India: Selected Issues

This Selected Issues paper paints a picture of the Indian economy that has made great strides, but has more to do to accelerate growth and reduce poverty. The paper assesses empirically whether India has entered a new phase of higher trend growth. Two alternative methodologies are used to disentangle underlying structural growth trends from shorter-term cyclical fluctuations around this trend. The paper focuses on a number of the reforms required to ensure that needed high growth can be achieved on a sustained basis.

Abstract

This Selected Issues paper paints a picture of the Indian economy that has made great strides, but has more to do to accelerate growth and reduce poverty. The paper assesses empirically whether India has entered a new phase of higher trend growth. Two alternative methodologies are used to disentangle underlying structural growth trends from shorter-term cyclical fluctuations around this trend. The paper focuses on a number of the reforms required to ensure that needed high growth can be achieved on a sustained basis.

IV. The Tax System in India: Could Reform Spur Growth?1

A. Introduction and Overview

1. While the average tax intake in India is low by international standards, marginal rates are high. High tax rates are thought to depress employment, investment, and growth. The empirical evidence is mixed. Cross-country studies generally confirm the negative impact of taxation on economic activity, but results are not robust. Firm-level evidence and simulation results are more conclusive, supporting the view that high tax rates have an adverse effect on growth and distort financing and investment decisions (Box IV.1). High tax rates may also contribute to the growth of the “shadow economy,” carrying costs in terms of foregone tax receipts and lower productivity growth (Farrel, 2004; Schneider and Klinglmair, 2004).

2. To improve the tax intake and savings and investment rates, which are low by regional standards,2 a series of tax reforms have been considered in India. 3 Their main thrust is to combine lower statutory rates with base broadening, to realize more revenues while lowering the marginal tax burden and removing distortions. This in turn should foster growth, leading to an “expansionary” fiscal adjustment.

3. This chapter assesses the potential impact of India’s tax system on growth. Section B establishes stylized facts about the tax system: (i) a high dependence on indirect taxes, (ii) low average effective tax rates (AETRs) and tax productivity, and (iii) high marginal tax rates and tax-induced distortions on marginal investment and financing decisions. Section C finds that the proposed tax reforms would improve tax productivity and lower the marginal tax burden and tax-induced distortions. But firms that rely on internal sources of funds or face problems borrowing would continue to face high marginal tax rates.

Empirical Evidence on Taxation and Growth

High labor taxation can negatively impact employment and growth by pushing up labor costs. In the presence of strong and decentralized labor unions, labor taxes are shifted into real wages, reducing labor demand; this in turn leads to substitution away from labor and downward pressure on the marginal product of capital, reducing investment and growth. Empirical evidence for European Union (EU) countries confirms this view.1 High marginal effective tax rates (due to the combination of tax and benefit systems) can also affect labor supply decisions by affecting the choice between additional work and leisure.2

Consumption taxes do not affect savings and investment decisions since future and current consumption are treated equally, and they remain neutral with respect to various sources of income. Empirical evidence is mixed, however. Some studies find that such taxes indeed have no impact on employment and growth,3 but others find that—like income taxes, although to a lesser extent—they have a negative impact on growth by distorting the choice between labor and leisure, and also could depress savings.4

Corporate taxes raise the required rate of return on investment and depress investment. In addition corporate taxes tend to favor debt over equity financing or retained earnings, potentially leading to an inefficient allocation of resources, higher insolvency risks, and discrimination against smaller companies that face more difficulties borrowing. Corporate taxes are also non-neutral given the widespread use of rebates, exemptions and special regimes for specific sectors or regions. This also benefits large companies which can bear a lower tax burden through tax planning and fiscal engineering.5 Cross-country studies confirm a negative link between the tax burden and growth for high-income countries. However, the result does not hold for low- and middle-income countries, perhaps reflecting measurement problems. 6Firm-level empirical results, as well as simulation results using computable general equilibrium models, in contrast support the view that higher taxes negatively affect growth.7

Taxation of capital income—even when at a low level—as is the case in most EU countries, appears to have a distortionary effect on savings. Although there is little evidence for the EU that taxes affect the aggregate level of savings, they appear to influence its composition and location. Many EU countries tend to grant favorable treatment to specific savings instruments, such as retirement schemes and housing investment. Moreover, they generally apply a preferential treatment to non-residents, thus distorting saving flows and potentially enhancing tax evasion possibilities associated with cross-border investment.8

