Taxation Structure Needs Reform

March 9, 2025

India’s tax system has undergone significant changes over the decades, shifting from a complex and fragmented structure to a more streamlined approach. While direct taxes now contribute a greater share of government revenue, indirect taxes remain an essential part of India’s fiscal strategy. However, their regressive nature disproportionately affects lower-income households, raising concerns about economic equity.

The roots of India’s taxation policies can be traced back to the post-independence era when the government relied on high direct tax rates to finance a planned economy. In the 1970s, under Prime Minister Indira Gandhi, the highest marginal income tax rate was 97.5%, while corporate tax rates reached up to 65%. These extreme rates discouraged compliance and led to widespread tax evasion.

The indirect tax system was particularly convoluted, comprising multiple levies such as central excise duty, service tax and state-level sales taxes. This resulted in a cascading effect, increasing compliance burdens for businesses and consumers alike.

A key moment in India’s fiscal history came with the economic crisis of 1991, which catalysed comprehensive reforms across various sectors, including taxation. The crisis prompted a shift towards liberalisation and market-driven policies, when P. V. Narasimha Rao was the Prime Minister, and Dr. Manmohan Singh was the Finance Minister. The reforms that followed sought to simplify the tax structure, reduce rates and broaden the tax base to enhance revenue productivity.

These changes marked the beginning of a new era in India’s approach to taxation, setting the stage for the current system we see today.

The most significant reform in recent years has been the introduction of the Goods and Services Tax (GST) in 2017 during the ongoing tenure of Prime Minister Narendra Modi, which replaced a multitude of indirect taxes levied by the central and state governments, creating a unified tax structure across the country.

Today, India’s tax revenue is primarily derived from two sources: direct taxes, such as income tax and corporate tax, and indirect taxes, including GST, excise duties and customs duties. The latest data from the Ministry of Finance for the financial year 2023-24 indicates that direct taxes contributed about 56% of total tax collections, while indirect taxes accounted for 44%. This marks a shift from earlier decades when indirect taxes dominated government revenue.

While GST has simplified India’s tax system, it remains complex, with multiple slabs—5%, 12%, 18% and 28%. The 18% slab is the most common, while luxury and sin goods, including tobacco, aerated drinks, and automobiles, attract 28% GST plus additional cess.

Fuel taxation in India is another major factor, as petrol and diesel remain outside the GST framework, allowing both central and state governments to levy high excise duties and VAT, sometimes comprising over 50% of retail fuel prices. Further, high import duties on certain goods, such as automobiles and electronics, further contribute to government revenue.

A key concern with India’s reliance on indirect taxes is their regressive impact.

Unlike direct taxes, which are based on income levels, indirect taxes apply uniformly to all consumers, regardless of earnings. This means that lower-income households end up paying a larger proportion of their income in taxes compared to wealthier individuals.

According to Oxfam India’s 2023 report, “Survival of the Richest: The India Story,” the bottom 50% of the population contributes around 64.3% of total GST revenue, while the top 10% contributes only 3-4%. This is largely due to sheer numbers, but it also suggests how the poor bear a disproportionate burden.

Since lower-income households spend a higher share of their earnings on essentials—many of which are taxed—they face a heavier financial strain. In contrast, wealthier households save or invest a larger portion of their income, reducing their overall tax burden. This structure limits disposable income for the poor, affecting access to necessities like food, healthcare and education. Over time, this can deepen economic disparities by raising the cost of living without proportional income growth.

While indirect taxes remain a critical revenue source, reducing their regressive impact requires policy adjustments. Measures such as lowering GST rates on essential goods and improving tax compliance among higher-income groups could create a more equitable tax structure.