M Govind Rao and Sudhanshu Kumar

Working paper
3. Analysis of tax revenue in India

How does revenue productivity of the Indian tax system compare by international standards?
Bird and Zolte (2003) show that in 2000, the average tax ratio for the middle income countries (per capita
income ranging from USD 1000 to USD 17,000) was 22%
The more recent IMF study (2011), covering 174 countries, shows that the average tax ratio for lower middle
income countries (per capita ji NP ranging from USD 995 to USD3945) for the time period 1980–2009, was
close to 18%

In comparison, the ratio in India has been lower. After reaching 17.5% in 2007–08, the ratio declined to
15.5% in 2009–10 and has been hovering around 16.2–16.5% during the last four years.

The cross-country estimates give the following conclusions

I) the tax does GDP ratio increases with the level of per capita income
II) India’s tax – GDP ratio of 16.5% is lower than the average of lower middle income group of 17.8% and
much lower than the predicted estimate for India from the regression which is at 19.95% and much lower
than the average predictive value for the group, which is at 21.46%
III) The revenue productivity of the Indian tax system has not only been low, but has not shown any
perceptible increase over the past few years, despite increase in the per capita income.
IV) In fact, it has shown a 1990s from 15.3% in 1991–92 to 14% in 2001–02
V) Thereafter the increased to 17.5% in 2007–08, but declined to 15.5% in 2009–10 and hovered around
16.5% there after

The country which aspires to accelerate its development has to substantially augment its public spending on
physical infrastructure and human development. It must be noted that public spending in India has been static
over the years hovering around 26 to 28% and investments in physical and social infrastructure have been
severely constrained by stagnant revenues, proliferating, subsidies, and transfers and limits on borrowing
placed by the , FRBM.

The following shows the predicted tax GDP ratio for India for the coming years.

What Ails the Indian tax system?

• The low revenue productivity of the Indian tax system – has been a matter of concern.
The most important factor for the low revenue productivity has to be found in the narrow tax basis. There are
a variety of reasons why the tax base is a narrow, and these include the following:
i. The fragmented constitutional assignment.
ii. Wide-ranging tax preferences
iii. Multiplicity of objectives assigned to tax policy, resulting in complications in the tax laws, wide avenues
for evasion and avoidance and large and increasing amounts held in disputes.
iv. Tax abuse by multinational companies resulting in base erosion and profit shifting
v. Poor capacity of tax administration, including the information system to effectively administer and
enforce the taxes.

An important reason for the narrow Tech space is a play Thora of exemptions, concessions and deductions
given in direct and indirect taxes.

Besides raising revenues, the tax system is required to fulfil a number of objectives such as incentivising,
savings, promoting exports, achieving balanced, regional development, promoting investments, in
infrastructure, expanding employment, promoting scientific research and development, encouraging,
cooperatives, and charitable activities. And incorporation of all these objectives in tax laws creates enormous
avenues for evasion and avoidance and no one can be sure of how much of these objectives are achieved. If
at all they are achieved.

• The tax expenditure estimates bring out the clearing shortcomings in the tax system, constraining the
revenue productivity.
• The revenue lost on account of special economic zones for 2014–15 was estimated at INR 20,376 crores
from the corporate tax alone
• The revenue cost of area-based incentives was estimated at INR17, 284 crores from excise duty in 2014–
15 and almost INR 8000 crores in the case of corporation tax
• A close scrutiny of the stacks preferences could easily result in enhancing the ratio of tax to GDP by at
least one percentage point

Detailed commodity composition of revenues from the tax shows high commodity concentration

• In 2009–10, petroleum products alone, contributed over 26% of total revenues and the contribution of
basic metals was 19%
• In contrast, the shares of revenue from textiles, minerals, chemicals, and electrical goods, show the decline
by bearing percentage points, reflecting the change in pattern of industrialisation in the economy
• The important point is that as a union excise duty is levied on manufactured products and the revenue
productivity will depend on the pattern of industrialisation. Hopefully, the introduction of GST will
broaden the base of the tax and will improve the revenue productivity.

Another important factor eroding The base is the way in which the multinational operate in the country.

• Base erosion and profit shifting by multinational companies is a worldwide phenomenal. MNCs indulge in
a variety of ways to avoid taxes.
• Creating a Web of complex subsidiaries and shifting the profits to subsidiaries located in low tax
jurisdictions and taking advantage of the tax treaties is one of the common methods employed
• Manipulating prices in related party transactions or what is usually called transfer pricing to reduce the tax
liability is another
• Although there are “arms, length pricing rules”, to deal with the transfer pricing issue, it is difficult to
apply it in practice when intangible assets are involved and these could include trade names, Goodwin and
brand recognition as well as intellectual property, such as patents, copyrights, brands, and trademarks, and
business methodologies.
• MNCs also act as intermediaries in product, sales and distribution, make loans and interest payments to
one another and charge fees to one another for activities such as management services, treasury services
and investment services to reduce the tax liability.

As mentioned above tax avoidance by MNCs is a global phenomenal. It happens in developed countries like
USA, UK, and EU, and has led the OECD, in more recent times, the G20 countries to demand the OECD to
reform the international corporate tax.

Evidence in India also supports the fact that MNCs have been indulging in abusive tax practises.
• Patnaik and Shah( 2011) in their study, showed that the effective corporation tax rate on MNCs was
significantly lower than domestic companies.
• Rau and Sengupta(2012) showed that during the period 2006–20,11, effective interest rate paid by the
MNCs were higher and amount of tax paid per unit of borrowing was lower.
• The problem is compounded by the fact that while MNCs have access to enormous resources which they
use in hiring the best accountants and lawyers, the tax administration in most developing countries is stuck
with low resources as well as Lo, administrative capacity.
• The Ministry of finance has put out the GAAR – General anti avoidance rules, but the implementation has
been postponed to repeatedly
• While it is legitimate for the countries to demand a fair share of the taxes, it is also important that they
should build capacity in their tax administration to draft laws better, have more competent staff and apply
the laws more evenly.

