Summary of Indian Economy-Part-II

7/23/2019 Summary of Indian Economy-Part-II

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Rajesh Naya

INTERNATIONAL ECONOMIC ORGANISATIONS & INDIA

INTERNATIONAL MONETARY SYSTEM

refers to the customs, rules, instruments, facilities, and organisations facilitating internationa

(external) payments. also referred to as an international monetary order or regime.

IMS can be classified according to the way in which exchange rates are determined (i.e., fixed

currency regime, floating currency regime or managed exchange regime) and the form foreign

reserves take (i.e., gold standard, a pure judiciary standard or a gold-exchange standard).

An IMS is considered good if it fulfills the following two objectives in an impartial manner:

(i) maximises the flow of foreign trade and foreign investments, and

(ii) leads to an equitable distribution of the gains from trade among the nations of the world.

The evaluation of an IMS is done in terms of adjustment, liquidity, and confidence which it manages to

weild.

Adjustment

refers to the process by which the balance-of-payment (BoP) crises of the nations of the world (o

the member nations) are corrected.

A good IMS tries to minimise the cost of BoP and time for adjustment for the nations.

Liquidity

refers to the amount of foreign currency reserves available to settle the BoP crises of the nations.

A good IMS maintains as much foreign reserves to mitigate such crises of the nations withou

any inflationary pressures on the nations.

Confidence

refers to the faith the nations of the world should show that the adjustment mechanism of the IMS is

working adequately and that foreign reserves will retain their absolute and relative values.

This confidence is based on the transparent knowledge information about the IMS.

BRETTON WOODS DEVELOPMENT

As the powerful nations of the world were hopeful of a new and more stable world order with the

emergence of the UNO, on the contrary, they were also anxious for a more homogenous world

financial order, after the Second World War.

The representatives of the USA, the UK and 42 other (total 44 countries) nations met at Bretton

Woods, New Hampshire, USA in July 1944 to decide a new international monetary system (IMS)



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The International Monetary Fund (IMF) and the World Bank (with its first group-institution

IBRD) were set up together — popularly called as the Bretton Woods‘ twins3 — both having their

headquarters in Washington, DC, USA

INTERNATIONAL MONETARY FUND came up in 1944 whose Articles came into force on the December 27, 1945 with the main

functions as exchange rate regulation, purchasing short-term foreign currency liabilities of th

member nations from around the world, allotting special drawing rights (SDRs) to the membe

nations and the most important one as the bailor to the member economies in the situation of any

BoP crisis.

The main functions of the IMF are as given below:

(i) to facilitate international monetary cooperation;

(ii) to promote exchange rate stability and orderly exchange arrangements;

(iii) to assist in the establishment of a multilateral system of payments and the elimination of

foreign exchange restrictions; and

(iv) to assist member countries by temporarily providing financial resources to correc

maladjustment in their balance of payments (BoPs).

The Board of Governors of the IMF consists of one Governor and one Alternate Governor from each

member country.

For India, Finance Minister is the Ex-officio Governor while the RBI Governor is the Alternat

Governor on the Board. The day-to-day management of the IMF is carried out by the Managing Director who is Chairman

(currently, Ms Christine Lagarde) of the Board of Executive Directors. Board of Executive

Directors consists of 24 directors appointed/elected by member countries/group of countries - i

the executive body of the IMF.

India is represented at the IMF by an Executive Director ( currently

Arvind Virmani), who also represents three other countries in India‘s constituency - Bangladesh

SriLanks and Bhutan.

India’s Quota & Ranking

IMF reviews members‘ quotas once in five years - last done in December 2010 - here

India consented for its quota increase.

After this India‘s quota (together with its 3 constituency countries) has increased to 2.75 per cen

(from 2.44 per cent) and it has become the 8th (from 11th) largest quota holding country among

the 24 constituencies.



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Once a member nation has signed the EFF (Extended Fund Facility) agreement with the IMF

borrowing can be done by the member nation –

India signed this agreement in the fiscal 1981-82.

India has been borrowing from the IMF due to critical balance of payment (BoP) situations - onc

between 1981-84 (SDR 3.9 billion) and next during 1991 (SDR 3.56 billion).

All the loans taken from the IMF have been repaid. India is now a contributor to the IMF as it

participates in the Financial Transactions Plan (FTP) of the IMF since September 2002 - a

this time India was in strong balance of payment situation and in a comfortable forex reserve

position.

Current US/EU Financial Crises: Challenges regarding International Payments

The recent financial crises of the US and the EU nations have raised the questions of the challenges o

international payments once again. At this crucial juncture, the world seems tossing the idea o

a reserved currency for all international payments - as if the famous Keynesian idea of such

currency (Bancor) is going for a kind of revival.

The Bancor was a supranational currency that John Maynard Keynes and E. F. Schumache

conceptualized in the years 1940-42 which the United Kingdom proposed to introduce after th

Second World War.

The proposed currency was, viz., be used in international trade as a unit of account within a

multilateral barter clearing system, the International Clearing Union, which would also have to b

founded.

The Bancor was to be backed by barter and its value expressed in weight of gold. However, this British proposal could not prevail against the interests of the United States, which

at the Bretton Woods conference established the U.S. dollar as world key currency.

the Governor of the People‘s Bank of China called Keynes‘s bancor approach fa rsighted and

proposed the adoption of International Monetary Fund (IMF) special drawing rights (SDRs) as a

global reserve currency as a response to the financial crisis of 2007-2010.

WORLD BANK

The World Bank (WB) Group today consists of five closely associated institutions propitiating

the role of development in the member nations in different areas. A brief account is as follows:

1. IBRD

The International Bank for Reconstruction and Development is the oldest of the World

Bank institutions which started functioning (1945) in the area of reconstruction of the war-ravaged

regions (World War II) and later for the development of the middle-income and creditworthy

poorer economies of the world.



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Human development was the main focus of the developmental lending with a very low interest rate

(1.55 per cent per annum) — the areas of focus being agriculture, irrigation, urban development

healthcare, family welfare, dairy development, etc. It commenced lending for India in 1949.