1 See Daveri, F., and G. Tabellini, 2000, “Unemployment, Growth, and Taxation in Industrial Countries,” Economic Policy, Vol. 30, pp. 48–104.2 For example, see OECD, 2001, Tax and the Economy: A Comparative Assessment of OECD Countries, (Paris: Organisation for Economic Co-operation and Development).3 See Daveri and Tabellini, 2000; and Kneller, R., M. F. Bleaney, and N. Gemmel, 1999, “Fiscal Policy and Growth: Evidence from OECD Countries,” Journal of Public Economics, Vol. 74(2), pp. 171–190.4 For example, see Milesi-Ferretti, G. and N. Roubini, 1995, “Growth Effects of Income and Consumption Taxes: Positive and Normative Analysis,” NBER Working Paper 5317; and Tanzi V. and H. Zee, 2000, “Taxation and the Household Saving Rate: Evidence from OECD Countries,” Banca Nazionale del Lavoro Quarterly Review, Vol. 53, pp. 31–43.5 See Rao, S., and J. Lukose, 2002, “An Empirical Study of the Determinants of the Capital Structure of Listed Indian Firms,” unpublished (Mumbai: Indian Institute of Technology); OECD, 2001; and Joumard, I., 2001, “Tax Systems in European Union Countries,” OECD Economic Studies, Vol. 34, pp. 91–151; and Nicodeme, G., 2002, “Sector and Size Effects on Effective Corporate Taxation,” Economic Papers No. 175 (Brussels: European Commission).6 See Blankenau, S., S. Nicole, and M. Tomljanovich, 2004, “Public Education Expenditures, Taxation, and Growth,” unpublished (Kansas: Kansas State University). Such studies typically use the tax revenue to GDP to proxy for the tax burden instead of the marginal or effective tax rate on corporates, which ideally should be used.7 See Fishman, R. and J. Svensson, 2000, “Are Corruption and Taxation Really Harmful to Growth? Firm Level Evidence,” unpublished (New York: Columbia University); and Feltenstein, A. and A. Shah, 1995, “General Equilibrium Effects of Investment Incentives in Mexico,” Journal of Development Economics, Vol. 46, pp. 253–69.8 See OECD (2001).

B. The Indian Tax System: Stylized Facts and Issues

The Tax System 4

4. India has a well developed tax structure, with the authority to levy taxes divided between the central government and the state governments. The central government levies direct taxes such as personal income tax (PIT) and corporate tax (CIT), and indirect taxes such as customs duties, excise duties, and central sales tax. The states levy state sales tax and various local taxes. Since 1991, the tax structure has been substantially rationalized. Changes include reducing customs and excise duties, lowering CIT rates, extending a form of VAT to some industries, and broadening the tax structure to some services.5

5. The principal direct taxes include PIT and CIT, state taxes on agricultural income, wealth tax, and various withholding taxes. The PIT is levied on non-agricultural income at rates of 10 percent–31.5 percent. It applies to Indian residents and foreigners, on income earned in India. The exemption threshold of Rs. 50,000 (US$1,111) results in a relatively narrow tax base of about 34 million taxpayers.6 States levy some taxes on agricultural income (land revenue tax and agricultural income tax), but their combined incidence is considerably less than that of the PIT. A wealth tax is levied on net assets in excess of Rs. 1.5 million. The corporate income tax (CIT) is levied at a basic rate of 35 percent, but with significant exemptions. Other corporate taxes include a dividend distribution tax (DDT), a minimum alternative tax on profits, and various withholding taxes on interest, royalties, etc.

6. The main indirect taxes are the sales tax, custom and excise duties, and service tax. A state sales tax is levied on intrastate trade and a central sales tax (CST) on interstate trade, at a rate that varies depending on the type of transaction and the rate of the state sales tax. The center also levies custom duties and a basic excise duty (modified VAT or CENVAT) on goods manufactured or produced in India. The CENVAT base is truncated to manufacturing and eroded by a complex and extensive system of exemptions, including for small-scale industries and Special Economic Zones. Special excise duties are levied on specific items. In 1994, a selective turnover tax on services was introduced on three specified services. The base was gradually widened to cover 58 services.7 Other minor taxes and duties imposed at both center and state level include stamp duty, taxes on land and buildings, and taxes on motor vehicles.

