Tyranny of the Status Quo: The Challenges of Reforming the Indian Tax System

The paper reviews Indian tax policy and recent reforms. Against a best-practice framework, it examines changes in policy and in tax revenue trends at the Union and State levels to help identify the major shortcomings of India’s tax system. A fragmented constitutional assignment of taxes on agricultural and non-agricultural income to the Union and State governments makes it difficult to levy a comprehensive income tax and opens the door to tax avoidance and evasion. Multiple objectives imposed on the tax system result in a plethora of exemptions and preferences, causing significant loss of revenue and creating unintended distortions. The government tends to tax sectors where it can raise revenue easily in an adhoc manner, causing further distortions. The difficulty in taxing unorganized sector incomes further narrows the tax base. Tax abuse by multinational companies evading tax through base erosion and profit shifting may be equally important. A poor organizational setting and low administrative capacity have been other constraining factors. The “tyranny of the status quo” arises because those who gain from tax reforms tend to be ungrateful and those who lose tend to be vengeful, explaining why tax reforms have been slow and often ineffective in India.