One India, one market

The GST will decisively alter the economy for the better besides symbolising Indian politics at its cooperative, consensual best. Parliament should seize this historic opportunity

Hype and hyperbole are temptations to which government officials, in particular, must not succumb. Yet, it is difficult not to view the Goods and Services Tax (GST) Bill as a game-changing reform for the country; and, when it happens, it would be curmudgeonly not to acknowledge its passage as a major, historic achievement. Why is GST important? What can be said about its design? How does it compare with similar tax reform in other countries? Consider each question in turn.

Benefits in the offing

Three major benefits will flow from the GST. First, as the Prime Minister outlined in an interview, the GST will increase the resources available for poverty alleviation and development. This will happen indirectly as the tax base becomes more buoyant and as the overall resources of the Central and State governments increase. But it will also happen directly because the resources of the poorest States — for example, Uttar Pradesh, Bihar, and Madhya Pradesh — who happen to be large consumers will increase substantially.

Second, the GST will facilitate ‘Make in India’ by making one India. The current tax structure unmakes India, by fragmenting Indian markets along State lines. These distortions are caused by three features of the current system: the Central Sales Tax (CST) on inter-State sales of goods; numerous intra-State taxes; and the extensive nature of countervailing duty exemptions that favours imports over domestic production. In one fell swoop, the GST would rectify all these distortions: the CST would be eliminated; most of the other taxes would be subsumed into the GST; and because the GST would be applied on imports, the negative protection favouring imports and disfavouring domestic manufacturing would be eliminated.

Arvind Subramanian & Hasmukh Adhia

Third, the GST would improve — even substantially — tax governance in two ways. The first relates to the self-policing incentive inherent to a valued-added tax. To claim input tax credit, each dealer has an incentive to request documentation from the dealer behind him in the value-added/tax chain. Provided the chain is not broken through wide-ranging exemptions, especially on intermediate goods, this self-policing feature can work very powerfully in the GST. The second relates to the dual monitoring structure of the GST — one by the States and one by the Centre. Critics and taxpayers have viewed the dual structure with some anxiety, fearing two sources of interface with the tax department and hence two potential sources of harassment. But dual monitoring should also be viewed as creating desirable tax competition and cooperation between State and Central authorities. Even if one set of tax authorities overlooks and/or fails to detect evasion, there is the possibility that the other overseeing authority may not.

Other benefits such as the boost to investment have been documented in the Report on the Revenue Neutral Rate that was submitted in December last year. Of course, these benefits will only flow through a well-designed GST. The GST should aim at tax rates that protect revenue, simplify administration, encourage compliance, avoid adding to inflationary pressures, and keep India in the range of countries with reasonable levels of indirect taxes.

The fewest flaws at inception
The report also urged that the GST be comprehensive in its coverage, that exemptions from the GST be limited to a few commodities that catered to clear social benefits, and that most commodities be taxed at the standard rate. There is no free lunch here. There is no escaping the fact that the more the exemptions/exclusions, the higher will be the standard rate which could affect poorer consumers.

Some have levelled the charge that the design of the GST is flawed. But the “flawed GST” charge fails to appreciate how reforms actually occur. In no country is the GST — even today after many years of implementation — perfect, and was therefore quite flawed at inception. In complex systems, change is introduced, learning from implementation takes place, leading to further and better change. That is what happened with the implementation of the value-added tax by the States and that is what will happen with the GST. It is far better to start and allow the process of endogenous change to unfold over time than to wait Godot-like for the best time and the best design before it is introduced.

That said, we must also be realistic about the time frame for assessing the GST. The GST is fiendishly, mind-bogglingly complex to administer. Such complexity and lags in GST implementation require that any evaluation of the GST — and any consequential decisions — should not be undertaken over short horizons (say months) but over longer periods, say one-two years.

In understanding GST systems around the world, we have been struck by how ambitious and how under-flawed the Indian GST is. GST-type taxes in large federal systems are either overly centralised, depriving the sub-federal levels of fiscal autonomy (Australia, Germany, and Austria); or where there is a dual structure, they are either administered independently — creating too many differences in tax bases and rates that weaken compliance and make inter-State transactions difficult to tax (Brazil, Russia and Argentina) — or administered with a modicum of coordination which minimises these disadvantages (Canada and India today) but does not do away with them.

The Indian GST will be a leap forward in creating a much cleaner dual VAT which would minimise the disadvantages of completely independent and completely centralised systems. A common base and common rates (across goods and services) and very similar rates (across States and between Centre and States) will facilitate administration and improve compliance while also rendering manageable the collection of taxes on inter-State sales. At the same time, the exceptions — in the form of permissible additional excise taxes on special goods (petroleum and tobacco for the Centre, petroleum and alcohol for the States) — will provide the requisite fiscal autonomy to the States. Indeed, even if they are brought within the scope of the GST, the States will retain autonomy in being able to levy top-up taxes on these goods.

To have achieved this, in a large and complex federal system of multiparty democracy, with a Centre, 29 States and 2 Union Territories of widely divergent interests via a constitutional amendment requiring broad political consensus, affecting potentially 7.5 million tax entities, and marshalling the latest technology to use and improve tax implementation capability, is perhaps breathtakingly unprecedented in modern global tax history.

Sometimes, we are insufficiently appreciative of how much the country has achieved in coming to this point with the GST. As the Prime Minister suggested, credit should go to all stakeholders at the Centre and the States for having worked towards the GST. The time is ripe to collectively seize this historic opportunity; not just because the GST will decisively alter the Indian economy for the better but also because the GST symbolises Indian politics and democracy at its cooperative, consensual best.

Hasmukh Adhia and Arvind Subramanian are, respectively, Revenue Secretary and Chief Economic Adviser to the Government of India.