2. IDA

The International Development Agency (IDA) which is also known as the soft window of the WB

was set up in 1960 with the basic aim of developing infrastructural support among the member

nations, long-term lending for the development of economic services.

Its loans, known as credits are extended mainly to economies with less than $895 per capita

income.

The credits are for a period of 35-40 years, interest-free, except for a small charge to cove

administrative costs.

Repayment begins after a 10-year grace period.

There was no human angle to its lending. But now there remain no hard and fast differences between

the purposes for the IBRD and IDA lending.

Every year developing nations make enough diplomatic attempts to carve out maximum loan

disbursal for themselves.

India had been the biggest beneficiary of the IDA support.

3. IFC

was set up in 1956 which is also known as the private arm of the WB.

lends money to the private sector companies of its member nations.

interest rate charged is commercial but comparatively low.

finances and provides advice for private public ventures and projects in partnership with

private investors and, through its advisory work, helps governments of the member nations to create

conditions that stimulate the flow of both domestic and foreign private savings and investment.

focuses on promoting economic development by encouraging the growth of productive enterprise

and efficient capital markets in its member countries.

participates in an investment only when it can make a special contribution that complements the

role of market investors (as a Foreign Financial Investor (FFI).

plays a catalytic role, stimulating and mobilising private investment in the developing world by

demonstrating that investments there too can be profitable.

4. MIGA

The Multilateral Investment Guarantee Agency (MIGA), set up in 1988 encourages foreign investmen

in developing economies by offering insurance (guarantees) to foreign private investors against loss



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caused by non-commercial (i.e. political) risks, such as currency transfer, expropriation, war and

civil disturbance.

provides technical assistance to help countries disseminate information on investmen

opportunities.

5. ICSID

The International Centre for Settlement of Investment Disputes (ICSID), set up in 1966 is

an investment dispute settlement body whose decisions are binding on the parties.

was established under the 1966 Convention on the Settlement of Investment Disputes

between States and Nationals of Other States.

Though recourse to the centre is voluntary, but once the parties have agreed to arbitration, they

cannot withdraw their consent unilaterally.

settles the investment disputesarising between the investing foreign companies and the hos

countries where the investments have been done. India is not its member (that is why the Enron issue was out of its preview).

BIPA

As part of the Economic Reforms Programme initiated in 1991, the foreign investment policy of the

Government of India was liberalised and negotiations undertaken with a number of countries to enter

into Bilateral Investment Promotion & Protection Agreement (BIPAs) in order to promote and

protect on reciprocal basis investment of the investors.

Government of India have, so far, (as by July 2012) signed BIPAs with 82 countries out of which

72 BIPAs have already come into force and the remaining agreements are in the process of beingenforced.

The objective of the BIPA is to promote and protect the interests of investors of either country in the

territory of other country.

Such agreements increase the comfort level of the investors by assuring a minimum standard o

treatment in all matters and provides for justifiability of disputes with the host country (it should be

noted here that India is not a member of the World Bank group‘s body, the ICSID, serving the

same purpose.

BIPA is India‘s version. While the former is a multilateral body, the latter is a bilateral one).

ASIAN DEVELOPMENT BANK

The Asian Development Bank (ADB), with an international partnership of 63 member countries, was

established in 1966 and has headquarters at Manila, the Philippines. India is a founder member

of ADB.



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The Bank is engaged in promoting economic and social progress of its developing member

countries in the Asia-Pacific region. Its principal functions are as follows:

(i) to make loans and equity investments for the economic and social advancement of its

developing member countries;

(ii) to provide technical assistance for the preparation and execution of development projects and

programmes and advisory services;

(iii) to respond to the requests for assistance in coordinating development policies and plans in

developing member countries; and(iv) to respond to the requests for assistance and coordinating

development policies and plans of developing member countries.

India started borrowing from ADB‘s Ordinary Capital Resources(OCR) in 1986.

The Bank‘s lending has been mainly in the Energy, Transport and Communications, Finance

Industry and Social Infrastructure sectors.

The Bank has extended technical assistance to India in addition to loans from its OCR window.

The technical assistance provided include support for institutional strengthening, effective

project implementation and policy reforms as well as for project preparation.

India holds the position of Executive Director on the Board of Directors of the Bank — it

Constituency comprises India, Bangladesh, Bhutan, Lao PDR and Tajikistan.

The Finance Minister is India‘s Governor on the Board of Governors of the Asian Developmen

Bank and Secretary (EA) is the Alternate Governor.

OECD

The roots of the Organisation for Economic Co-operation and Development (OECD), Paris, go back

to the rubble of Europe after World War II.

Determined to avoid the mistakes of their predecessors in the wake of World War I, European

leaders realised that the best way to ensure lasting peace was to encourage co-operation and

reconstruction, rather than punish the defeated.

The Organisation for European Economic Cooperation (OEEC) was established in 1947 to run

the US-financed Marshall Plan for reconstruction of a continent ravaged by war.

By making individual governments recognise the interdependence of their economies, it paved

the way for a new era of cooperation that was to change the face of Europe.

Encouraged by its success and the prospect of carrying its work forward on a global stage, Canada

and the US joined OEEC members in signing the new OECD Convention on December 14, 1960.

The Organisation for Economic Co-operation and Development (OECD) was officially born on

September 30, 1961, when the Convention entered into force.

Other countries joined in, starting with Japan in 1964.



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Today, 34 OECD member countries worldwide regularly turn to one another to identify problems

discuss and analyse them, and promote policies to solve them.

The US has seen its national wealth almost triple in the five decades since the OECD was created

calculated in terms of gross domestic product per head of population.

There are many countries that a few decades ago were still only minor players on the world stageChina, India and Brazil have emerged as new economic giants.

Most of the countries that formed part of the former Soviet bloc have either joined the OECD o

adopted its standards and principles to achieve the common goals.

Russia is negotiating to become a member of the OECD, and now the organisation has close

relations with Brazil, China, India, Indonesia and South Africa through its ―enhanced

engagement‖ programme.

Together with them, the OECD brings around its table 40 countries that account for 80% o

world trade and investment, giving it a pivotal role in addressing the challenges facing the world

economy.