7. As in other developing countries, tax incentives feature prominently in India. They are used to encourage new industry to locate in “backward” regions; to promote exports; and to promote investment in sectors including hotels, power, telecommunications, and infrastructure. The question remains whether tax incentives are decisive factors in the decision to invest. They may be important for some companies to offset other costs of doing business in India—such as still relatively high import duties, cascading sales taxes, and inadequate public infrastructure—but an unfortunate outcome has been to thin out the overall direct and indirect tax bases (Shome, 2004). Tax holidays, which are the preferred form of incentives in India, have the most serious shortcomings (Tanzi and Zee, 2001).

Stylized Facts

8. India’s general government tax revenue has declined since the 1990s, to under 14 percent of GDP in 2002/03. This is more than 5 percentage points below the average for selected non-OECD countries and 2 percentage points below the Asian average. The decline in revenue during 1992–2002 contrasts with the increase in tax intake observed in other large Asian countries (Indonesia, China, and Korea) over the same period. It occurred as major tax reforms were implemented, aimed at improving the buoyancy of revenues and increasing the share of direct taxes in total revenues. Direct tax revenues increased, but indirect tax collections declined, mainly due to tariff reductions (Figure IV.1).

Figure IV.1.
Figure IV.1.

India: Tax Burden, 1974/75–2003/04

(In percent of GDP)

Citation: IMF Staff Country Reports 2005, 087; 10.5089/9781451818611.002.A004

Sources: Indian authorities; and staff projections.

9. The most recent reforms (2002-04) were moderately successful in reversing the declining trend of revenues. The peak tariff reduction for non-agricultural imports advocated by the 2002 Kelkar committee reports (Box IV.2) was fully implemented and the revenue loss was more than offset by buoyant corporate tax collections. However, excise and PIT revenues rose only marginally, reflecting the extension of further exemptions, deductions, and rebates (against the recommendation of the Kelkar reports). The states succeeded in raising sales tax collections, but the introduction of a VAT was postponed.

Kelkar 2002 Reports Proposals

As part of its overall reform agenda, the government in 2002 set up a tax reform task force (Kelkar task force) to propose a far-reaching reform agenda for direct and indirect taxes. 1 Proposals centered around the following elements:

  • A change in the exemption level and rate structure of the personal income tax and broadening of the base, as well as minimizing exemptions and replacing allowances by credits. A constitutional device would allow the government to tax agricultural income. The general exemption would be increased, the number of brackets reduced, and the highest marginal rate reduced to 30 percent. A range of special deductions would be eliminated and some would be converted into credits. The report also proposed changes to the taxation of capital income, specifically exempting dividends from Indian companies and long-term capital gains on equity.

  • A reduction in the rate and in the large number of deductions and exemptions of the corporate income tax. The rate would be reduced to 30 percent for domestic companies and 35 percent for foreign companies. The minimum alternate tax would be eliminated.

  • A rationalization of the import tariff structure and export promotion schemes. The existing 20 tariff rates, ranging up to 182 percent, were to be reduced to a range of 0 percent-20 percent for most goods, with higher rates—up to 150 percent—for certain agricultural products and “demerit” goods, with the new schedule to be adopted as of 2004/05. Exemptions would be significantly narrowed.

  • Broadening the base of the central excise tax (CENVAT) and moving it further toward a VAT.

1 See Ministry of Finance, 2002a, Report of the Task Force on Indirect Taxes, (New Delhi: Government of India); and Ministry of Finance, 2002b, Report of the Task Force on Direct Taxes, (New Delhi: Government of India).

10. Despite reforms, the tax structure remains dominated by indirect taxes. State taxes on commodities and services are the prominent source of general government revenue (representing more than a third of the total tax intake), followed by central government excises (one-fifth of the total) (Table IV.1). The share of revenue from indirect taxes is more than three quarters, compared to half in the average non-OECD country (Table IV.2).

Table IV.1.

India: Structure of General Government Tax Revenue, 2003/04

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Sources: Indian authorities; and staff estimates.

Mostly service tax.

Staff estimates based on projected GDP growth and historical elasticities.

Table IV.2.

Non-OECD Countries General Government: Tax Revenue, 2001

(In percent of total)

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Sources: Government Finance Statistics (IMF); and International Financial Statistics (IMF).

11. The tax system is characterized by extremely low AETRs. The AETR on labor, at 2 percent in 2001, is much lower than in the European Union, United States, or Japan, which range from 21–36 percent (Table IV.3). This reflects India’s narrow tax base and the lack of social security system.8 The AETR on capital income is also low, reflecting the wide coverage of tax incentives, low personal taxes on capital income, and a large informal sector.9 Korea in the mid 1970s had similar low AETRs, but they have since risen significantly (Figure IV.2). Finally, the AETR on consumption is broadly average despite a tax base that largely excludes services. As in Korea, it has declined over time.

