A new fiscal reform has the power to lift India’s economy into orbit
What do Indian engineers and Elon Musk, the man behind the world’s first reusable rocket, have in common? They’re both trying to grow space travel into a big business by making it cheap as chips. New Delhi’s blasting ahead in the race: in June, India successfully launched 20 satellites on a single rocket – the third-highest number ever sent off at once (a week later Musk’s Falcon 9 exploded in flight).
But this month it’s a more earthly matter that some describe as a fresh injection of “rocket fuel” for India. On August 9, lawmakers passed a constitutional amendment enabling a nationwide Goods and Services Tax – a policy in the making since 2000, and the country’s biggest tax reform in 70 years. Politicians are so happy with themselves that even bitter political foes of Arun Jaitley, India’s finance minister, got invited to an epic celebratory banquet he hosted on the day. TV anchors and columnists have been on cloud nine ever since.
“The GST is completely revolutionary, the sort of economic backroom plumbing that changes your life without you even noticing it," says Mihir Sharma, an Indian writer.
Understanding why something as arcane as a tax reform is making everyone ecstatic isn’t, well, rocket science. The purpose of GST – often known elsewhere as VAT – is to help turn India’s $2 trillion economy into a common market. Achieving this would bring down the cost of goods, converting India’s strong domestic demand into economic growth; it would also make Indian companies more competitive, allowing them to export more of their stuff and attract more investment from abroad.
“If implemented properly, it should result in a significant increase in the growth rate of GDP,” Pinaki Chakraborty, a professor at New Delhi’s National Institute of Public Finance and Policy, told me last week. Estimates range from 0.8 to 2 percent – no small boost for India, which at 7.5 percent is already the world’s fastest-growing large economy.
“The GST is completely revolutionary, the sort of economic backroom plumbing that changes your life"
Under the current rules, states and central governments levy multiple taxes. Some of them are charged on production, others on consumption; goods are taxed by the states, while the central government taxes services. Products are also taxed when they get sold to another state, which often charges an entry tax at the other end. This byzantine system often leads to double taxation. It also creates long queues of trucks at state borders, a source of logistical nightmares, and generates hefty compliance costs. For governments, this has a nasty side effect: only 20 percent of Indian businesses pay taxes.
The GST will simplify this system by bringing 17 state and federal taxes under one roof, with a common levy applied nationally on both goods and services.
“That will put an end to the tax-induced fragmentation of markets. Our domestic economy will get liberalised because there will be one tax throughout the country,” says Chakraborty.
But for that to happen, more than half of India’s 29 states need to ratify the bill. Could that be a problem? Historically, states have had a hard time accepting the concept. And the reform’s timing is ambitious: Prime Minister Narendra Modi is committed to roll out the supertax by April 1 next year.
“You have to understand the political economy of tax reform in India,” notes Chakraborty. “The taxes that states collect on goods represent about 70 percent of their fiscal revenue.” States will continue to tax goods, but that power will now be shared with the central government. If the GST rate is 18 percent, for instance, states and federal authorities will in most cases pocket 9 percent each. “For states, giving up that exclusive power is a decision that requires a lot of deliberation, and the resolution of many conflicts of interest,” Chakraborty says.
Why would they accept? Because, in exchange, they get to start a lucrative new business – taxing services. “In that sense it’s a win-win situation for both centre and states, because they can all expand their tax base.”
At least that’s the theory. The complicated thing, says Chakraborty, is that “it’s not just centre versus states. It is also a tax that plays out differently for different states”. GST is a destination-based levy, meaning that a product is taxed only where it is consumed. Big manufacturing states, like Gujarat and Maharashtra, could therefore stand to lose big. Federal authorities have pledged to plug the shortfall with money transfers for at least five years – but compensation remains a sensitive topic.
No surprise then that Mamata Verma, industries commissioner of Gujarat, declined to comment on “political” questions when I probed her on GST last week. Instead, she preferred to focus on what has made her state one of India’s manufacturing engines: “a combination of good governance, political stability and focus on development of robust physical and social infrastructure”.
The GST should induce many more businesses to pay their taxes, which may help convince states that the reform is also a good deal for them. Like VAT, the tax has a self-policing aspect to it: companies can deduce the tax they’ve already paid on inputs – the intermediary stuff they use to manufacture products – from the GST they’re liable for when they complete a sale (otherwise they’d be paying GST twice). In order to do that, however, their suppliers have to fulfil their own tax obligations as well.
“Rather than the tax officer, it will be your customer who is shouting at you to pay your tax,” Rajeev Dimri, a partner at accountancy firm BMR, told the FT earlier this month.
A lot could still go wrong. The reform’s details have yet to be hammered, starting with the tax’s basic rate – something that’s likely causing headaches to the GST Council, the body responsible for converting the concept into concrete policy. On this point the centre and the states’ interests diverge: the former favour a lower rate, to avoid stoking vote-sapping inflation, while the latter want to raise more money through a higher levy. “It’s a delicate balance that will have to be achieved,” Chakraborty says. Many analysts reckon the debate will end up settling on 18 percent.
Other challenges abound. Petroleum and alcohol products remain exempt from GST, leaving a big chunk of government revenue out of the reform’s remit. It is not known if and when these will be brought under the main regime. Higher-than-expected compensation payments to states could also push the centre’s finances in the red. Arun Jaitey, India’s finance chief, wants to bring the fiscal deficit down to 3 percent by 2017. It’s not clear this target remains realistic.
But the main challenge will be to implement the reform on the ground. India’s fiscal revolution will need entire IT systems to be revamped, and armies of civil servants and compliance officers to be trained. Governments seem ready to put money where their mouth is: Indian software giant Infosys is building a $200 million electronic platform to help administer the levy; 60,000 tax officials are due to receive training on GST laws and IT between now and March 2017. Yet the task remains formidable, and few nations with similar ambitions have got it right the first time.
A successful GST rollout would delight India’s businesses. It should also please the common man: the country’s indirect taxes on goods currently add up to an average 25 percent; replacing them with a GST at 18 percent should make everyday products cheaper. But before getting there, India’s facing a stellar amount of work. Time to get back to earth.