WORLD TRADE ORGANISATION (WTO)

The World Trade Organisation (WTO) came into being as a result of the evolution of the multilatera

trading system starting with the establishment of the General Agreement on Tariffs and Trade (GATT

in 1947.

The protracted Uruguay Round negotiations spanning the period 1986-1994, which resulted

in the establishment of the WTO, substantially extended the reach of multilateral rules and discipline

related to trade in goods, and introduced multilateral rules applicable to trade inagriculture (Agreement on Agriculture), trade in services (General Agreement on Trade in

Services — GATS) as well as Trade Related Intellectual Property Rights (TRIPS).

A separate understanding on WTO dispute settlement mechanism (DSU) and trade policy review

mechanism (TPRM) was also agreed upon.

WTO and India

India is a founder-member of both GATT and WTO. The WTO provides a rule based, transparent and

predictable multilateral trading system.

The WTO rules envisage non-discrimination in the form of National Treatment and Most Favoured

Nation (MFN) treatment to India‘s exports in the markets of other WTO Members.

National Treatment ensures that India‘s products once imported into the territory of other WTO

Members would not be discriminated vis-à-vis the domestic products in those countries.

MFN treatment principle ensures that members do not discriminate among various WTO Members



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If a Member country believes that the due benefits are not accruing to it because of trade

measures by another WTO Member, which are violative of WTO rules and disciplines, it may file

dispute under the Dispute Settlement Mechanism (DSM) of the WTO.

There are also contingency provisions built into WTO rules, enabling member countries to take care

of exigencies like balance of payment problems and situations like a surge in imports.

In case of unfair trade practices causing injury to the domestic producers, there are provisions to

impose Anti-Dumping or Countervailing duties as provided for in the Anti-Dumping

Agreement and the Subsidies and Countervailing Measures Agreement.

WTO Membership

The present strength of WTO membership is 161. Last member-Yemen-2014.

Russian Federation joined it after an 18-year accession process - it applied to join the WTO in1993 - then they entered a period of 18 years of bilateral negotiations with GATT/WTO

members concerning goods and services and various systemic obligations.

Significant divergence of views between Russia and the EU, US and Georgia respectively were

the source of repeated setbacks in the accession process

WTO MINISTERIAL CONFERENCES

highest decision-making body of the WTO is the Ministerial Conference, which has to meet at

least once every two years.

brings together all members of the WTO, all of which are countries or separate customs territories.

The Ministerial Conference can take decisions on all matters under any of the multilateral trade

agreements.

Fifth Trade Policy Review (TPR) of India

In order to promote transparency and provide better understanding of the trade policies and

practices of its members, the WTO has a mechanism for regular review of their trade policies.

Depending upon its share in world trade, each member‘s trade policy is reviewed by the WTO at

fixed periodic intervals.

India‘s TPR is carried out every four years.

The TPR offers an opportunity to other WTO members to ask questions and raise concerns

on different aspects of policies and practices of the country under review.

The Fifth TPR of India was held on 14 and 16 September 2011 in the WTO. Before the meeting, the

WTO Secretariat circulated a compilation of India‘s written replies to 886 advance questions raised

by 26 WTO members.



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During the review, most of the members commended the resilience of the Indian economy

that smoothly withstood the adverse effects of global financial crisis without taking

recourse to protectionist measures.

Members appreciated India for using its trade policy to promote sustainable development and

inclusive growth. Members also noted India‘s positive engagement in Doha Round negotiations.

Some of the members, notably the US, raised concerns in certain areas, namely tariffs and duties

licensing and restrictions, trade defence measures (anti-dumping), governmen

procurement, incentive schemes to promote investments and exports and protect agriculture

tariff protection on agriculture, services and investments. Responses to the issues raised were

provided in India‘s Closing Statement on September 16, 2011 which are as follows:

Gap between Rates on Agri Products

Some members mentioned the large gap between India‘s bound and applied rat es on

agricultural products.

India responded that the large gap reflected India‘s steady and continued autonomous tariff

liberalization.

During the four years since the last TPR, the tariffs on some agricultural commoditie

had to be adjusted in the face of high volatility in food prices.

In most cases, tariffs have been brought down and have stayed down. In a few instances, they have been raised again but never above their original levels.

Export Incentives

India‘s export promotion schemes are based on the concept of duty neutralization and providing a level playing field.

FDI Policy

To a number of questions on FDI policy, India explained that the continuing thrust, during the period

since India‘s last TPR in 2007, has been on making the FDI policy mo re liberal and investmen

friendly.

The FDI guidelines have been significantly rationalized, simplified, and consolidated, with the aim

of providing a single policy platform for reference of foreign investors.

Several new sectors, such as petroleum and natural gas and civil aviation were either opened up to

foreign investment or significantly liberalised during this period. Efforts were also being made to

streamline and simplify the business environment and make regulations conducive to business. IPRs

On questions related to India‘s IP policies, India replied that a number of initiatives have been taken

to enhance IP protection and enforcement.



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The changes proposed in the Copyright and Trademark Acts would enhance protection to

intellectual property rights (IPRs) in digital technology particularly with regard to the

dissemination of protected material over digital networks.

These have been supplemented by administrative as well as judicial measures to strengthen

the IPR regime.

The provisions on IP protection in these laws are further supplemented by broader measures to

prevent the import of goods involving copyright piracy and counterfeit trademarks.

Another initiative taken by Indian customs is the facility for online registration by the righ

holders through the web-based Automatic Recordation and Targeting for IPR Protection System.

Sanitary & Phyto-sanitary (SPS) and Technical Barriers to Trade (TBT)

In response to question on India‘s SPS and TBT measures, India explained that specific trade

concerns raised against India have been largely addressed.

Regulations adopted in the past have been on the basis of scientific risk analysis.

Export Restrictions

There were some questions on India‘s use of export restrictions. India responded that expor

restrictions have been used on some occasions for purposes of domestic supply management,

but these have been purely on a temporary basis.

The ban on the export of rice and wheat had to be extended in 2009 due to a dislocation in

production and again in 2010 due to the severest drought in the country in the last forty years.

