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Unity at midnight beckons with India’s tax reform

Submitted by shashi on Wed, 07/05/2017 - 13:47

This defines a visionary moment as the country chooses 'pooled sovereignty'

The tax reform is expected to transform the business landscape but will test India's weak administrative capacity © AP There are rare moments when a nation will do the sensible thing despite itself. Such a moment will come this weekend when India introduces the most far-reaching tax reform in its history.

The goods and services tax, which comes into force on July 1, replaces 17 state and federal levies on everything from bread and electricity to Birkin bags. It will transform India into a common market larger than Europe, the US, Brazil, Mexico and Japan combined.

It may also be the most daunting tax reform ever implemented and will test the weak administrative capacity of the Indian state. A 10-year battle to win over the country's powerful states and fractious political parties has entailed compromises that may prevent the world's fastest-growing economy from realising GST's full potential to become an easier place to do business.

If Bollywood, cricket and Hinglish unite Indians, their irrational system of indirect taxes divides them. Anyone who sells a product here lives through a nightmare of state sales taxes, central sales tax, entry tax, turnover tax, service tax, excise, octroi — all cascading to make India one of the highest indirectly taxed nations in the world. Octroi — a tax levied on goods when they enter an area — is the worst. A truck can take 35 hours to deliver goods from Delhi to Mumbai, of which only 20 hours may be spent driving; the remaining 15 are taken up by negotiating bribes to reduce taxes at check posts.

It is also a visionary constitutional moment in India's history: 29 states and seven union territories will voluntarily give up some sovereignty over taxation for the common good. Ironically, when Tory Brexiters in England are fighting for symbols of sovereignty, Indians have chosen the path of "pooled sovereignty" based on a sobering recognition that the freedom to act independently in our interconnected world is an illusion.

The tax reform will gradually reshape India's business landscape. Companies will be able to distribute products from a single warehouse rather than replicating supply chains in each state. Manufacturers will make rational decisions about sourcing raw materials and locating manufacturing facilities. Thick state tax codes will be replaced by a single, IT-enabled, digital filing.

Reduced logistics costs and efficiency gains will benefit consumers through lower prices. Because it is a value added tax, sellers will have the incentive to comply so as not to lose credit for taxes already paid. Greater compliance will widen the tax net and boost government revenues in a country notorious for tax evasion. The promise of a huge single market with a simplified tax structure should attract more foreign investment. All this should promote economic growth, and according to the International Monetary Fund, the GST will mean India's medium-term growth in gross domestic product rises above 8 per cent, even if it doesn't add the full 2 percentage points hoped for by India's finance minister.

Companies, meanwhile, are shouldering one-time costs by switching to new systems and hoping for minimal disruption. Logistics companies are big gainers as they make it easier to move goods. India's love for complexity means, however, that the tax will probably bring confusion. Companies have to file a mass of returns. Instead of just one tax rate, there are four slabs — 5, 12, 18, and 28 per cent — and this will mean potential disputes, clogging an inefficient judicial system.

India will also be perceived as a high-GST country because of the top rate. Ideally, it should have had a single low standard rate of about 16 per cent that abolished the distinction between goods and services. The Achilles heel, of course, is a mulish bureaucracy. It's not going to be easy.

However, a poll of chief executives has overwhelmingly endorsed the tax. Driven by GST optimism, stock markets have been buoyant. About 70,000 tax officers and staff had earlier protested, but that mostly reflected a worry that they wouldn't have enough to do, which presumably means the system will be easier for everyone to deal with.

What seemed a distant dream is a reality. For a government sometimes criticised for being authoritarian, it has shown patience and listening ability — cajoling obdurate states, ushering amendments to the constitution, building consensus through the GST Council, and accommodating dissenting voices. It has delivered on an effort that has been more than a decade in the making, and will be its most lasting achievement. If only it would show the same bravery and skill in implementing other much-needed reforms in land, labour and capital.

The writer is author of 'India Grows at Night: A Liberal Case for a Strong State'