India Bill Unites 1.3 Billion Consumers
By Vrinda Gupta | June 29, 2017
While India’s Prime Minister Narendra Modi visits U.S. President Trump for the first time, his government is set to roll out his new transformational tax reform, the Goods and Services Tax (GST). After nearly a decade of bureaucratic stalling, the bill will officially be implemented on July 1st. All states are on board, and Google CEO Sundar Pichai hailed the bill as a “game-changing reform.” This piece of legislation comes from the same bold administration also responsible for the risky demonetization experiment. In a historic move, the 29 states and 7 Union Territories will be under one common market, with a single nationwide tax. Government research found that implementation of the GST will drive economic growth and increase tax revenue. There are also predictions for a smoother state-to-state transition of goods and more incentives for foreign investment.
Middle men are everywhere in India. Most commodities in the country go through 4 stages of production: manufacturing, distributing, wholesale and retail. The price is increased at every stage, mainly due to value addition, but also due to sales tax, which makes the final price higher than it should be. Now, with GST, tax will only be on the profit made by the middle man. It does away with double taxation and, perhaps more importantly, reduces tax evasion albeit to a certain extent. To redeem tax credit, it is necessary to disclose all records of profit and further pay the required tax on it. In a country said to have more black money than the rest of the world combined, any prevention of tax evasion will be huge. Unfortunately, this check does not extend to income tax, a big source of the illegal cash.
Most of the 150 countries that have adopted GST use a single rate structure. However, Finance Minister Arun Jaitley says the bill will be highly regressive without multiple rates. The bill pushes a general increase in tax rates as some goods become less essential. There are 4 divisions of rates, with coal in the 5% division, and luxury cars and air conditioners in the 28% division, the highest. Most products will lie in the middle 12% to 18% divisions, while agricultural products and health and education services will be exempt. The government has faced criticism for including sanitary napkins, an indispensable household product, in the second highest division of 12%. Despite the protests of 11 million women, the product was grouped with sports goods and artifacts. Another disadvantage of this clause is the potential dispute over the appropriate classification of goods. Although the multiple rate structure may seem complex, it aims to improve the current system while maintaining prices and inflation.
A typical truck in India spends nearly 16% of its time in 3 kilometer long queues at checkpoints along state borders. Different states have starkly different tax structures and existing procedures require that the excessive hard-copy forms be checked on the spot. This reduced efficiency is detrimental to both producers and consumers. The GST will subsume 6 different Central Government taxes and another 6 state government taxes, thus simplifying the system and doing away with most state barriers besides tolls. A more transparent system should spur easy movement of goods and a higher productive capacity for transportation services.
The underlying principle of this indirect, consumer-based tax, “One Nation, One Rate,” has yet to see the light of day. Highly lucrative products such as fuels, drinking alcohol and real estate are kept out of the GST regime, facing multiple other duties and charges. Also, temporary slow growth is expected, stemming from the frenzy around any new system. Modi has decided to be lax on filing requirements for the first two months to allow more time for smaller businesses, in more inaccessible areas, to adapt. Regardless, eliminating the tax cascade and bringing all states under one tax policy will reduce complications. An economy boost is always welcome, but perfect execution is a must when changing a system that currently includes 1.3 billion consumers.