Table IV.3.

India: Average Effective Tax Rates Comparison, 1990–2000

(In percent)

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Sources: Carey and Rabesona (2002); and staff estimates for India.

Combined effective tax rate on labor and consumption.

Average 1993–2000, based on data availability.

12. Reflecting the low AETRs, India’s tax productivity is also lowr elative to both OECD and non-OECDcountries.10 For example, CIT tax productivity is much below average (Table IV.4a) and (table IV.4b).11While this is unwelcome in a static sense, it is attractive if considered dynamically: by expanding the taxpayer net, broadening the tax base, or stepping up tax administration, revenue can be raised without rate increases. During the period 1993–2001, India increased AETRs on labor and capital despite reductions in statutory rates and a declining CIT tax base 12 This suggests that improved tax administration and compliance was the main factor underlying the improvement in tax productivity.

Table IV.4a.

India: Revenue Productivity of the Corporate Tax, 2001

(In percent)

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Sources: Standard & Poor’s; and staff estimates for India and Korea.

Ratio of effective CIT rate to statutory CIT rate.

As of 2000.

The Burden of Taxation on Investors

13. This section assesses to what extent the Indian income tax code affects incentives to invest. We calculate two standard indicators, the marginal effective tax wedge (METW) between the pre- and post-tax return on capital, and the marginal effective tax rate (METR), defined as the ratio of the METW to the real required pre-tax rate of return.13 By summarizing various tax effects, including the statutory CIT rate, depreciation allowances, inventory valuation method, and personal taxes, the METW measures the potential cost of taxation to investors, which in turn affects their decision to invest.14 Comparable estimates have been published for OECD countries.

Figure IV.2.
Figure IV.2.

India and Korea: AETRs on Labor, Capital, and Consumption

Citation: IMF Staff Country Reports 2005, 087; 10.5089/9781451818611.002.A004

Source: Staff estimates.
Table IV.4b.

India: Revenue Productivity of the Corporate Tax, 2003

(In percent)

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Sources: KPMG; Government Finance Statistics (IMF); and International Financial Statistics (IMF); and various country databases.

As of January 1, 2004.

Used as proxy for the effective CIT rate. For 2003, unless otherwise indicated.

Ratio of corporate tax/GDP to statutory CIT rate.

14. The total tax wedge on capital income in India is broadly average, but tax-induced distortions tend to be high. Firms that rely on internal financing are particularly penalized (Table VI.5a, IV.5b, and IV.6):

  • The tax wedge on capital (1.4 percent) is slightly lower than the OECD average. This reflects low personal taxes and the indexation option available for long-term capital gains.

  • The standard deviation of the tax wedge across investment assets is three times higher than the OECD average. Inventory investment is treated more harshly than investments in machinery and buildings, so that firms that need to carry more inventories are penalized, more so than in other countries.15

  • The standard deviation of the tax wedge across financing sources is twice as high as the OECD average. The large negative tax wedge enjoyed by debt financing means that the government is effectively subsidizing marginal debt-financed investments, more so than in other countries. Investments financed by new equity face a below average tax wedge, thanks to low dividend taxation. However, investments financed by retained earnings face a tax wedge of nearly 3 percent (compared to the OECD average of 2 percent). Smaller firms that face problems in borrowing and tend to be more dependent on internal sources of funds are thus disadvantaged compared to larger firms (Rao and Lukose, 2002; Joseph et al., 1998). The relatively large tax advantage of debt finance may also have contributed to relatively high financial leverage in India, exacerbating firms’ vulnerability.15

Table IV.5a.

India: Marginal Effective Tax Wedge by Investment Type 1/

(In percent)

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Sources: Dalsgaard (2001) based on OECD calculations; and staff estimates for India.

These indicators show the degree to which the personal and corporate tax systems scale up (or down) the pre-tax real rate of return that must be earned on an investment, given that the representative investor can earn a 4 percent real rate of return on a demand deposit. The estimates shown refer to 2004 for India, 1999 for other countries.

The standard deviation across investment vehicles provides an indicator of the neutrality of the tax system towards corporate investment decisions. The lower the standard deviation, the more neutral the tax system.

Table IV.5b.

India: Marginal Effective Tax Wedge by Financing Source 1/

(In percent)

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Sources: Joumard (2001) based on OECD calculations; and staff estimates for India.