3.3 Tax Administration

• Tax administration is a critical element as it sets up the management of the tax system.
• There have been a number of reports on the reform of the taxidermist ministration beginning with the
report of the tax reform commission in 1991.
• The important problems of tax administration in India which have to be dealt with or the following:
i. Lack of autonomy.
ii. Low moral of tax administrators arising from low prospects of progression in the careers of
administrators
iii. Organisational problems of separation of direct and indirect administration of tax and the lack of
coordination, effective communication and information exchange between them
iv. Area wise rather than functional divisions and lack of functional specialisation, including developing
intelligence system
v. Poor information system and the limited use of technology for tax administration
vi. Perverse incentive from setting targets to tax administrators and judging their performance is based on
the fulfilment of the targets
vii. Poor capacity to forecast revenues
viii. Lack of clarity in tax laws and white discretion to tax officials and buildup of huge amounts of revenues
ix. Adverse real attitude of the tax administration towards taxpayers and essentially considering them as tax
Raiders rather than agents who collect the tax from people on behalf of the tax departments

One of the consequences of and care, tax laws and poor administration has been the buildup of huge tax
areas.
An important innovation however, has been the creation of large taxpayer units which have helped to
coordinate the functioning of CBDT* and CBEC and has helped to reduce the compliance cost for large
taxpayers.

Another important reform has been the requirement for electronic filing of the return payments of refunds
directly to the account of taxpayers. These are only small initiatives and by and large the tax administration
does not involve much confidence among the taxpayers to improve the voluntary tax compliance.

Professionalise in the administration is important for building the confidence of taxpayers with in the tax
department. Some of the initiative is required for the purpose include
i. organisation of the department on the functional lines to achieve functional specialisation.
ii. Improvement in the information system and the capacity to undertake data mining
iii. Improvement in intelligence networks.

4. The Way Forward

• Increasing revenue, productivity of the tax system to raise the tax ratio and message for development
underlines the need for the reform of both direct and indirect tax and Central as well as state levels.
• Increasing revenue productivity in the least distortion of the manner requires the expansion in the tax
space, rationalisation of rates to Levi, the tax at reasonable rates, simplifying the tax system and reforms of
tax administration.
• The reforms can be categorised into immediate, medium and long-term. Because some of the reforms or
not difficult, others were not easy to carry through and in this aspect, they can be challenging to apply
them.
• The most formidable task in evolving a comprehensive income tax in India is the fractured assignment
system. While it may not be easy to integrate income from agriculture in non-agricultural sectors, the
practical solution may be to enter into an agreement with the states and Levi, the tax according to the
applicable rates on the income declared as agricultural incomes after allowing deductions for crop
 insurance premiums, while computing the agricultural incomes and distribute the proceeds to the states
when the income originates.
• It is also important to work on a time bound plan to effectively apply the GEER on the MNCs and to
develop the capacity to administer it, maybe a special cell should be created and a time bound plan for
building capacity should be taken up.
• Indeed, there is a need to overhaul the administrative framework to enable functional specialisation and
coordination among various tax departments including sharing of information.
• However, the transition is not likely to be easy and in the short term, it would be advisable to create
specialised agencies like the van for administrating, GEER and finally effect proper administrative
divisions into various functionally specialise groups from the prevailing region based divisions
• The major item in the reform agenda comprises of the introduction of GST at union and state levels.
• The tax system for accelerating economic growth should not only have high revenue productivity but also
should minimise distortion. The national for having brought basis and low rates of taxes is essentially to
void distortions as distortions rice exponentially with the rate of tax.
• With the passage of time, hopefully the presently excluded items of consumption from the base of GST,
such as petroleum products will be brought into the tax net
• An important characteristic of a good tax system is that it should promote formalisation of the economy
and prevent informal forms of transactions
• Attacks and commodity transactions and security transactions, even when divided low rates, significantly
increases the transaction costs
• A forward-looking tax policy should promote the development of markets rather than constraining them.

Concluding Remarks
Taxes matter for the government, business and common people alike.
• Governments have to collect them to provide public services,. The impact the profitability of businesses.
People are concerned about parting with their hard earned money for the services. They cannot really see
and perceived. For the point of view they call me, tax policy is an important factor in determining the
business climate.
• This people argues at the best practice approach to tax policy and reform is to broaden the tax pace, reduce
the rates and their differentiation and evolve a simple and transparent system. Loading the tax policy with
too many objectives just will complicate the system.
• Objective of the reforms should be to reduce the administrative, compliance and the distortion costs. Does
the major reform agenda for the government should be to phase out the tax preferences to evolve a simple
tax system.
• Indian tax system is characterised by low revenue productivity and stagnancy in the tax ratio. This paper
has attempted to identify the reasons for the low revenue productivity of the tax system.
• The constitutional assignment has constrain the Levi of comprehensive income taxation. Although, it is
possible to coordinate the divide between the union and the states, political difficulties have a constraint is
• Narrow tax basis of both direct and indirect taxes are also the consequence of wide-ranging exemptions,
concessions and deductions given to pursue a variety of objectives though tax policy
• Lack of clarity in tax laws and huge building of tax areas, an overwhelming proportion of which is stuck in
tax disputes is another problem

The paper underlined the need for forming both direct and indirect tax system is not only to increase the
revenue productivity but also to improve the business climate in the country. The reforms relating to tax
administration to professionalise the administration and make it taxpayer friendly also needs to be pursued
with vigour to improve the administrative efficiency and compliance.