Nearly seven decades after India’s independence, the country has yet to become a single market for goods and services. Trade between states is subject to tariffs, and both the federal as well as state governments levy a myriad of taxes discouraging production and inter-state commerce.
Prime Minister Narendra Modi’s government has been attempting to change this with a big-ticket reform aimed at modernizing the nation’s arcane tax code. If Modi succeeds, it would mark a major achievement of his premiership and contribute to his core electoral promise of reinvigorating the economy.
A growth-boosting reform
The government wants to introduce a national sales tax, dubbed the goods-and-services tax (GST), which would replace more than a dozen types of federal and state taxes. Successive governments have tried and failed to implement the GST over the past decade.
“India currently suffers from a highly fragmented, multi-layered and complex indirect tax system,” said Sumedh Deorukhkar, Asia economist at BBVA Research.
“The GST is a nationwide value-added tax that will subsume most indirect taxes in India, enable voluntary tax compliance due to input tax credit and facilitate investment decisions independent of tax considerations,” he added.
But introducing it requires amending India’s constitution, which needs the support of two-thirds of MPs in both houses of parliament, as well as approval from at least half of the South Asian nation’s 29 states.
The measure has already been approved by the lower house as Modi’s ruling Bharatiya Janata Party (BJP) commands a comfortable majority in the chamber. However, it has been stuck in the upper house where the BJP and its allies lack the numbers to ram through the legislation.
Bringing in a single nationwide value-added tax is likely to provide a significant boost to the economy, with some economists estimating that growth could accelerate by as much as 1.7 percent a year.
The GST is also expected to bolster domestic trade and raise government tax revenues. In addition, it could help reduce overall tax evasion by giving incentives for businesses to declare transactions to claim tax credits.
A simplified, uniform tax, say experts, could also draw in more foreign investment and increase India’s competitiveness as well as attractiveness as a manufacturing location, thus helping Modi’s “Make in India” campaign – an initiative to transform the country into a global production hub. According to India’s ICICI Bank, some 140 nations around the world have already introduced a GST-style tax, with rates ranging between five to 20 percent.
Despite the numerous benefits, there has been considerable resistance to GST, with the main opposition Congress party emerging as the principal opponent of the measure.
It was the Congress party that first proposed the GST in 2006 when it was in power. The then-opposition BJP, however, brought parliament to a halt at various times to prevent progress from being made, as this would have given Congress a major legislative victory. “In return, Congress has recently adopted the same tactics to block passage of the GST in the Rajya Sabha, where Modi’s BJP lacks a majority,” said Shilan Shah, India expert at London-based Capital Economics.
Congress’ main demand is to set a constitutional cap on the maximum rate for the GST – at 18 percent. It also wants the government to scrap the proposal to levy an additional one percent central sales tax, and is calling for the setting up of a dispute resolution mechanism.
“Another key bottleneck in GST introduction is a lack of impending political consensus over several issues related to operation, infrastructure and consensus amongst individual states,” Deorukhkar told DW. This relates to the division of taxation powers between the central government in New Delhi and the states.
Although the states would receive a significant share of revenues from the GST, they wouldn’t be able to impose a number of state-specific taxes like they do now.
Nevertheless, hopes that the GST might finally pass during the ongoing parliament session are growing, said Shah, pointing to changes in the composition of the upper house following recent state elections.
“The BJP will remain short of a majority, but there will be greater representation from state parties, most of whom support the GST bill in some form or other,” he noted.
But even if it were to be passed in the current parliament session, several hurdles such as the drafting of legislation that needs to be approved by a GST council, and the process of seeking approval from at least half of the state legislatures will take a considerable amount of time, Chua Han Teng, Asia economist at BMI Research, told DW.
This view is shared by Shah, who stresses that there are “some stumbling blocks to implementation of the bill.”
Furthermore, experts say that India’s competitive federal structure makes it difficult to implement GST in its true form.
Unlike elsewhere in the world, Indian state governments are unlikely to abandon their current tax system anytime soon, thus having a negative impact on business, Deorukhkar underlined.
The economist also pointed out that the GST could leave a significant number of taxes outside its purview – such as on alcohol and petroleum – which can undermine GST’s ability to boost revenue gains.
“Also, in the near to medium term, a higher services tax rate in the advent of GST can pose an upside risk to India’s inflation outlook,” he said.
This is particularly the case as the GST, in effect, will eliminate taxes on production and distribution – and only final consumption will be taxed. While this benefits businesses, consumers may fare less well as producers and retailers of all kinds of products might raise prices to cover the duty.