However, the export of wheat and non-basmati rice is now completely free. The export of

basmati rice is and has always been free.

Restrictions on cotton exports were imposed for only a brief period last year. Cotton yarn

exports have been made completely free. Similarly, cotton is also freely exportable.

LOOKING BEYOND DOHA

At the Eighth Ministerial Conference (MC8) of the WTO in Geneva, December 15-17 , 2011

three

Working Sessions were held in parallel (the NGOs were not allowed to take part in it), directed to

three topics:

i.Importance of the Multilateral Trading System and the WTO;

ii.Trade and Development; and

iii. The Doha Development Agenda negotiations.



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As had been expressly stated in the run-up to the MC8 both from the WTO, from capitals, and

in media reports, the Doha Round negotiations generally had come to an impasse.

The impasse was made especially clear from the outcome of the so-called Easter Package in

April 2011 - which comprised the collected reports of the WTO negotiating bodies in all the

different areas involved in the Doha Round negotiations.

Pascal Lamy, Director General of the WTO, said in a statement March 29, 2011, that the ‗bigges

stumbling block‘ was what is called ‗NAMA sectorals‘.

This is about proposals for major trading countries, including emerging economies, to allow

duty-free or lower-than-normal duty on imports in particular sectors within the non-agricultura

market access (NAMA),negotiations.

That assessment was also made very clear in the statement by the US Trade Representative at

the MC8, ‗… the current impasse in many ways comes down to one single, vexing quandary: the

WTO has not come to terms over core questions of shared responsibilities among its biggesand most successful Members.

The world has changed profoundly since the negotiations began a decade ago, most obviously

in the rise of the emerging economies.

The results of our negotiations thus far do not reflect this change, and yet they must if we are to

be successful.‘

TRIPS issues had already earlier in 2011 been placed in what was called a ‗slow lane‘ in the

negotiations.

For the ‗Easter package‘ in April 2011, the status of the GI (Geographic Indication)

issues and of the TRIPS/CBD issue was reported by the Director-General, document TN/C/W/61

dated April 21, 2011. On the TRIPS/CBD issue a submission was made in the context of the

Easter Package from a number of WTO Members including Brazil, India, and China in Apri

2011, requesting a revised version of the TRIPS Agreement calling for disclosure of origin o

genetic resources and/or associated Traditional Knowledge involved in patent applications

Noteworthy in that this submission was not sponsored by the EU and Switzerland, two of the origina

sponsors of the 2008 ‗mini-ministerial‘ proposal for a TRIPS package on GIs and disclosure o

origin of genetic resources. Nevertheless, of the decisions taken at the MC8, two are TRIPS-related

(i) extending until the next Ministerial Conference, to be held in 2013, the moratorium on what icalled ―non-violation complaints‖ under the TRIPS Agreement; and

(ii) instructing the TRIPS Council to extend, under TRIPS Article 66.1, the transition period

expiring June 30, 2013, for LDCs, for implementing the TRIPS Agreement.

Future Directions

At the MC8 the WTO members acknowledged the concerns on the global economic climate and agreed

that:



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(i) There is no credible alternative to the rules based multilateral trading system; and

(ii) Protectionist trade measures must be avoided.

BILATERAL AND REGIONAL COOPERATION

India has always stood for an open, equitable, predictable, non-discriminatory, and rule

based international trading system.

Considering that regional and bilateral trade and economic cooperation agreements serve a

building blocks towards achieving the multilateral trade liberalisation objective, India is actively

engaging in regional and bilateral negotiations with her trading partner countries/blocs to

diversify and expand the markets for its exports. Some of the recent developments related to majo

Free Trade Agreements (FTAs) are the following:

(i) India-Japan Comprehensive Economic Partnership Agreement (CEPA)

(ii) India-Malaysia Comprehensive Economic Cooperation Agreement (CECA)

(iii) India-ASEAN Trade in Goods Agreement

(iv) India-EU Trade and Investment Agreement Negotiations

(v) India-European Free Trade Association (EFTA)

(vi) BTIA (Iceland, Norway, Liechtenstein, and Switzerland)

(vii) India-New Zealand FTA/CECA

(viii)India-Australia CECA



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TAX STRUCTURE IN INDIA

TAX

Modern economics defines tax as a mode of income redistribution.

the usual meaning of tax people think is that a tax is imposed by the government to fulfill itsimportant obligations on the expenditure front

Incidence of Tax

The point where tax looks being imposed is known as the incidence of Tax — the event of tax

imposition

Impact of Tax

The point where tax makes its effect felt is known as the impact of tax — the after effect o

tax imposition.

Direct Tax

The tax which has incidence and impact both at the same point is the direct tax — the person who is

hit, the same person bleeds. As for example income tax, interest tax, etc

Indirect Tax

The tax which has incidence and impact at the different points is the indirect tax — the person who i

hit does not bleed someone else bleeds.

As, for example, excise, sales tax, etc which are imposed on either producers or the traders, but it is

the general consumers who bear the burden of tax.

METHODS OF TAXATION

There are three methods of taxation prevalent in economies with their individual merits and demerits

—

Progressive Taxation

method has increasing rates of tax for increasing value or volume on which the tax is being

imposed.

Indian income tax is a typical example of it.

The idea here is less tax on the people who earn less and higher tax on the people who earn

more — classifying income earners into different slabs.

method is believed to discourage more earnings by the individual to support low growth and

development unintentionally.



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Being poor is rewarded while richness is punished.

Tax payers also start evading tax by showing lower unreal income. But from different angles this

tax is pro-poor and taxes people according to their affordability/ sustainability.

the most popular taxation method in the world and a populist one, too.

Regressive Taxation

just opposite to the progressive method having decreasing rates of tax for increasing value o

volume on which the tax is being imposed.

There are not any permanent or specific sectors for such taxes.

As a provision of promotion, some sectors might be imposed with regressive taxes.

As for example, to promote the growth and development of the small scale industries, India at one

time had regressive excise duty on their productions — with increasing slabs of volume they

produced, the burden of tax used to go on decreasing.

appreciated for rewarding the higher producers or income-earners, is criticised for being mor

taxing on the poor and low-producers.

not a popular mode of taxation and not as per the spirit of the modern democracies.

