India's Battle to Become a Single Market
One of the most complex policy discussions in the history of modern India -- one that affects almost every citizen; involves debates about federalism, economic history and statistical techniques; requires the cooperation of more than half of the nearly 30 state governments; and passes through dozens of permutations of conflict and compromise -- appears to have reached its endgame.
As plenty of episodes in economic history prove, only a tax could have roused men to such peaks of passion and obduracy, paranoia and optimism. But the stage is finally set for a comprehensive goods and services tax, or GST, to be introduced in 2016: An amendment to the Indian constitution has been approved by the Union Cabinet and could reach the parliament in the coming week.
The proposed legislation is a historic one: It would make India a unified market for the first time. A single comprehensive, value-added tax on goods and services (the revenues from which will be shared between the central government and the states) will replace a slew of taxes currently in place in India, remedying -- in principle -- the many distortions and duplications of the current system and in all likelihood provide a small but significant boost to the economy.
Because it is not based on the purchase price of a product or service but on the value added at each stage of production, the GST is expected to make Indian manufacturing and exports more competitive, as well as improve tax compliance. It should eliminate many logistical logjams, too -- a World Bank study in 2005 showed that Indian truck drivers lose millions of operating hours each year stuck at interstate checkpoints, negotiating an often corrupt bureaucracy -- and vastly increase the speed of freight.
And it will bring an end to the fractious and sometimes preposterous debates in India on what is a good and what is a service, as different tax systems (sales tax, service tax), each with an accumulated strata of arcane qualifications and exemptions, are currently activated by this distinction. Not bad for a tax system that almost no one had heard of 60 years ago but is now considered one of the most important innovations in the history of taxation.
Nevertheless, there has been considerable resistance in India to the move from a decentralized system to a universal GST. The debate channels another ubiquitous theme in tax history: the division of taxation powers between the central government and the states in a federal system. Although Indian states would get to keep a significant share of revenues from the GST, they would lose the powers to levy a wide range of (quite lucrative) state-specific taxes currently in force all over India.
Even the central government has acknowledged that the states must be given something to sweeten the deal and push the reform through. But what exactly, and how much? It has offered to compensate states for any loss of revenue for the first three years, but other concessions could derail the system itself. For several years now, states have lobbied to keep some low-hanging fruit -- most notably, petroleum products and alcohol -- off the GST list, as they are major sources of tax revenues, and demand for them is relatively price-inelastic. If states were to have their way, they would retain a considerable amount of fiscal autonomy.
But in a GST-style system, how can one leave out a key capital input such as petroleum without dragging the entire mechanism of value-added taxation down? As negotiations have dragged on, optimism about the GST’s inception has died down. It’s become clear that the GST is not a magic wand, and that its projected benefits will depend greatly on the quality of the design of the new system and the universality of its application. Indeed, the difference between different kinds of GST systems may be greater than the difference between a GST-based system and the one it replaces.
This week, as the proposed reform appeared to be close at hand, economist Arvind Panagariya broke with the positive consensus on the GST. “Given the vast exclusions, high GST rate and evasions the high rate would attract, this is not going to be the game-changer reform that was once considered," he wrote in the Times of India. "There are other reforms India needs that would bring more and certain benefits and would require far less effort and political capital.”
It seems clear that the new tax regime will require a considerable amount of time -- perhaps a decade or more -- to be broken in. Its flaws will have to be pointed out only when they have imposed their costs and conflicts. In the interim, the new system will serve (as with the recent policy changes for tourism) as a vast natural experiment. There will be fascinating data on revenue collection for economists to break down and new numbers to compare with old ones.
There’s a great deal of sense, then, in economist M. Govinda Rao’s advice that the GST reform be considered “a process rather than an event.” Even so, if India manages to kick off the new tax system by 2016, it will still be a major event of sorts, more because of its sharp break with the past than its assurance of a better future.
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