India's Big New Reform Should Be Just the Start
In opening up sectors from aviation to defense to 100 percent foreign ownership this week, India's government is clearly hoping to signal that its reform drive is revving up again. Next on the agenda may be one of the most far-reaching new measures in years: a long-awaited, nationwide goods-and-services tax, or GST.
Skeptics have reason to roll their eyes, of course. Indian leaders have been promising to introduce a GST for at least a decade. What even optimists should be worried about, though, is getting the new tax to work.
All sides accept the need for a GST. In many ways, India is currently less of a single market than the European Union. Different states have different -- and hideously complicated -- regulations. Their licensing schemes vary and their tax systems aren’t interconnected. There's a reason Indian companies are, on average, smaller than their global counterparts: The moment you grow out of your home state, even if just to open a warehouse elsewhere, your paperwork increases exponentially.
For months, the opposition Congress Party and its regional allies in the upper house of Parliament have stalled the GST bill -- whether out of principle or political obstructionism depends on one’s point of view. Now, though, Prime Minister Narendra Modi’s government says it’s corralled most of India’s fractious and demanding regional political players into supporting the measure, and all but one of India’s state governments. Modi’s Bharatiya Janata Party should have enough votes to pass the constitutional amendment needed to bring the tax into force.
If this gets done in the next session of Parliament as hoped, taxpayers and investors will rejoice -- out of relief that something so big and fiercely contested has finally been passed, if nothing else. It would be a great signal for reforms in general, suggesting that India’s cutthroat and dysfunctional politics can’t stand in the way of a good idea forever.
But it’s vital to remember that passage of the bill will only be the beginning of the battle, not the end. And the costs of adjustment will be considerable, at least in the short-to-medium term.
For one thing, we don’t yet know what the eventual GST tax rate will be. Unless designed with as few exemptions as possible, the “revenue-neutral” rate -- the level needed to ensure that government receipts don’t decline after the GST is introduced -- could be significantly higher than what many businesses now pay. That could damage both business sentiment and overall demand, which is already struggling.
Most Indians aren’t prepared for the temporarily higher prices likely to ensue as many businesses are forced to pay tax for the first time. Currently, enterprises with a turnover of less than 15 million rupees annually (about $223,000) aren’t subject to excise tax; the Finance Ministry has convinced states to lower that threshold sharply, to 1 million rupees, or just $15,000. Yes, expanding the tax net has its advantages: It will help reduce the size of India’s “black,” or informal economy and cut corruption. But small business owners are almost certain to pass along some of the burden to consumers.
In addition, services are currently taxed in India at 15 percent. If the final GST tax rate is higher, which it may well be, then that’s likely to boost inflation as well. And there’s nothing much that anyone can do but wince and wait for the initial effects to subside.
What can be fixed, even in the short term, is the paperwork. Some worry that, with its usual brilliance, the Indian bureaucracy might actually be able to make compliance with a GST tougher than the existing system. One would imagine a single national tax system would require only a single tax form. In fact, it’s been suggested that every enterprise might have to file several forms -- one for the central GST, one for the state GST in each state in which it operates, and one for the “integrated GST” on inter-state transfers. This is certainly not going to make doing business easier. The final system will have to slash paperwork significantly if it’s to boost growth by the two percent that some studies suggest it will.
The most realistic way to look at the GST bill is as a first step in a long struggle to integrate India’s many markets. Agriculture, for example, desperately needs a national market so that farmers can connect directly with their customers and bring down India’s endemic food inflation. Licensing and environmental regulations need to be harmonized across states. The government has left labor law reform to the states, which means that a patchwork of different regulations governing hiring and firing might soon come into effect.
Unless the government picks up the pace on these other reforms as well, creating a true single market might take longer than it took the Europeans. In India, even one promise kept is cause for celebration. But it’s critical to build on that momentum quickly, lest disappointment make future reforms even tougher.
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