Written by Nidhi Parihar
Fact Checked & Verified
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Written by Nidhi Parihar
Fact Checked & Verified
Taxation is one of the most controversial public policy tools and has evolved under the combined influence of political, economic, and social factors.
The Indian tax structure has not been shaped by any ideal economic model, but rather developed in response to conflicting goals.
Two contradictory forces have influenced tax policy in India:
(a) Revenue maximisation
(b) Social and economic reforms through taxation
Revenue generation has typically taken precedence over reform objectives in actual tax policies.
The tax reforms initiated since 1991 were a vital part of India’s broader structural reform programme following the 1991 economic crisis.
Tax receipts sharply declined in the immediate period following the introduction of reforms due to the rationalisation of the tax structure.
The Tax Reforms Committee (TRC) focused on creating a suitable framework for reforming both direct and indirect taxes.
The committee’s two key recommendations on direct tax reforms were:
(i) Simplification and rationalisation of the direct tax structure — The Chelliah Committee, 1992
(ii) Introduction of a service tax to broaden the tax base — The Chelliah Committee, 1994
The 1992 economic reforms brought a significant shift in the composition of tax revenue at the central level.
Direct taxes rose as a percentage of GDP from 2.0% in the 1980s to 6.5% in 2008–2009.
Corporation tax emerged as the largest contributor among direct taxes, followed by income tax.
Estate tax, wealth tax, and gift tax contributed marginally, targeting wealthier segments to ensure equity in taxation.
Agriculturalists pay only two direct taxes:
(i) Land revenue
(ii) Agricultural income tax
Together, these account for only 7% of total direct tax revenue, meaning non-agriculturists bear the majority of the direct tax burden.
While revenue maximisation through indirect taxes was emphasized, it also triggered inflationary pressures due to increased excise duties.
Historically, excise duties were levied on intermediate goods, raising input costs.
Despite reforms, indirect tax revenue as a percentage of GDP fell from 7.9% to 5.3% during the same reform period.
Service tax was introduced in 1994 based on The Chelliah Committee recommendations to tap the service sector.
Initial coverage included three services:
(i) Telephone services
(ii) Stock broking
(iii) Insurance services
By 2011, nearly 119 services were under the service tax net.
The tax rate evolved as follows:
(i) 1994–95: 5%
(ii) 2004–05: 10%
(iii) 2006–07: 12%
(iv) 2009: reduced to 10.3%
Service tax collection increased from 0.2% of GDP in 1994–95 to 1.1% in 2008–09, yet comprised only 10.4% of total central tax receipts.
The government plans to implement the Goods and Services Tax (GST) to replace both CENVAT and state-level VAT.
This marks a significant step toward tax regime unification and eliminating tax arbitrage that skews investment decisions.
State fiscal health depends on two factors:
(i) Revenue from state taxes
(ii) Transfers from the central government — both constitutional and discretionary
These transfers form an essential part of the states' revenue receipts.
There is no doubt that fundamental changes in the Centre’s tax structure were introduced in the 1990s. Systematic and comprehensive reforms began only after the market-based economic liberalisation in 1991.
Centre’s tax reforms included:
Personal income tax was simplified to just three slabs: 10%, 20%, and 30% in 1997–98. Financial assets were excluded from wealth tax, and the marginal rate was brought down to 1%. Corporate income tax also saw significant reforms.
The indirect tax structure underwent major reforms over the last two decades:
Both domestic excise duties and customs duties were simplified and rationalised.
The number of excise rates was reduced and merged into a unified rate structure under Central VAT (CenVAT) in 2000–01.
Additional excise slabs at 8%, 16%, and 24% applied to select commodities.
The standard CenVAT rate was 16% and later reduced to 14%.
Customs duty reforms began in 1991–92, reducing major duty rates from 22 (in 1990–91) to just 4 rates by 2003–04. 90% of customs collections now fall under these four rates.
At the start of reforms in 1991–92:
Direct taxes made up 22.6% of gross tax revenue
Indirect taxes accounted for 74.8%
Following reforms and gradual reduction in customs and excise duties along with rising income levels, this shifted:
2004–05 (FRBM regime operationalised):
2009–10:
This marked a major structural shift in India's tax system towards greater reliance on direct taxation.
The primary goal of any tax system is to generate revenue to finance government expenditures. This revenue depends heavily on defined tax bases and tax rates, but also on a variety of measures like:
These instruments are known as tax preferences and impact government revenue by offering implicit subsidies to certain taxpayers — referred to as tax expenditures.
Tax expenditures are essentially spending programs embedded in tax statutes. Experts argue that they should be treated as budget expenditures to enhance fiscal transparency and allow better programme budgeting.
To ensure efficient public finance management, such tax provisions should be aligned with:
The policy decisions should not be swayed by lobbying interests but grounded in equity and national interest.
As per the Income-tax Act, tax incentives are offered for multiple developmental objectives including:
Accelerated depreciation is also provided to stimulate capital investment. These benefits are available to both corporate and non-corporate taxpayers.
The Finance Ministry estimated that the revenue forgone due to exemptions, incentives, and deductions rose from ₹4.14 lakh crore in 2008–09 to ₹5.02 lakh crore in 2010–11.
A liberal estimate suggests that the Union Government could have collected an additional 8.1% of GDP in 2009–10 if all such measures were withdrawn.
While total elimination is impractical, experts recommend removal of those incentives that disproportionately benefit privileged classes.
This led to the following effective vs statutory tax rates:
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