REVIEW WRITING

In this, we are going to review the article written by M. Govinda Rao on the heading “TAX
REFORM IN INDIA: ACHIEVEMENTS AND CHALLENGES” comprehensive study on
the concept of Tax and its achievements and challenges in economy”, Asia-Pacific
Development Journal, published on 2nd December 2000. This article mainly concentrates on
the tax. Here he firstly discusses about the concept of tax reform. Next about the challenges
on the economy.

In his abstract he tells the general information about Tax Reform and challenges in India. In
India there have been major changes in tax systems in several countries over the last two
decades for a variety of reasons. The objective of this paper is to analyse the evolution of the
tax system in India since the early 1990s.

In the introduction, he tells a brief information about tax reform and explains in detail. It
describes and assesses the introduction of new forms of direct and indirect taxes, their
revenue and equity implications and the successes achieved in their implementation. There
have been major changes in tax systems of countries with a wide variety of economic systems
and levels of development during the last two decades. The motivation for these reforms has
varied from one country to another and the thrust of reforms has differed from time to time
depending on the development strategy and philosophy of the times. In many developing
countries, the immediate reason for tax reforms, has been the need to enhance revenues to
meet impending fiscal crises.

He mentioned one of the most important reasons for recent tax reforms in many developing
and transitional economies has been to evolve a tax system to meet the requirements of
international competition (Rao 1992). The transition from a predominantly centrally planned
development strategy to market based resource allocation has changed the perspective of the
role of the state in development. As in other countries, the systemic reforms in the tax system
in India in the 1990s were the product of crisis but the reforms were calibrated on the basis of
detailed analysis. The objective of this paper is to analyse the evolution of the India tax
system with special reference to the systemic reforms in the design and implementation of the
structure and operation of the taxes in Indian federal polity.
Paradigms of tax reform, The philosophy of tax reform has undergone significant changes
over the years in keeping with the changing perception of the role of the state. With the
change in the development strategy in favour of market determined resource allocation, the
traditional approach of raising revenues to finance a large public sector without much regard
to economic effects has been given up. This also calls for reducing differentiation in tax rates
to reduce unintended distortions in relative prices.

The concepts he explained here are so easy to understand. India’s tax system prior to
comprehensive reforms in 1991. The trends in tax revenues presented in table 1 present three
distinct phases. In the first, right from the 1970s to mid-1980s, there has been a steady
increase in the tax-GDP ratio in keeping In the Indian federal polity, both central and state
governments exercise revenue powers and the latter raise about 37 per cent of total revenues.
The Seventh Schedule to the Constitution specifies revenue sources of the centre and the
states respectively in the union and state lists with the buoyant economic conditions and
acceleration in the growth rate of the economy.

He mentioned about Constitutional amendments is quite interesting. In 72nd and 73rd

Constitutional amendments also specify some tax sources to urban and rural local
governments. The two important taxes assigned to the local bodies are property taxes and
taxes on the entry of goods into a local area for consumption, use or sale. Information on
local tax collections consolidated for all urban and rural local governments is not available.
However, available information shows that local governments have very little revenue raising
powers and much of the expenditures of the local governments are met from devolution of
revenues from the state governments. This is understandable, as the central government had
to reduce tariffs as a part of the structural adjustment programme. On the other hand, there
have been hardly any worthwhile reforms at the state level and yet, the tax ratio has shown a
decline, albeit marginal.

Tax reform attempts until 1990 There have been a number of attempts at improving the tax
system since independence. The principal objective of these attempts has been to enhance
revenue productivity to finance large development plans. Although the various tax reform
committees considered economic efficiency as one of the objectives, the recommendations do
not bear much testimony to this aspect. The recommendations were in keeping with the
philosophy of the times. Further, even when the committees did recommend certain measures
on efficiency considerations, this was not acted upon if it involved loss of revenues.