Proportional Taxation

In such taxation method, there is neither progression nor regression from the rate of taxes poin

of view.

Such taxes have fixed rates for every level of income or production, they are neutral from the poo

or rich point view or from the levels of production point of view.

Usually, this is not used by the economies as an independent method of taxation.

Generally, this mode is used as a complementary method with either progressive or regressive

taxation.

If not converted into proportional taxes, every progressive tax will go on increasing and similarly

every regressive tax will decrease to zero, becoming completely a futile tax methods.

That is why every tax, be it progressive or regressive in nature, must be converted into proportiona

taxes after a certain level.

A GOOD TAX SYSTEM

there is a broad consensus on five principles10

of a good tax system, among economists and the

policy making experts:

(i) Fairness



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Though fairness (i.e., the first criteria of a good tax system) is not always easy to define, economists

suggest inclusion of two elements in the tax system to make it fair namely, horizontal equity and

vertical equity.

Individuals in identical or similar situations paying identical or similar taxes is

known as horizontal equity.

When ‗better off‘ people pay more taxes it is known as vertical equity.

(ii) Efficiency

Efficiency of a tax system is its potential to affect or interfere the efficiency of the economy.

A good tax system raises revenue with the least cost on the taxpayers and least interference on the

allocation of resources in the economy.

The tax system affects the economic decisions of individuals and groups by either encouraging o

discouraging them to save, spend, invest, etc.

Taxes can improve efficiency of economy — taxes on pollution or on smoking give revenue to the

government and serves broader social purposes, too.

This is known as the double dividend of a tax.

(iii) Administrative Simplicity

This is the third criterion which includes factors like computation, filing, collection, etc. of the taxes

that all should be as simple as possible. Simplicity checks tax evasion too. Tax reform in India has simplification of tax as its majo

plank — also recommended by the Chelliah Committee.

(iv) Flexibility

A good tax system has the scope of desirable modifications in it if there is any such need.

(v) Transparency

How much tax taxpayers are actually paying and what are they getting against it in the form of th

public services should be ascertainable i.e. the transparency factor.

METHODS OF EXPENDITURE

Similar to the methods of taxation the modes of government expenditure are also of three types

— Progressive, Regressive and Proportional.



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At first instance it seems that as a country achieves better levels of development, sectoral and the

item-wise expenditure of the economy must have decreasing trends.

But practical experience shows that the level of expenditure needs enhancement everyday and

economy always needs more and more revenues to fulfill the rising expenditures.

That is why for economies the best form of government expenditure is the progressive expenditure.

The best way of taxation is progressive and the best way of government expenditure is

also progressive and they suit each other beautifully.

Most of the economies around the world are having progressive taxation with progressiv

expenditure.

VALUE ADDED TAX

a method of tax collection as well as name of a state level tax ( at present) in India.

A tax collected at every stage of value addition, i.e., either by production or distribution i

known as value added tax.

The name itself suggests that this tax is collected on the value addition (i.e., production).

Production of goods or services is nothing but stages of value additions where production of goods is

done by the industrialists or manufacturers.

But these goods require value addition by different service providers/ producers (the agents

the wholesalers and the retailers) before they reach the consumers.

From production to the level of sale, there are many points where value is added in all goods.

VAT method of tax collection is different from the non-VAT method in the sense that it is

imposed and collected at different points of value addition chain, i.e., multi-point tax collection.

That is why there is no chance of imposing tax upon tax which takes place in the non-VAT method

— single point tax collection.

This is why VAT does not have a ‗cascading effect‘ on the prices of

goods it does not increase inflation — and is therefore highly suitable for an economy like India

where due to high level of poverty large number of people lack the market level purchasing

capacity.

It is a pro-poor tax system without being anti-rich because rich people do not suffer either.

NEED OF VAT IN INDIA

Over 150 nations in the world have implemented the VAT system of taxation regarding

collecting their indirect taxes.

There have been valid reasons why India should move towards the VAT method of tax collection

We may see some of the major reasons:



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(i) Indian indirect tax collection system was price-increasing (having cascading effect on the price)

was highly detrimental to the poor masses.

Implementation of VAT will improve the purchasing capacity and so living standard of the poor people.

(ii) Being a federal political system the central government states have also been given power to

impose taxes and collect them. At the central level, there had been uniformity of taxes for the economy. Bu

there was no ‗uniformity‘ at the state level taxes (i.e., state excise, sales tax, entertainment tax, etc.). To

bring in uniformity at the state-level taxes, VAT was a necessary

step in India.

(iii) With the process of economic reforms, India moved towards market economy. And for this,

firstly India needed to have a single market. Without uniformity at the state level taxes

(uniform VAT) this was not possible.

(iv) Indian federal design has resulted in economically weaker states and stronger centre. As VAT

increases the total tax collection (experience of the world suggests so) it was fit to be

implemented at the state level.

(v) India has been a country of high level tax evasion. By implementing VAT method of indirect

tax collection, it becomes almost impossible to go for large scale tax evasion. To prove one‘s

level of value addition, the purchase invoice/receipt is a must which ultimately makes it

cross-check the level of production and sale in the economy.15

(vi) If some of the state level taxes (which are many) are converted into state VAT the complexity

of taxation will also be minimised. And at the end, it is possible to merge some of the centre‘s

indirect taxes with it, i.e., arrival of the single VAT.

Keeping all such things in mind, India started tax reform (Chelliah Committee and Kelka

Committee) and a certain level of sucess has been achieved in this area which can boost our

motivation.

In the year 1996, the central government started collecting its excise duty on the VAT method and the

tax was given a new name — the CENVAT.

The next proposal was to merge the states excise duty (imposed on intoxicants only) and their

sales taxes into one tax — the state VAT or VAT.

This could not take place due to states‘ lack of political will. Ultimately o nly sales taxes of the

states were changed to be named VAT and was started to be collected on the basis of the VAT

method (some states did not join it and some joined later).

Implementation Experience of VAT



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The implementation experience of VAT in India has been very encouraging — the new tax system

has been received well by all the stakeholders, the transition being quite smooth.

