Jitendra Prakesh / Reuters A Hindu holy man speaks with a street vendor in Allahabad, August 2017.

India's Tax Reform

The GST Is an Important, Limited First Step

“The greatest political venture since that originated in Philadelphia in 1787.” That is how the renowned American historian Granville Austin described the framing of India’s Constitution in his seminal 1966 book. Between 1946 and 1949, over 300 elected representatives of India’s 548 princely states met over 11 sessions under the auspices of a Constituent Assembly. Against a backdrop of grinding poverty, in a starkly diverse nation steeped in religious division and great feudal obduracy, they enshrined an “Idea of India,” elucidated in Sunil Khilnani’s 1999 book of that name. The idea was based on unity in diversity, in the country’s constitution, the world’s longest. The assembly was an attempt at striking a deft balance between India’s staggering religious, cultural, and linguistic diversity and the cherished desire for a unified nation. Defying all odds, the resulting constitution proved to be extraordinarily successful in building and fortifying the political Republic of India.

Seven decades later, India undertook a similar exercise—much smaller in size and scale, but perhaps as complex and influential as the original Constituent Assembly. Between September 2016 and June 2017, nearly one hundred representatives of India’s 36 states and territories met over 17 sessions under the auspices of the Goods and Services Tax Council to usher in a “one nation, one tax” regime. The result was India’s Goods and Services Tax (GST), an economic reform initiative to fortify the fiscal Republic of India. Like the Constituent Assembly of the 1940s, this attempt at fiscal unification comes against a difficult backdrop of stark and widening regional disparities—demographic, economic, social, and political. Although the GST is characterized as a one nation, one tax idea, today’s India is not truly one nation and the tax is not truly one tax.

ONE TAX?

Introduced on July 1, the GST is an attempt at unifying thousands of different tax rates for goods and services across India’s many subnational geographical units. Since its introduction in the Union Budget of 2006, the GST has waded through four different committees, missed three deadlines, and overcome defiant opposition, including, ironically, from Prime Minister Narendra Modi, who opposed the GST in 2013 as the then Chief Minister of Gujarat. Before the GST, India had a complex tax structure that included more than 1,000 tax rates across 32 states and territories for a basket of 1,700 goods and services. Often, the same good or service had different tax rates in different states. The GST has cut these down to just six rates—three percent, five percent, 12 percent, 18 percent, and 28 percent, plus zero percent for tax-exempt items. Rates depend on the type of good or service in question, with luxuries taxed more heavily than necessities: air-conditioned restaurants, for example, must pay the 18 percent rate, while non-air-conditioned ones pay only 12 percent. Although six rates may seem like an adulteration of the one-tax idea, this was an essential compromise given India’s complex and diverse political economy. And the GST is still a big leap forward—the same good or service is now taxed at the same rate across the entire country. The multiple categories, however, will ensure rent-seeking opportunities for tax officials, who will have the power to force (for example) an ice cream sandwich to be taxed at the higher rate for ice cream and not at the lower rate for a sandwich.

Simplification of the rates aside, India’s GST project is also a mammoth exercise in retooling the country’s taxation architecture. New Delhi will now tax goods and services at their final destination rather than their source, meaning that goods will have to be tracked across the entire value chain, from their origin as raw materials to their transformation into finished goods at the point of consumption. To accomplish such tracking in a $2 trillion economy, India has built a new GST Network system using state-of-the-art technology. Nearly ten million registered businesses will have to register on the new network. Fifty million more small and medium-sized businesses that are currently out of the formal taxation network may also have to register in order to provide and receive tax credits. The GST Network is expected to generate and store 3.2 billion invoices every month at a peak rate of 120,000 transactions a second. Despite apprehensions, the GST Network has thus far proved to be robust.

The underlying premise of the GST is that uniform tax rates across all of India’s states will increase efficiency by reducing friction in the movement of goods and services across state borders, potentially boosting economic activity and contributing substantially to GDP growth. Finance Minister Arun Jaitley has hailed the GST as an “important achievement for the entire country.” He added, “The old India was economically fragmented. The new India will create one tax, one market, for one nation.”

Adnan Abidi / Reuters Indian Prime Minister Narendra Modi inspects guards at the Red Palance on India's Independence Day, August 2017.

But uniformity through unity can be an illusory pursuit. Research shows that India is currently experiencing a “3-3-3 paradox”: the three richest large states, Maharashtra, Tamil Nadu, and Kerala, are three times richer per capita than the three poorest large states, Bihar, Uttar Pradesh, and Madhya Pradesh. This level of regional economic inequality is the highest in independent India’s history. Just four states account for as much inter-state trade as the other 32 states and territories combined. India’s states have also been growing further apart on social and demographic indicators. For all the talk of India being a young nation, the average person in Kerala and Tamil Nadu is 30 years old, and in Bihar and Uttar Pradesh the average person is only 19—almost a generation apart. Measures such as life expectancy, literacy, infant mortality, and share of women in the workforce diverge widely from region to region. Today’s India is not one nation but a continent of nations that are economically, demographically, and socially as different from one another as Eastern Europe and sub-Saharan Africa. How can one tax reconcile such stark regional differences? Branded hair shampoo is taxed as a luxury good at 28 percent. But if it is a luxury in a poor state such as Bihar, it may be a necessity in richer Tamil Nadu. Further, should tax policies reflect the interests of an aging workforce in the rich states or those of aspirational youth in the poor states? On such questions rests the future of Indian federalism.

Another big faux pas is the bizarre decision by the Indian government to constitute a new GST anti-profiteering authority. This authority will now determine if prices of goods and services have been accurately priced by businesses to reflect commensurate changes in GST rates. For example, if the GST rate for bread is reduced by two percentage points but the rate for butter is increased by one percentage point, the price of buttered toast paid by the consumer should reflect this combination of GST rate changes, failing which a government official can levy punitive charges. Yet if the government feared price gouging and market manipulation, it could have used India’s Competition Commission, which already has adequate powers to regulate such market failures. It is a travesty that a supposedly pro-market government is seeking to set prices of goods and services of private businesses in twenty-first-century India.

DON'T MESS WITH TAXES

The economic benefits of GST are easy to perceive but difficult to estimate. One study by the economists Pravin Krishna and Eva Van Leemput predicts a 25 percent increase in internal cross-border goods flows that could yield a one-time boost to GDP of three to four percent. Another study from 2013 by India’s National Institute for Public Finance and Policy predicted a 1-1.5 percent increase in GDP due to the GST. Yet these are at best theoretical models, and the tax’s potential economic impact is still unclear. The only safe prediction that one can make is that the GST will increase India’s tax-to-GDP ratio, currently at the abysmally low level of 17 percent.

The GST comes at a time when a new idea of India is emerging—one that calls for more regional autonomy in line with the country’s expanding demographic, economic, and social diversity. Imposing uniformity on a rapidly diverging India may exacerbate regional tensions and create fault lines in India’s federal system. For instance, the rising tide of protests in Tamil Nadu against New Delhi’s imposition of education policy, language, gas exploration policy, and farm loan waiver policy are small but tangible signs of sub-national fault lines that cannot be overlooked.

The economics of a one nation, one tax regime are exciting but its political economy challenges of aligning fractious states is daunting. Seventy years after India’s constitution successfully forged a political union, the GST is attempting to forge an economic union amid stark regional disparities. Yet in the decades to come, the rigidity of the GST will likely have to be sacrificed in the larger interest of preserving the edifice of India’s union of states. 

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