These indicators show the degree to which the personal and corporate tax systems scale up (or down) the pre-tax real rate of return that must be earned on an investment, given that the representative investor an earn a 4 percent real rate of return on a demand deposit. The representative investor is supposed to be a resident person, taxed at the top marginal income tax rate (see OECD, 1991). The estimates shown refer to 2004 for India, to 1999 for other countries.

The standard deviation across financing instruments provides an indicator of the neutrality of the tax system towards corporate financing decisions. The lower the standard deviation, the more neutral the tax system.

Weighted average across available countries (weights based on 1995 GDPs and PPPs).

Table IV.6.

India: Statutory and Effective Tax Rates on Corporations

(In percent)

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Sources: KPMG for 2004 statutory tax rates; staff estimates for India; Devereux, Griffifth and Klemm (2002) for 1999 statutory; and effective tax rates for other countries.

As of January 1, 2004.

Based on investment in plant and machinery, financed by equity or retained earnings (but not debt). Taxation at the shareholder level is not included (hence no distinction between new equity and retained earnings). Other assumptions: real post-tax required rate of return fixed at 10 percent. The estimate is for the current tax system for India, the 1999 tax system for all other countries.

15. A related result is that corporates that rely mainly on internal financing face a high marginal tax rate. The METR for investments financed by retained earnings is 26 percent, compared to the OECD average of 22 percent, reflecting a relatively high CIT rate.17

C. Priorities for Reforms

16. The facts highlighted above suggest that a tax reform combining lower statutory rates with base broadening is likely to enhance growth prospects in India. AETR and tax productivity estimates suggest ample scope for raising revenue through base-broadening and improved tax administration. These measures in turn would create room for lowering statutory rates, reducing the METR and raising investment. These broad directions for tax reform were highlighted in the FRBMA roadmap (Ministry of Finance, 2004).

An Assessment of the FRBMA Roadmap Tax Proposals

17. The roadmap proposes the introduction of a national VAT on goods and services and a number of changes to corporate and personal income taxation: reduction of the statutory CIT rate to 30 percent and elimination of the surcharge; reduction of the general depreciation rate to 15 percent; elimination of the withholding tax on distribution of dividends; and elimination of the long term capital gains tax. The reforms also envisage lifting most exemptions and incentives to expand the tax base and increased reliance on IT to improve tax administration and compliance.

18. The proposals implemented as a package would imply a significant increase in tax productivity. For example, the corporate tax to GDP ratio is projected to nearly double from 2.3 percent of GDP in 2003/04 to 4.2 percent of GDP by 2008/09, despite a lower CIT rate (Ministry of Finance, 2004). CIT tax productivity would more than double to 14 percent by 2008/09 (nearing the non-OECD average). The proposed extension of the CENVAT to services should also help enhance its revenue productivity.

19. The reforms would also decrease the METW on capital income and reduce tax-induced distortions. The METW would be nearly halved thanks to lower personal taxes (Table IV.7). Neutrality with respect to sources of financing would improve, but firms that rely on internal finance would remain relatively penalized.18 Neutrality with respect to investment patterns would improve by a third, thanks to the lower depreciation rate, but remain more than double the OECD average, suggesting scope for further improvements. Replacement of the sales taxes and excise duties by a national VAT should also help reduce distortions, with favorable effects on investment and exports (Ministry of Finance, 2004).

20. To mitigate potentially excessive reliance on debt finance and help further improve the neutrality of the tax system, additional tax measures can be considered. These include (IMF, 2004): limiting the deductibility of interest to a percentage of net taxable income; limiting debt for the purposes of income tax (e.g., debt-to-equity ratios in Canada are limited to 2, in Germany to 1.5, and in Japan to 3); limiting interest to a referential rate (e.g., in Portugal, the 12-month Euribor plus 1.5 percent); or introducing an allowance for corporate equity.19

Table IV.7.

India: Tax Wedges Under Current Tax System Versus Reformed Tax System

(In percent)

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Source: Staff estimates.

The standard deviation measures the neutrality of the tax system with respect to corporate financing and investment decisions. The lower the standard deviation, the more neutral the tax system.

Corresponding marginal effective tax rates are reported in italics.

Annex I.

India: Main Features of the Tax System (June 2004) 1/

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Sources: IBFD (2004); Price Water House Coopers (2002a, 2002b, and 1996); Deloitte Touche (1999); and information provided by the Indian authorities.

Taxes are administered and levied by the Central government, unless otherwise specified.