The revenue performance of VAT — implementing states/UTs (25) has been encouraging the tax

revenue registered, an increase of 13.8 per cent over the annual growth rate of the last five years.

Only 8 states claimed for VAT compensation from the Centre in 2005-06 which came down to only

5 in the fiscal 2006-07.

GOODS AND SERVICES TAX

The Goods and Services Tax (GST) is a proposal of tax in India which will emerge after merging

many of the state and central level indirect taxes. Important points of the proposed GST are

as follows:

(i) It will be a tax collected on the VAT method — having all the benefits of a VAT kind of tax.

(ii) It will be imposed all over the country with the uniformity of rate and will replace multiple

central and state taxes (a single VAT it will be known). The taxes to be withdrawn or merged

into the GST are —

Central Taxes: CENVAT, service tax, sales tax and stamp duty.

State Taxes: State excise, sales tax, entry tax, lease tax, works contract tax, luxury tax, octroi

turnover tax and cess.

(iii) The proposed tax has a single rate of 20 per cent of which centre and state will have a share

of 12 per cent and 8 per cent, respectively. The Union Budget 2006-07 repeated its commitment towards inplementation of GST. The

major challenges in the path of its implementation as per the experts are as follows:

(i) States are collecting VAT with five rates — 0 per cent, 1 per cent, 4 per cent and 20 per cent.

The fifth rate is 12.5 per cent known as the RNR (revenue neutral rate).

Now the challenge is to convince the states to be satisfied with their share of only 8 per cent in the GST at

one hand and making it politically happen from the consumers point of view.

(ii) The next challenge is to decide the things like how and where to integrate central taxes and the

state taxes as VAT or as the GST. (iii) What to do with the custom duty is also a matter of concern as there is a move to integrate i

with the GST at present.

Recent Attempts to Implement GST

The Goods and Service Tax Bill or GST Bill, officially known as The Constitution (122nd

Amendment) Bill, 2014, would be a Value added Tax (VAT) to be implemented in India, from Apri

2016.



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GST stands for ―Goods and Services Tax‖, and is proposed to be a comprehensive indirect tax levy on

manufacture, sale and consumption of goods as well as services at the national level.

It will replace all indirect taxes levied on goods and services by the Indian Central and State

governments.

It is aimed at being comprehensive for most goods and services.

Some goods, namely crude petroleum, diesel, petrol, aviation turbine fuel, natural gas and alcoho

are not to come under the purview of the GST.

The constitutional amendment bill also seeks to empower the President to set up within 60 days of the

passage of the legislation, a GST Council with the union Finance Minister as chairperson and

union Minister of State for Revenue and Finance Ministers of all the states as members.

The GST Council is to work on the basis of consensus and make recommendations on issues like

GST rates, exemption lists, and threshold limits.

Further, the bill provides for setting up of a GST dispute settlement authority, comprising

a chairperson and two members to resolve disputes arising out of deviations from the

recommendations of the GST Council either by the central or state governments.

The draft Bill has since been referred to the Parliamentary Committee on Finance fo

examinationAmong the other steps that are being taken for the introduction of the GST is the

establishment of a strong information technology (IT) infrastructure.

For this purpose the government has set up an Empowered Group headed by Nandan Nilekani

Chairman, Unique Identification Authority of India (UIDAI).

Significant progress has been made in the conceptualisation and design of the GST Network

(GSTN), which is a common portal for the centre and states that will enable electronic processingof the key business processes of registration, returns and payments. For this purpose, the

structure of these processes is in advanced stages of finalisation.

The National Securities Depository Limited (NSDL) has been selected as technology partner fo

incubating the National Information Utility that will establish and operate the IT backbone for the

GST. In this regard the NSDL has set up a pilot project in collaboration with eleven states prior to its

roll-out across the country.

ADDITIONAL EXCISE DUTY

There is a tax in India known as the Additional Excise Duty (AED) imposed and collected by the

centre.

Basically, this is not a form of excise duty. At the same time, though the centre collects it the tota

corpus of collected tax is handed over to the states.

On the request of states, the central government passed the Goods of Special Importance Act, 1957

which empowered the centre to collect the AED on tobacco, textile and sugar in lieu of states‘



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sales tax on them so that these regionally produced goods (which are consumed nationally) have

uniform and affordable prices across the country.

Once VAT is fully operational in the economy this responsibility will be handed over to the states (as

proposed) to be integrated with their VAT with the condition that none of these commodities will be

charged VAT exceeding 4 per cent.

CST REFORMS

The Central Sale Tax (CST), being an origin — based non-rebatable tax, it is generally agreed

isinconsistent with the concept of VAT.

That is why it needs to be phased out; the CST reforms is a par

of the tax reforms in India.

The critical issue involved in phasing out of CST is that of compensating

the states for revenue losses on account of such a phase out. Since phasing out of CST will entai

a revenue loss, states have been insisting on a mechanism to compensate them on a permanen

basis.

The 4 per cent rate of the CST has to be phased out in stages with 1 per cent phase out in

one financial year and the states duly compensated through tax devolution. Because of phasing

out, it is now at 2 per cent.

SERVICE TAX

The share of the services sector in the GDP of India has been going upward for the last decade.

The introduction of service tax in 1994-95 by the Government of India has started paying thegovernmenton its tax revenue front.

Introduced to redress the asymmentric and distortionary treatment of good

and services in the tax regime, the service tax has seen gradual expansion in the country.

VOLUNTARY COMPLIANCE ENCOURAGEMENT SCHEME

Announced in the Union Budget 2013-14, the Service Tax Voluntary Compliance Encouragemen

Scheme (VCES) is a one-time amnesty for those who have collected service tax but not deposited

the same with the government.

Those service tax providers that have not filed service tax return since October 2007 can disclose

true liability and get an interest or penalty waive off.

COMMODITIES TRANSACTION TAX (CTT)

The Union Budget 2013-14 has introduced (basically, reintroduced) the CTT, however, only

fornon-agricultural commodity futures at the rate of 0.01 per cent (which is equivalent to the rate

of equity futures on which a Securities Transaction Tax is imposed in India).



