SELECTED DISCIPLINE IN INDIAN STATES: MARKET-BASED AND OTHER OPTIONS

The goods and services tax (GST) is a milestone reform in India’s tax policy, taking the important step of unifying and harmonizing numerous indirect taxes across all states of the federation and the central government. Yet, the GST has a complex structure with a relatively high number of rates (and exemptions), which could be simplified without sacrificing progressivity of the current GST and with potentially significant gains from lower compliance and administrative costs. A dual rate structure with a low standard rate and an additional higher rate on select items can be progressive and preserve revenue neutrality, while streamlining exemptions would further contribute to progressivity and reduce compliance and administrative costs. States’ finances have deteriorated in recent years, and states are a key determinant of general government public finances. Traditionally fiscal discipline has been imposed on states through central control over state borrowing and states’ self-adopted fiscal rules. Market-discipline in combination with fiscal rules can strengthen fiscal discipline; but is not found to be effective so far in Indian states despite predominantly market-based financing. To strengthen the role of market discipline, fiscal reforms should focus in the near term on further liberalizing financial markets, improving the quality and timeliness of state fiscal data, ensuring sufficient fiscal flexibility for states to respond to fiscal shocks, and, over the medium term, on steps to strengthen no-bailout expectations. 10. India’s FDI performance could be enhanced through implementing sound economic policies and further supply-side reforms . India’s infrastructure quality and capital account openness remains well below the median in the sample. Based on the empirical evidence, bringing infrastructure and capital flow liberalization to the median level in the sample would lead to an increase in FDI inflows of 1.1 and 1.9 percent of GDP, respectively. That said, the benefits could be smaller, as there have been some improvements in these indicators since the year This chapter analyzes the nature, magnitude, and sources of resource misallocation. It finds the magnitude is relatively large and unevenly-distributed across Indian states. Strict labor market regulations appear to be a major contributor to misallocation. Further labor reforms will therefore improve firm-level efficiency and productivity and help reap the full benefits of the demographic dividend. reduces productivity), and (iii) TFP gap (measuring the distance between “efficient” and “observed” output). The analysis uses firm-level balance sheet data from India’s Annual Survey of Industries (ASI) for FY2003/04, FY2006/07, FY2008/09, and FY2010/11. Klenow (2009) is measured by TFP dispersion and is sensitive to data outliers by definition and that the firm-level industry survey may not be comparable across countries. The cross-country results may partially be subject to measurement errors as described in Nishida et al (2016). Nevertheless, this study focuses on the extent of misallocation across Indian states and the impact of cross-state labor reforms. Given also that the ASI survey is similarly designed across Indian states for each year, the main conclusions of this study are not likely be affected.