India Wants a Nationwide Sales Tax

Prime Minister Modi has an alternative to cumbersome state levies.

Indian Prime Minister Narendra Modi.

Photographer: Michael Gottschalk/Photothek via Getty Images

Prime Minister Narendra Modi took power in May 2014, promising to make India a better place for business. Investors are still waiting. Stymied by opponents who control key parts of the government and distracted by controversies such as attacks on Muslims suspected of killing cows, Modi’s Hindu nationalist Bharatiya Janata Party (BJP) has made good on only a few reforms.

His team says 2016 will be different. Modi faces an April 1 target for the launch of a nationwide goods and services tax (GST) that will do away with state sales taxes. The percentage rate of the new tax will be in the mid- to high teens.

Switching to a GST, a move business has urged for years, could increase revenue substantially, since any Indian who makes a purchase will pay the tax, says Rajiv Biswas, an economist in Singapore with research firm IHS Global Insight: The GST is “the one reform that’s really crucial among the ones stalled.” The federal government relies on customs and excise taxes for a big part of its budget. Only 3 percent of working-age Indians pay federal income taxes, IHS says. Most farmers are exempt, as are workers at small businesses. Sticking with today’s system, Biswas says, is “a lost cause.”

The Year Ahead

Although the income and excise taxes will remain in force, the real action will be the GST. Not only does it replace state sales taxes, ranging from 5 percent to 15 percent, it also ends the practice of imposing entry fees on goods coming from outside a state. Truckers can wait five hours or more at state border checkpoints, since they can’t enter cities until 10 p.m., the same time state workers start collecting levies on the goods in the trucks. The truckers also must often buy off corrupt officials. The status quo creates “artificial barriers that hamper movement of interstate trade and commerce,” Rajeev Bakshi, managing director at wholesaler Metro Cash & Carry, wrote in an e-mail. Replacing state taxes with the GST would “greatly enhance our ease of doing business.” The GST, by ending tax collection at state borders, would help turn India into one market.

To start the GST in 2016, Modi needs parliament to act quickly. Both houses must approve the tax, but the BJP controls only the lower one. The upper house is dominated by the BJP’s opponents. “This is legislation almost every politician, bureaucrat, and party fundamentally agrees on,” says S.L. Rao, former chairman of the Institute of Social and Economic Change in Bangalore. Yet non-BJP politicians aren’t keen to pass legislation that gives Modi a victory. The BJP blames the rival Congress party for blocking passage of the law. “The Congress strategy was to disturb the house and not allow it to function,” says Finance Minister Arun Jaitley.

Even if Modi wins upper house approval, he’ll also need the blessing of the states, which are reluctant to sign away a revenue source. “The timeline looks iffy at best,” says R. Kavita Rao, professor at the National Institute of Public Finance and Policy, a think tank in Mumbai that’s advised Modi. Still, “everyone knows the GST will help propel the economy when it passes,” says Madan Sabnavis, chief economist at Credit Analysis & Research, a Mumbai-based credit rating service. “And it will pass.”

    Before it's here, it's on the Bloomberg Terminal.