India’s One Nation Sales Tax Depends on Local Statesmanship

India’s one nation sales tax depends on local statesmanship.
August 10, 2016 • Commentary
This article appeared in Financial Times on August 10, 2016.

One nation, one tax, one market. That is the aim of India’s goods and services tax, for which a constitutional amendment was last week passed by the upper house of parliament after years of wrangling. One single tax code will replace the welter of 15 different codes at central and state levels. The World Bank’s 2016 “Doing Business” report ranks India at 157th of 189 countries in the ease of paying taxes, and the GST could transform that.

It will also check tax evasion. Its software will enable the matching of 3bn‐​5bn invoices per month, identifying evaders. It will help match indirect tax payments with the payment of (or failure to pay) income tax. Only 12.5m of 1.3bn Indians pay income tax currently.

The GST will reduce paperwork, disputes, corruption and logistical costs. The Infrastructure Development Finance Corporation, India’s top infrastructure financier, estimates the tax could raise India’s GDP by 1–2 per cent. Yet good implementation is crucial — never the country’s strong point.

The IDFC estimates that the nation’s trucks travel 280km a day against about 800km in the west — a discrepancy caused by hassles, delays and corruption at state and city border checkpoints. The GST will subsume all existing state and city entry taxes into a single tax collected at the point of consumption. Not all checkpoints will disappear: some will remain to deal with criminal activity and vehicle registration. The Essential Commodities Act empowers states to restrict the movement across state or district borders of items such as grain, vegetables, edible oil, alcohol and petroleum products, and will continue to do so after the GST is enacted. So corrupt border officials may still find ways to harass truckers and extort pibes. India will not become a seamless market. But delays and corruption should fall drastically.

The constitutional amendment must now be ratified by the lower house and a majority of states. Then a GST council, comprising the central and state finance ministers, begins the crucial task of determining tax bands for different items. These rates will have to be passed by the central and state governments.

An expert committee had suggested four tax bands — zero for essentials, 12 per cent for “merit” goods consumed mostly by poorer people, a standard rate of 17–18 per cent and 40 per cent for luxury goods. However, the council may have different ideas. The GST will not cover alcohol and petroleum products: the states will be free to set their own rates for these high‐​revenue items.

State governments need to show statesmanship in accepting tax uniformity as a public good. History suggests that such statesmanship is in short supply. Big disagreements are possible in the GST council on the number and coverage of tax bands. Some states want the standard rate to be over 20 per cent, which New Delhi opposes as inflationary. Some states, such as Kerala, claim they have the right to set their rates well above or below those of the council, seriously eroding the “one nation, one tax, one market” ideal. A dispute settlement mechanism is being set up but it will take time to deliver its verdicts.

The new law obliges New Delhi to compensate the states for all revenue losses from the switch to the GST for five years. There is no clarity on how these losses will be computed, leaving much scope for quarrels and heartburn.

Staff retraining, new documentation and the digital network for switching from multiple taxes to the GST have been in the works for some time but are far from complete. Tax disputes and litigation are rife today — and a switch to a new system will inevitably create many new areas of dispute, with officials and economic actors offering very different interpretations of the rules. In the long run, a simpler, more uniform tax code should reduce disputes and litigation. But in the short term the pain of transition could actually worsen the problem.

Arun Jaitley, the finance minister, has set April 1 2017 as the deadline for implementing the GST. This looks very ambitious, given the technical and staffing problems and the need for the GST council to decide on the number, rate and coverage of tax bands. These are thorny political issues, and swift decisions are far from certain.

Still, Mr Jaitley is right to push for an early deadline and then fix problems as they arise. In many countries, fixing glitches in a new GST has taken years. India may be no different. The policy is best seen as a process. It may be messy and drawn out, yet it has great potential.

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