He explains about the first comprehensive attempt at reforming the tax system was by the
Tax Reform Committee in 1953. This provided the backdrop for the generation of resources
for the Second Five Year Plan (1956-60), and was required to fulfil a variety of objectives
such as raising the level of savings and investment, effecting resource transfer from the
private to the public sector and achieving a desired state of redistribution. Since then, there
have been a number of attempts, most of them partial, to remedy various aspects of the tax
system. The expenditure tax levied on the recommendation of the Kaldor Committee in 1957-
58 had to be withdrawn after three years as it did not generate the expected revenues. The
attempt to achieve the desired state of redistribution caused the policy makers to design the
income tax system with confiscatory marginal rates.

It was an income type VAT applicable only to a few manufactured goods. Also, there was an
attempt to substitute ad valorem taxes to specific levies though quite a few commodities are
subject to specific tax even today. There were attempts to simplify and rationalize the
structures, but these cannot be considered comprehensive. Tax reform since 1991 was
initiated as a part of the structural reform process, following the economic crisis of 1991. In
keeping with the best practice approaches, the TRC adopted an approach of combining
economic principles with conventional wisdom in recommending comprehensive tax system
reforms.

He mentioned three parts in the report. In the first interim report, the Committee set out the
guiding principles of tax reform and applied them to important taxes namely, taxes on income
and wealth and taxes on domestic consumption. The overall thrust of the TRC was to 1.
decrease the share of trade taxes in total tax revenue; 2. increase the share of domestic
consumption taxes by transforming the domestic excises into VAT and 3. increase the
relative contribution of direct taxes.

He discusses about the Implementation of reforms since 1991 The government accepted the
recommendations of the TRC and has implemented them in phases. Although it did not
entirely follow the recommendations and is yet to implement many of the measures to
strengthen the administration and enforcement machinery, most of the recommendations have
been implemented. Revenue implications of reforms, The economic crisis of 1991 resulted in
a significant decline in revenues. Although the tax reforms were intended to be a revenue
neutral exercise, the natural consequence of a significant decline in tax rates was to reduce
revenues. As there was no commensurate increase in the tax base, the revenue naturally
showed a declining trend.

He also explains shortcomes and challenges, After eight years of tax reform, as already he
mentioned, a number of disquieting features in the tax system still remain. Improving the
productivity of the tax system continues to be a major challenge in India. The tax ratio is yet
to reach the pre-reform levels. Although he said that the coverage under income tax has
shown significant improvement, much remains to be done to reach the hard-to-tax groups. In
the case of direct taxes, as already mentioned, the revenue ratio has shown an upward trend.
Marked decline in tax rates seems to have improved tax compliance, though much of the
increase seems to have come about due to increases in public sector wages.

He also mentioned the most important challenge in restructuring the tax system in the country
is to evolve a co-ordinated consumption tax system. Although tax assignment between
different levels of government follows the principle of separation, as these separate taxes
levied by the centre (excise duties), states (sales taxes, state excise duties, taxes on motor
vehicles, goods and passengers), and local governments (octroi) fall on the same tax base, we
end up in a chaotic situation with tax on tax and mark up on the tax. Besides cascading and
relative price distortions, this results in a totally nontransparent tax system. Development of
dual VAT manufacturing stage VAT by the centre and a consumption type destination based
retailed stage VAT by the states is a solution, which needs to be progressively applied.

Lastly, he discusses about the a major difficulty in evolving a destination based retail stage
VAT at the state level arises from the fact that the states do not have the power to levy tax on
services. As mentioned earlier, the states can levy sales taxation of only goods. Taxation of
services is not assigned to either the centre or the state, but the former levies taxes on selected
services based on power to levy taxes on residual items. Proper levy of goods and services
tax would, therefore, require an amendment of the Constitution. The central government can
use this as a leverage to persuade the states to reduce and eventually eliminate the taxation on
inter-state sales so that a levy of destination based VAT becomes a reality.