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OECD Backs Indian Tax Reform Efforts

by Mary Swire,, Hong Kong

25 November 2014

In its annual Economic Survey of India's policies, released on November 19, 2014, the Organisation for Economic Co-operation and Development (OECD) has welcomed progress towards the implementation of a goods and services tax (GST, a value-added tax), but has called for a review of tax exemptions and red tape.

The OECD said that the Indian economy is showing signs of a turnaround, on the back of new reforms that target strong, sustainable, and inclusive growth.

OECD Chief Economist Catherine L. Mann said: "The Indian economy is coming out of some tough times in recent years, with a steep decline in growth, stubbornly high inflation, and a wide current account deficit, but the situation is now improving. Key reforms in the business environment, to labor markets and to infrastructure, will bring economic growth back to the higher levels seen in the recent past, create good jobs, and improve well-being for all Indians."

However, the report highlights that "structural reforms would raise India's economic growth. In their absence, however, growth will remain below the eight percent growth rate achieved during the previous decade. Infrastructure bottlenecks, a cumbersome business environment, complex and distorting taxes, inadequate education and training, and outdated labour laws are increasingly impeding growth and job creation."

In particular, the OECD said "labor and tax regulations are complex and raise cost of doing business above a certain size. Manufacturing firms therefore tend to be small and their productivity is low."

It also said the budgeted 17 percent increase in tax revenue seems optimistic. "Achieving a sustainable and quality fiscal consolidation would require streamlining the many tax breaks which undermine revenues and contribute to the complexity of the tax system, as well as other public finance reforms."

The OECD said that plans to introduce a GST from April 2016 will boost the nation's tax revenue base, as the measure will simplify tax compliance and support businesses to grow. However, in the meantime, tax revenues (excluding social contributions) as a proportion of gross domestic product (GDP) stood at 17.1 percent in the 2012-13 fiscal year, far below the tax burden in other developing countries Brazil, Russia, and China.

It pointed out that this is despite high tax rates, which are levied across a narrow base, with compliance rates being low. The corporate income tax, for example, has a high rate –  30 percent on domestic companies plus a five-to-ten percent surcharge for large companies, but derives relatively average revenue.

It noted that the 2010 Direct Tax Code Bill was to reduce the corporate income tax rate to 30 percent and remove some tax allowances, but this lapsed, and the marginal tax rate on individuals remains substantially higher than in other comparable nations.

Despite the forthcoming introduction of GST. which will involve the repeal of numerous indirect tax revenues, the OECD said that much remains to be done to broaden the base of indirect taxes. It highlighted the importance of ensuring that the GST is introduced with only limited exemptions.

It said: "A welcome move by the Government has been to list the services exempted under the Service Tax, replacing a list of those to be taxed. The suggestion by the Tax Administration Reform Commission (TARC) to amalgamate the Direct tax and Indirect Tax Departments, to make it easier for companies to file returns, has merit."

"The long-awaited GST, yet to be passed by the Parliament, provides an opportunity to restrict the use of reduced rates and exemptions. Replacing the existing complex and multilayer indirect tax system by a broad-based GST would promote growth and competitiveness. International experience suggests that distributional concerns are poorly addressed by special and low VAT rates. In Colombia for instance, the implicit subsidy associated with VAT exemptions and reduced rates is more than ten times higher for the ten percent richest households than for the ten percent poorest, because the rich consume more in absolute terms than the poor."

The OECD concluded that the Government should look instead to expand the social security safety net or implement targeted cash transfers to more effectively address distributional concerns.

TAGS: compliance | VAT rates | tax | business | value added tax (VAT) | tax compliance | India | law | Organisation for Economic Co-operation and Development (OECD) | tax rates | social security | tax breaks | regulation | services | VAT goods & services classification

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