Rationalisation of Indian Tax System

What is Rationalization of Taxation?

Rationalization of taxation is an attempt made by the fiscal authority to change the pre-existing  ad-hoc pattern of taxation into one which is based on a set of published rules after simultaneous research and practical observation. The aim and purpose of rationalization of tax system is to bring about efficiency, coordination and control of the tax collecting procedure. 

Rationalization of taxation in India

An introduction: After independence the Govt. of India initiated its Five Years planning in 1951 with an aim to pace the way of economic development in the country. The acceleration of economic development required a huge amount of revenue to meet capital and revenue expenditure as well as bulk development and maintenance imports. Therefore rationalization in the tax system became a need of hour for the economy.

Indian economy was gone through a structural change in 1991 and the government was forced to adopt a set of fiscal reforms. Aim was to reduce the fiscal deficit and inflation. To meet this twin objective it was necessary to increase the tax revenue. On the other hand it was carefully observed by the policymakers that increase in tax rate may lead to the deterioration of willingness to work of the citizens and the strategy may lead to the move for black money. Therefore the rationale behind such policy prescription may appear to be highly questionable. Rationalization was brought through widening of tax base and modernizing of tax administration.

Strategies of Rationalizing of Tax System

One of the reasonable steps was taken by the govt. in 1991 by setting up the Tax Reforms Committee under the Chairmanship of Raja J. Chelliah to examine the then tax structure of the country and suggest appro­priate reforms therein. The committee submit­ted its report in January 1993, it made several recommendations including the simplification of tax system, steps to discourage tax evasion and much more. As recommended by the committee many changes were brought into the Indian tax system. Important among them are:

1.      To make the direct tax system more ef­fective, it was necessary to reduce the tax rate so that there would be less tax evasion and avoidance. There was also the need to narrow down the spread between the lowest rate and maximum mar­ginal rate. To neu­tralize the fall in revenue due to lowering of the rates of taxation some of the tax incentives were withdrawn and the tax base was broadened.

2.      The personal income tax system has been restructured by lowering rates, introducing few slabs, providing a higher exemption limit and by reducing saving-linked tax exemption. Initial exemption limit for the levy of income tax has been raised from Rs. 22,000 in 1991 to Rs. 1,00,000 in 2007-08. The number of slabs has been reduced from 4 to 3 (i.e., 10 p.c., 20 p.c. and 30 p.c.). In 2016-17 budget the exemption limit has been raised to Rs 4 Lakh from earlier 2.5 Lakh of 2015-15.

3.      Presumptive tax (lump-sum) for small traders, retailers and small road transport op­erators has been introduced. To widen the tax net, in the 1994-95 budget, a service tax at the rate of 5 p.c. on the amount of telephone bills, premium payments for non-life insurance and on commission/brokerage charged by the stock-brokers was introduced. At least 100 types of services are subject to service tax as against 3 in 1994-95. In 2015 Union budget also service tax was proposed to increase.

4.      Since 1994-95, a number of provisions were introduced to widen the tax base. These in­clude taxation for small business, estimated income scheme for persons engaged in the business of civil construction, plying, leasing or hiring of trucks; tax deduction at source introduced on interest on term deposits in­come in respect of units of mutual funds, pro­fessional fees and host of contracts.

5.      Corporate tax rates have been reduced and simplified over the past few years. At present, the rate of corporate tax for domestic compa­nies is 30 p.c. and for foreign companies 40 p.c. of their net profit. With a view to tack­ling the phenomenon of zero tax companies having substantial book profits, a ‘minimum alternate tax’ (MAT) was introduced in the 1996-97 budget.

6.      To promote research and development ac­tivities—five-year tax holiday for investments in infrastructure facilities, power generation and distribution in backward states and electronics hardware and software parks.

7.      Government has also taken several meas­ures since 1991-92 to reform the indirect tax structure by reducing the number of rates, re­moving exemptions, and by switching over to ad valorem rates. Import duties which rose to more than 150 p.c. in several cases prior to reform have been reduced in a phased man­ner to 10 p.c. by 2007-08.

8.      The ex-Finance Minister of India, Pranab Mukherjee in his Budget speech indicated the government's intent of merging all taxes like Service Tax, Excise and VAT into a common Goods and Service Tax by the year 2011. To achieve this objective, the rate of Central Excise and Service Tax were targeted to be progressively altered and brought to a common rate. However, as of May 2015, Goods and Services Tax Bill had not been passed by the Parliament because of disruption by Opposition Allies (INC) on some State level issues.  Now, Service Tax and Excise will be inclusive part of GST in due course of time.

9.      Budget 2016 focused on tax rationalization and simplification while unveiling steps to boost 'Make in India'. In direct tax, the govt. is losing about Rs 1lakh crore because of exemptions. The shortfall in direct taxes to the tune of Rs 40,000 crore is targeted to make up by robust collections in indirect taxes and the total tax collection target for the fiscal will be met for the first time in five years. The income tax department is trying to widen its base, as currently 3.5% of total population pays the income tax.

Consequences of Rationalization

As a consequence of tax reform measures, tax rev­enues increased to 18.3 p.c. of GDP in 2007- 08. Overall tax reforms since July 1991 have helped in correcting the imbalance in the struc­ture of revenue sources. The share of direct taxes in GDP rose from 2.1 p.c. in 1990-92 to 5.7 p.c. in 2007-08. Also, the share of direct taxes in gross tax revenue rose from 19 p.c. in 1990-91 to 30.2 p.c. in 1995-96 and to 48.8 p.c. in 2007-08. Improved performance of the services and manufacturing- sector has helped to keep tax revenues buoyant. Further, higher growth in rev­enues relative to the growth in revenue ex­penditure resulted in a decline in revenue deficit to 1.9 p.c. of GDP in 2006-07 as against 4.4. p.c. in 2002-03. Same is true about fiscal deficit that declined to 3.4 p.c. in 2006-07 from 5.9 p.c. in 2002-03. These macroeconomic changes have allowed India to be more appropriate to become a quick decision maker (in Capital Account Convertibility etc.) and an emerging super power.