India’s fiscal policy architecture | Implications & Trends
The comprehensive framework of India’s fiscal policy has been provided in the constitution of India. The powers to levy taxes and spending responsibilities of India has been divided between the central and the state government due to its federal form of government. Since, it is not mandatory that the taxing capabilities of the states are adequate as per their spending responsibilities, it is due to this reason that some of the revenue of the central government needs to be assigned to the state government. The Indian constitution therefore, provides for the formation of a Finance Commission every five years so as to provide the basis for this assignment and give medium term guidance on financial matters. On the basis of the report of the Finance Commission, the central taxes are transferred to the state governments.
For every financial year, both the governments, i.e.centre and state has to place a statement of its future taxing and spending provisions before the legislature for legislative debate and approval which is known as budget as per the Indian constitution.
The central government is accountable for the whole country, i.e. national highways, shipping, airways, national defence, foreign policy, railways, post and telegraphs, banking and foreign trading. Whereas, the state government is concerned with state related issues such as law and order, agriculture, fisheries, water supply and irrigation, and public health. There are certain other profiles which are the responsibilities of both state as well as central government. These are forests, economic and social planning, education, trade unions and industrial disputes, price control and electricity. In contemporary Indian polity, many of the powers have also been transferred to the local governments also. The taxing powers of the central government cover taxes on income (excluding income from agriculture), excise on goods produced (other than alcohol), customs duties, and inter-state sale of goods. The state governments are bestowed with the power to tax income from agriculture, land and buildings, sale of goods (other than inter-state), and excise on alcohol.
Since 1950, in order to achieve long-term economic objectives, India has also adopted a system of five year plans apart from annual budgetary process which is directed by the Planning commission. There is no specific provision for the same in the constitution. The division of expenses into plan and non-plan expenditures is the main fiscal impact of the planning process. The plan expenditures are the ones that are related to the long-term socio-economic goals as prescribed by the current planning process. They include some specific projects and schemes which are usually directed through centre to state government in order to attain desired objective.Most of the times, these funds are an add-on to the assignment of central taxes as stated by the Finance Commissions for which the state government also contributes with its own funds in certain circumstances. The non-plan expenditures are responsible for salaries, pensions, economic services in the various sectors and other routine expenditures for the administration of the government.
The above mentioned institutional set up was initially appeared adequate for driving the development agenda but the sharp decline of the fiscal situation in the 1980s resulted in the balance of payments crisis of 1991. Following economic liberalisation in 1991, when the fiscal deficit and debt situation again found to head towards unmanageable levels around 2000, a new fiscal discipline framework was instituted. While at the central level, this agenda was introduced in 2003 when the Parliament passed the Fiscal Responsibility and Budget Management Act (FRBMA).
Taxes are the main source of government revenues. Direct taxes are so named since they are charged upon and collected directly from the person or organization that ultimately pays the tax (in a legal sense).Taxes on personal and corporate incomes, personal wealth and professions are direct taxes. In India the main direct taxes at the central level are the personal and corporate income tax. Both are till date levied through the same piece of legislation, the Income Tax Act of 1961. Income taxes are levied on various head of income, namely, incomes from business and professions, salaries, house property, capital gains and other sources (like interest and dividends).Other direct taxes include the wealth tax and the securities transactions tax.
Some other forms of direct taxation that existed in India from time to time but were removed as part of various reforms include the estate duty, gift tax, expenditure tax and fringe benefits tax. The estate duty was levied on the estate of a deceased person. The fringe benefits tax was charged on employers on the value of in-kind non-cash benefits or perquisites received by employees from their employers. Such perquisites are now largely taxed directly in the hands of employees and added to their personal income tax. Some states charge a tax on professions. Most local governments also charge property owners a tax on land and buildings.
Indirect taxes are charged and collected from persons other than those who finally end up paying the tax (again in a legal sense). For instance, a tax on sale of goods is collected by the seller from the buyer. The legal responsibility of paying the tax to government lies with the seller, but the tax is paid by the buyer. The current central level indirect taxes are the central excise (a tax on manufactured goods), the service tax, the customs duty (a tax on imports) and the central sales tax on inter-state sale of goods. The main state level indirect tax is the post-manufacturing (that is wholesale and retail levels) sales tax (now largely a value added tax with intra-state tax credit). The complications and economic inefficiencies of this multiple cascading taxation across the economic value chain (necessitated by the constitutional assignment of taxing powers) are discussed later in the context of the proposed Goods and Services Tax (GST).