**Figure 6. Excise and Customs Duties (% of GDP)**

<!-- Start of picture text --> 4.5<br>4.0 3.7%<br>3.5<br>2.9%<br>3.0<br>2.6%<br>2.5<br>2.5%<br>2.0<br>1.5 2.0%<br>1.0<br>1.3%<br>0.5<br>0.0<br>Excise Duty Customs Duty<br>1980-81 1981-82 1982-83 1983-84 1984-85 1985-86 1986-87 1987-88 1988-89 1989-90 1990-91 1991-92 1992-93 1993-94 1994-95 1995-96 1996-97 1997-98 1998-99 1999-00 2000-01 2001-02 2002-03 2003-04 2004-05<br><!-- End of picture text --> _Source_ : Handbook of Statistics on Indian Economy, Reserve Bank of India At the same time, marginal corporate taxation is high. Poirson (2006) computes two standard indicators based on the Indian tax code, the marginal effective tax wedge (METW) between the pre- and post-tax return on capital and the marginal effective tax rate (METR), defined as the ratio of the wedge to the required real pre-tax rate of return. These are low for India largely because of low personal taxes on dividends and the elimination of the tax on longterm capital gains; corporate tax rates tend to be higher than average. At the same, there is considerable variance across sectors and types of financing because of exemptions and differences in depreciation allowances. In particular, Poirson (2006) argues that there is a bias against financing investment through new equity or retained earnings and in favor of debt financing. Reducing this bias is important because the DFIs, which have traditionally been the source of long-term investment funds, are restructuring to compete with banks and capital markets in the radically new environment of market-based pricing and allocation of funds. As Mohan (2004, p. 329) notes, “Lending by the DFIs has fallen continuously over the last 5-7 years.” This might mean a paucity of long-term funds to finance investment, especially for small and medium-size firms.

The fact that AETRs are low because of a low tax base suggests that direct tax revenues can be raised while lowering statutory and hence marginal tax rates. The way to do this would be to eliminate exemptions while improving tax administration, as both the Chelliah 1991, 1992, 1993 and Kelkar 2002 tax committee reports have recommended. The results could be striking— for example, GoI’s 2004 road map for implementing the Fiscal Responsibility and Budget Management Act (FRBMA) foresees a virtual doubling of corporate tax revenue from 2.3 percent of GDP in 2003/04 to 4.2 percent by 2008/09 even while the CIT rate is reduced to 30 percent from over 35 percent in 2004.<sup>32</sup> On indirect taxes, the plan is to introduce a national VAT on goods and services (goods and services tax, GST), which would replace the existing state VAT, central sales tax CST, central excise duties and central service tax. All these measures would help complete the shift towards a broader tax base with lower marginal rates and higher AETRs. While there is considerable potential for increased revenue, especially as services are brought more fully into the tax base, IMF (2006, chapter III) cautions that the GST should be regarded only as a medium-run solution because of the many administrative pitfalls.

> 32 See Ministry of Finance (2004) and Poirson (2006), page 16-17.

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