Reblog: Goods and Services Tax will transform Indian economy

The original article appears in the Khaleej Times and is available here.

Building a consensus and getting all political parties on the same page was the biggest hurdle.

A uniform Goods and Services Tax (GST ) will soon be a reality in India following the passage of constitutional amendment bill in its upper house of Parliament on Wednesday. The bill now allows the central government to frame law for a unified tax regime in the country for most products and services and do away with as many as 17 indirect taxes prevalent at the central, state and concurrent levels. As of now, taxes are fragmented along states and push costs up by 20 to 30 percent.

Building a consensus and getting all political parties on the same page was the biggest hurdle. Now, it is just a matter of time, more discussions and debates, and ratification by the state assemblies before India will be able to introduce a uniform tax and join a league of more than 160 nations that enjoy a single tax regime.

Why is it important and why are most industry experts heralding it as a truly transformational move? Well, that is because of the multiplier effect a common tax regime could usher in the Indian economy. “The multiple and cascading taxes that make India a very high cost and fragmented market with massive tax revenue leakages will be replaced by a simplified and unified tax structure. India will truly become a Common Market instead of the 29 state markets it is divided into at present,” says Ajay Bagga, a veteran market expert based in India.

Over the long term, that GST is expected to bring down the cost of capital goods, increase tax collections, help in attracting investments from abroad, increase the ease of doing business, bolster the manufacturing sector and exports, and generate more jobs in a country where two-thirds of Indians are under 35, and almost a million enter the workforce each month.

“While everyone talks about global trade and how free trade across the world can help economies grow, few people discuss how difficult it can be to trade within a country. A good GST regime is a step forward in that direction.GST should likely boost manufacturing by simplifying the complex taxation systems, however, it is going to make services a lot more expensive. Services taxes were below 13 per cent in India till recently, and are now at 15 percent. The GST rate looks to be 18 percent, a significant increase,” says Pavan Srinath, a policy researcher at Bangalore-based Takshashila Institute.

Manufacturing will get more competitive as this tax addresses cascading of tax, inter-state tax, high-logistics costs and a fragmented market. Consequently, it will prop up the GDP growth rate too and give a much-needed boost to the Make in India initiative of Prime Minister Narendra Modi. HSBC estimates an 80 basis point rise in GDP growth over the next three to five years, while the National Council of Applied Economic Research (NCAER) suggests there will be a 90 basis points to 170 basis points jump in GDP numbers largely due to the elimination of tax cascading.

“Logistics and consumption industries like FMCG, consumer durables will benefit the most. Also sectors like auto, which used to be hit with entry taxes like octroi, will benefit with one common market. However, service industries like telecom, banking services as well as industries that enjoyed lower taxation (jewellery, pharma, etc) will see higher tax outgos, and could pass on the burden to customers,” explains Bagga.

Resident Indians and NRIs

The common resident of India is likely to benefit, as manufactured goods should become cheaper. Services, however, might become more expensive but the ease of starting and doing businesses in India will improve significantly – which bodes well for encouraging entrepreneurship and making India a hot spot for new businesses.

Non-resident Indians (NRIs), on the other hand, who export goods from India will benefit as cascading multiple level taxes will be subsumed under a simple one tax structure. There will be less tax harassment and easier compliance for NRI businesses.

Rate discussion

But much depends on the rate of GST. It will free manufacturers from the burden of multi-level taxes, as the tax will be levied only at the destination. It will affect manufacturing states such as Maharastra, Gujarat, Tamil Nadu, etc.

So the whole idea is to bring down the overall cost of goods and services. In this regard, too high a rate will definitely hurt the service industries and consumers. However, too low a rate will likely be a regressive move as it might affect the revenues of manufacturing states.

The larger consensus on the standard GST rate is around 18 to 19 per cent. A panel headed by Arvind Subramanian, Chief Economic Advisor, has recommended a revenue neutral rate of 15-15.5 per cent and a standard-rate of 18 per cent.

The panel has also recommended a three-tier rate structure for implementing of the tax regime. As per the proposal, essential goods (the ones that impact the common man) can be taxed at a lower rate of around 12 per cent; goods such as luxury cars, tobacco products, pan masala, aerated beverages, (which are categorised as demerit goods) can be taxed at a higher rate of 40 per cent. The rest can attract a standard rate of 17 to 18 per cent.

A GST is the right way to go for an economy as aspirational as India that wishes to be the growth engine of the world. China, for instance, had revamped its taxation law preceding the manufacturing boom that it enjoyed for decades starting in the early 1990s.

But it took almost 13 years for the country’s ruling party to build consensus and get things moving. A GST regime heralds a transformational reform that might elevate PM Modi’s position as an economic moderniser, improve India’s economy and bring along a powerful campaigning spiel for the next general elections.