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Alongwith this,transactions in commodity derivatives have been declared to be made non

speculative; and hence for traders in the commodity derivative segment, any losses arising from

such transactions can be set off against income from any other source (similar provisions are also

applicable for the securities market transactions).

Like all financial transaction taxes, CTT aims at discouraging excessive speculation, which

is detrimental to the market and to bring parity between securities market and commodities marke

such that there is no tax/regulatory arbitrage.

Futures contracts are financial instruments and provide fo

price risk management and price discovery of the underlying asset commodity / currency / stock

/interest.

It is, therefore, essential that the policy framework governing them is uniform across all the

contracts irrespective of the underlying assets to minimize the chances of regulatory arbitrage.

The proposal of CTT also appears to have stemmed from the general policy of the government towiden the tax base.

Commodities Transaction Tax (CTT) is a tax similar to Securities Transaction Tax (STT), proposed

to be levied in India, on transactions done on the domestic commodity derivatives exchanges

Globally, commodity derivatives are also considered as financial contracts.

Hence CTT can also be considered as a type of ‗financial transaction tax‘.

The concept of CTT was first introduced in the Union Budget 2008-09. The government had

then proposed to impose a commodities transaction tax (CTT) of 0.017% (equivalent to the rate o

equity futures at that point of time).

However, it was withdrawn subsequently as the market was nascent then and any imposition o

transaction tax might have adversely affected the growth of organised commodities derivative

markets in India.

This has helped Indian commodity exchanges to grow to global standards [MCX is the world‘

No. 3 commodity exchange; globally, MCX is No. 1 in gold and silver, No. 2 in natural gas and

No. 3 in crude oil].

SECURITIES TRANSACTION TAX (STT)

The STT is a type of ‗financial transaction tax‘ levied in India on transactions done on thedomestic stock exchanges.

The rates of STT are prescribed by the Central government through its Budget from time to time. In

tax parlance, this is categorised as a direct tax.

The tax came into effect from October 1, 2004.

In India, STT is collected for the Government of India by the stock exchanges.



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With charging of STT, long-term capital gains tax was made zero and short-term capital gains tax

was reduced to 10 per cent (subsequently, changed to 15 per cent since 2008).

The STT framework was subsequently reviewed by the central government in the year 2005, 2006

2008, 2012 and 2013. The STT rates were revised upwards in the year 2005 and 2006 while i

was reduced for certain segments in 2012 and 2013.

The STT provisions were altered in the year 2008 such that for professional traders (brokers)

STT came to be treated as an expense which can be deducted from the income instead o

treating the same as an advance tax paid.

[The 2004 STT provisions provided that the STT payments of professional traders, whos

‗business income‘ arising from purchase and sale of securities could be set off against their total tax

liability.]

As on date, STT is not applicable in case of preference shares, Government securities, bonds

debentures, currency derivatives, units of mutual fund other than equity oriented mutual fundand gold exchange traded funds and in such cases, tax treatment of short-term and long-term gain

shall be as per normal provisions of law.

Transactions of the shares of listed companies on the floor of the stock exchange or otherwise

mandated under the regulatory framework of SEBI, such as takeover, buyback, delisting offers, etc

also does not come under STT framework.

The off-market transactions of securities (which entails changes in ownership records a

depositories) also does not attract STT.

CAPITAL GAINS TAX a direct tax and applies on the sales of all ‗assets‘ if a profit (gain) has been made by the owne

of the asset - a tax on the ‗gains‘ one gets by selling assets. The tax has been classified into two -

(i) Short Term Capital Gain (STCG): It applies ‗if the Asset has been sold within 36 months o

owning it‘. In this case the ‗rate‘ of this tax is similar to the normal income tax slab. But the period

becomes‘ 12 months‘ in cases of shares, mutual funds, units of the UTI and ‗zero coupon bond‘ - in

this case the ‗rate‘ of this tax is 15 per cent.

(ii) Long Term Capital Gain (LTCG): It applies ‗if the asset has been sold after 36 months of

owning it‘. In this case the ‗rate‘ of this tax is 20 per cent. In cases of shares, mutual funds,

units of the UTI and ‗zero coupon bond‘ there is ‗exemption‘ (zero tax) from this tax

(provided that such transaction is subject to ‗Securities Transaction Tax‘).

INVESTMENT ALLOWANCE

Announced in the Union Budget 2013-14, a tax break given to companies for high value investmen

in plant and machineries, over and above depreciation benefits enjoyed by them.



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A company investing Rs. 100 crore or more in plant and machinery during the April 2013 to March

2015 will be entitled to deduct an investment allowance of 15 per cent of the investment.

This is expected to see enormous spill-over benefits to small and medium enterprises.

The proposed investment allowance scheme should be seen a drain on the government‘s tax

collections - it may be seen as a kind of tax exemption.

COLLECTION RATES

Given the large number of exemptions to rate of customs, the increase in value of imports does

not necessarily imply similar magnitude in customs revenue.

Collection rates are an indicator of overall incidence of customs tariffs including countervailing

and special additional duties of imports.

These are computed as the ratio of revenue collected from these duties to the aggregate value o

imports in a year (or period) and thus represent trade-weighted tariffs.

A major reason for the fall in rates has been the lower levels of duties on many items including on

petroleum, oil, and lubricants (POL), which has significant import value and of course the impact o

the various exemptions.

Tax Expenditure and Budgetary Policies

Tax Expenditure corresponds to relaxations given when tax burden becomes difficult for the

sustainability of a particular sector. Tax exemptions or incentives are given in the form of lower

rates of tax relative to normal rates.

Tax expenditures are revenue losses attributable to tax provisions that often result from the use of

the tax system topromote social goals without incurring direct expenditures. Normally these

exemptions are generated for particular purposes as tax incentives. [Why we are talking about thi

now : Because, UPSC asked a question in 2013 Mains as below : ―What is meaning of the term

tax-expenditure? Taking housing sector as an example, discuss how it influences budgetary

policies of the government.‖

Tax Expenditure and its importance in Indian Economy

The term ‗tax expenditure‘ is associated with budget. Though many are familiar with the concept

of subsidies and its impact on Indian Economy, it seems not every one know the details of tax-

expenditure. Tax-expenditure more or less has the same impact as subsidies as a necessary evil.

