expenditure for sustainable
development in India, Swedish Embassy, New
Delhi.
Delhi