ORGANISATION FOR ECONOMIC CO-OPERATION AND DEVELOPMENT
Economic survey - India
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This is what the OECD Economic Survey for India 2007 says,
The indirect tax system needs to be simplified to create a true national market, while for direct taxes, the taxable base should be broadened and rates lowered. Public expenditure should be reoriented towards infrastructure investment by reducing subsidies.
While the optimal policy would be to remove these bottlenecks across the country, the creation of Special Economic Zones that aim to reduce a number of these barriers locally might demonstrate the benefits of such reforms and so act as a catalyst for more generalised change, but care needs to be taken as to the extent of tax concessions that are granted. Furthermore, taxation policies need to be reformed in order to create a truly national market and improve incentives and release resources for reducing bottlenecks in infrastructure, which are a key constraint on growth.
Direct taxes have been reformed, but more needs to be done
Despite large cuts in direct tax rates, which have strengthened the economy, the share of direct tax revenues in GDP has risen. Nonetheless, the tax system still bears some traces of past interventionism, through extensive loopholes and exemptions which introduce distortions and complexity, facilitating tax evasion. These are most noticeable in the areas of saving, agriculture and corporate taxation. The treatment of some forms of savings is so favourable that they are often exempted from taxation at the time of initial savings, during the period when invested funds earn returns, and finally when investments are liquidated. Agricultural incomes are not subject to income tax and numerous exemptions exist in the corporate tax system. Indeed, these are so prevalent that corporate tax collections are only half of the theoretical yield.
The government should consider reducing exemptions and loopholes in all these areas, creating room for cuts in statutory rates, thereby moving towards equalisation of effective tax rates across sectors and activities.
Significant reform of indirect taxation has also been undertaken, including the introduction of a destination-based, state-level VAT on goods in 2005. However, as taxes still represent a barrier to trade between states, further reform is needed to achieve a true internal market for goods and services. At present, there are a series of indirect taxes at the central and state levels that need to be integrated into a single tax that is neutral, both as to the sector and location of production, and minimises the possibilities for fraud.
At present, the major barrier to interstate trade is the Central Sales Tax and this is being phased out. When this process is completed, controls could be abolished on nearly all state borders as they would not be needed for this purpose.
The government is committed to the introduction of a nationwide goods and services tax by 2010 that would meet these objectives, but its final form has yet to be determined. Experience with VAT systems in Europe shows that careful design is necessary to simultaneously reduce trade barriers and contain fraud.
The government should consider two options: either, moving to a national VAT with central revenue collection and redistribution of the tax yield to the states through a formula, or, introducing a two-tier system that would allow both a central VAT and a state VAT.
The first option would not exempt interstate exports while the second option would for the state VAT (as is currently the case) but not for the federal VAT. Such a system would maintain the audit chain in interstate trade (through the federal VAT), thereby facilitating tax enforcement. With this option states could retain a degree of fiscal sovereignty and could also set different tax rates. The second option would require close co-operation between state fiscal authorities to limit fraud. However, if this system were to also include a central rebatable VAT surcharge on cross-border trade, then fraud could be minimised.