Tax expenditures can take many forms. Some result from tax provisions that reduce the present

value of taxable income through deferral allowances, or special exclusions, exemptions, ordeductions from gross income. Others affect a household‘s after-tax income more directlythrough tax credits or preferential rates for specific activities.

http://www.clearias.com/civil-services-mains-2013-general-studies-paper-3-gs3-question-paper/






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Why Tax Exemptions given are called Tax Expenditure?

If government didn‘t give any tax exemptions, this deducted amount would have belonged to

government itself. Though Tax Expenditure are not direct spending by government, the concept o

tax expenditure is that, government is giving back money to achieve certain social goals, likestrengthening housing sector or industrial sector. But in actual sense, Government is not collectin

money to be re-distributed later, but gives away tax exemptions.

Tax Expenditure and Budgetary Policies in Housing Sector

1. Exemptions allowed for deduction of HRA (Income tax) and various other income tax deductions

and exemptions (Eg: Medical Premium).

2. Exemptions allowed for interest payment and principal repayment for housing loans.

3. Tax Expenditure in Union Budget 2013 : First home loan from a bank or housing finance

corporation upto Rs. 25 lakh entitled to additional deduction of interest upto Rs. 1 lakh.

4. NB: It should be noted that due to various policies of government, the number of persons who own

houses have increased. More over, the people can afford to spend on infrastructure as they don‘t

have to give taxes.

Tax Expenditure Budget

The tax expenditure budget comprises the estimated revenue losses attributable to various

exclusions, exemptions, deductions, nonrefundable credits, deferrals, and preferential rates in the

tax code. These provisions reduce the income tax liabilities of individuals or businesses thatundertake certain types of activities.

Volume of Tax Expenditure and Subsidies

So hope now it is clear that tax-expenditure corresponds to the revenue a government foregoes

through the provisions of tax laws that allow deductions, exclusions, or exemptions from the

taxpayers‘ taxable expenditure.

The revenue foregone from corporate and personal income taxes, estate, and customs duties

amounts to near 6.5 per cent of GDP. As a share of revenue realised, the foregone revenue

accounts to near 80%. As is it is clear, this is by now means a meager amount.

You might have heard opposition parties shouting about crony capitalism and excess favors done

to corporates. Yes, you can connect tax expenditure right here. And that may be one of the reason

why UPSC asked this question. But UPSC was concerned only about Housing sector; so the

answer should also be written from that perspective, highlighting the positives and negatives.

14TH

FINANCE COMMISSION



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The Commission was constituted on January 2, 2013 under the Chairmanship of Dr. Y. V. Reddy

former RBI Governor with Prof. Abhijit Sen, Ms. Sushma Nath, Dr. M. Govinda Rao and Dr. Sudipto

Mundle as the other four members. The recommendations of the Commission will apply on the period

2015-20 and its report has to be submitted by October 31, 2014.

The broad Terms of Reference and the matters to be taken into consideration by the Commission

are: 1. Tax Devolution & Grant related references

(i) the distribution between the union and states of the net proceeds of taxes which are to be,

or may be, divided between them under Chapter I, Part XII of the Constitution and the

allocation between the states of the respective shares of such proceeds;

(ii) the principles which should govern the grants-in-aid of the revenues of the states out of

the Consolidated Fund of India and the sums to be paid to the states which are in need of

assistance by way of grants-in-aid of their revenues under Article 275 of the Constitution

for purposes other than those specified in the provisos to Clause (1) of that article; and

(iii) measures needed to augment the Consolidated Fund of a state to supplement the

resources of the panchayats a nd municipalities in the state on the basis of the

recommendations made by the Finance Commission of the state. 2. To review the state of finances, deficit,

and debt levels of the union and states and suggest measures for maintaining a stable and sustainable fisca

environment consistent with equitable growth including suggestions to amend the FRBMAs currently in

force. The Commission has been asked to consider and recommend incentives and disincentives for states

for observing the obligations laid down in the FRBMAs.

3. In Commission is required to consider -• the resources of the central government and the demands on the resources of the centra

government;

• the resources of the state governments and demands on such resources under different

heads, including the impact of debt levels on resource availability in debt-stressed

states;

• the objective of not only balancing the receipts and expenditure on revenue account of al

the states and the union but also generating surpluses for capital investment;

• the taxation efforts of the central government and each state government and the potentiafor additional resource mobilization;

• the level of subsidies required for sustainable and inclusive growth and equitable

sharing of subsidies between the central and state governments;

• the expenditure on the non-salary component of maintenance and upkeep of capital assets

and the non-wage-related maintenance expenditure on Plan schemes to be completed by



March 31, 2015 and the norms on the basis of which specific amounts are recommended

for the maintenance of capital assets and the manner of monitoring such expenditure;

• the need for insulating the pricing of public utility services like drinking water,

irrigation, power, and public transport from policy fluctuations through statutory

provisions;

• the need for making public-sector enterprises competitive and market oriented; listing

and disinvestment; relinquishing of non-priority enterprises;

• the need to balance management of ecology, environment, and climate change

consistent with sustainable economic development; and

• the impact of the proposed goods and services tax on the finances of the centre and

states and the mechanism for compensation in case of any revenue loss.

5. To review the present public expenditure management systems and recommend, including -

• budgeting and accounting standards and practices;

• the existing system of classification of receipts and expenditure;

• linking outlays to outputs and outcomes; and

• best practices within the country and internationally.

6. To review the present arrangements of financing of Disaster Management with reference to

the funds constituted under the Disaster Management Act 2005 and make recommendations.

7. To indicate the basis on which it has arrived at its findings and make available the state-wise

estimates of receipts and expenditure.

The Commission is required to generally take the base of population figures as of 1971 in all

cases where population is a factor for determination of devolution of taxes and duties and grants-

in-aid. However, the Commission may also take into account the demographic changes that have

taken place subsequent to 1971.

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Summary of Indian Economy-Part-II

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