Annex IV.II Average Effective Tax Rates (AETRs) Based on Macroeconomic Data

1. The AETR on labor is derived in two steps. First, the effective tax rate on total household income is calculated as the ratio of individual income tax and household income. including: operating surplus of unincorporated enterprises (OSPUE), property income (PEI), and wage income (CE). Second, the AETR on labor is calculated by dividing the sum of taxes paid on labor income (tax on wages and salaries—calculated by applying the household income AETR to wage income—,1 social security contributions, and other payroll taxes) by the sum of wages and salaries and employer-paid social security contributions.

2. The AETR on capital is obtained by dividing the sum of taxes paid by capital (corporate income tax, household taxes on capital income, and various property taxes) by the net operating surplus of the economy.

3. The AETR on consumption is calculated as the sum of domestic taxes on goods and services, export, and import duties, divided by the sum of private and government nonwage consumption, net of indirect taxes. Indirect taxes are excluded in the denominator to reflect the common practice of expressing indirect tax rates as a percentage of the price before tax.

4. More recent studies however have argued that it is preferable to express the consumption tax base in gross terms (i.e., including indirect tax rates in the denominator), to improve comparability with the tax ratios on labor and capital and facilitate calculating a combined AETR on labor and consumption (Carey and Rabesona, 2002). We therefore also present this alternative (revised) estimate together with the original Mendoza et al estimate.

Notes

1

Labor and capital income of households are assumed to be taxed at the same rate.

Annex IV.III Tax Parameter Data, June 2004

(In Percent)

A. Corporate Tax System

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B. Personal Tax System

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C. Tax Depreciation Rates

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1

Prepared by Hélène K. Poirson.

2

National savings during 1999–2004 in India reached 24 percent of GDP on average annually, compared to 43 percent in China, 34 percent in Malaysia, and 32 percent in Korea.

3

For a history of reforms, see Ministry of Finance (1982, 2001, and 2004), Patel (1995), Mulheisen (1998), Burgess, Howes and Sterne (1997), and Shome (2004).

4

As of June 2004. See Annex IV.1 for detailed provisions of the tax system.

5

The budget 2004/05 imposed a 2 percent education surcharge on all taxes.

6

The exemption threshold was raised to Rs. 111,250 (US$2,472) in the 2004/05 budget. An estimated 14 million taxpayers are expected to benefit, further narrowing the base.

7

The service tax net has been further widened in the 2004/05 budget to cover 71 services. The service tax rate was raised to 10 percent. Credit of service tax and excise duty was extended across goods and services.

8

Estimates for non-OECD countries are not publicly available.

9

The operating surplus of unincorporated enterprises (a proxy for the share of the informal sector) accounted for three quarters of the operating surplus of the economy in 2000/01.

10

Tax productivity measures the extent to which revenues that should be received—given the rate and base of the tax—are actually being realized. It is measured as the ratio of the effective to statutory tax rate (Kraemer and Zhang, 2004).

11

In Table IV.4a, following the Kraemer-Zhang approach, we use the operating surplus of the economy (from national accounts) as the potential tax base. In Table IV.4b, in the absence of such data for non-OECD countries, we use nominal GDP.

12

The operating surplus of the economy declined by 2.7 percent of GDP during 1993–2001.

13

See Annex IV.III for tax parameters used. See OECD (1991) and Poirson (2004) for further details on the methodology and parameters. Indirect taxes impose additional costs on investment, but the METR approach focuses on direct taxation, thus understating the tax burden on investors.

14

The AETR, although commonly used for this purpose, does not accurately reflect incentives, as it is backward looking. Moreover, international comparisons using this indicator are difficult to interpret due to differences in accounting definitions and the timing of tax payments. Further, it does not incorporate personal tax provisions.

15

The use of the FIFO method (first in first out) for inventory valuation also entails a higher tax burden, as increases in the value of inventories due solely to inflation are taxed.

16

The average debt-to-equity ratio for Indian companies is high relative to their counterparts in Asian countries and elsewhere, and has risen recently to 1.4 in 2002 from a low of 1.2 in 1996 (Topalova, 2004).

17

The METR calculated here follows the methodology of Devereux, Griffith, and Klem (2002) and ignores any personal taxes, focusing on the marginal tax burden at the firm level.

18

The METR on retained earnings (ignoring any personal taxes) would increase by 3 percentage points to 29 percent following reforms, due to the lower depreciation rate.

19

The notional rate of return on invested equity is deductible under the CIT in Croatia (1994–2001), and imputed equity return is taxed at a reduced rate in Austria and Italy (until 2001).

India: Selected Issues
Author: International Monetary Fund