India’s Tax Gamble

India’s Tax Gamble

Modi government introduces a revolutionary tax regime

On July 1, India will toss its labyrinthine tax regime out the window and replace it with a more streamlined nationwide Goods & Services Tax (GST) that is hailed by many as the country’s most pathbreaking tax reform and deplored by others who fear it will turn the economy down.

The new system will eliminate India’s notorious complex layers of taxation including purchase, entertainment, excise, luxury and sales taxes (VAT) and others. Analysts predict that the GST, if properly implemented, will likely bolster the country’s GDP by 2 percent.

Union finance minister Arun Jaitley has likened the roll out of the GST – whose bill was cleared by both houses of Parliament last month after six years of stormy debate – to a revolution and the “most significant taxation overhaul in India.” Prime Minister Narendra Modi said the GST reflects the spirit of “one nation, one aspiration, one determination.”

The GST, a worldwide accepted tax system, was first introduced by France in 1954.  Presently, around 160 countries follow the GST or VAT in some form or the other. In some countries, analysts say, VAT is the substitute for a GST, but conceptually it is a destination-based tax levied on consumption of goods and services. However, only Canada has a dual GST model, akin to what India intends doing.

How it works

How will the new tax regime work?

“GST will change the way India does business with India – potentially the democratic world’s largest common market,” said Gurdeep Singh Soin, chief financial strategist at Reliance Capital. “The new system will have a single tax in the economy replace multiple taxes at the state level for goods as well as services. It will create something like a common market, wherein all goods and services, irrespective of their point of origin or transaction, will have a common treatment and a common, capped rate.”

Tax experts feel that the modified system will bring together the economies of all 29 Indian states and create a tax-on-value-add concept to avoid duplication of taxes. The assumed rate of GST will be 16 to 17 percent, less than half the current rate of taxation of 35-40 percent.

A unified tax system will also remove a slew of indirect taxes as well as the cascading effect of taxes, Soin said. “Manufacturing costs will be reduced, hence prices of consumer goods – cars, phones, FMCG goods – will also likely plummet. A unified tax regime will also be a deterrent to corruption which will benefit the common man.”

Cutting red tape

Other benefits include simpler administration which will ensure an easier collection of revenues, widening of the tax net and plugging of leakages and multiple taxations which will boost the government’s revenue stream and efficiency. For the consumer/tax-paying citizens, the GST would mean more transparency, proportionate taxation, relief in overall tax burdens, slightly cheaper goods and services.

India’s gold industry is optimistic that the gold supply chain will be more transparent and efficient. “It will also likely boost India’s economy which in turn will support gold demand, ” said Ved Prakash, a Delhi-based fourth generation jeweller.  “But there’s no denying that it is a long-term strategy and its real impact will be visible in the long run only. We’re not expecting immediate gains anyway.”

The GST, some hope, will also provide an edge to the travel and tourism industry by reducing costs for customers, streamlining taxes and thus promoting overall growth. Under the GST, rates finalized for air travel, flying economy will attract a 5 percent tax, down from 6 percent, making economy airfares marginally cheaper.

Concerns over consumers

However, current speculation around the GST and its implementation has also fuelled fears that this paradigm shift in the country’s taxation structure will lighten the common man’s pocket. Many feel that imposition will also result in a surge in prices of services like telecoms, banking and airlines. “If the actual tax benefit is not passed to consumers, and sellers increase their profit margin, the prices of goods will go up instead of down,” Prakash said.  

A 2000 study commissioned by the Curtin University of Technology in Perth, Australia highlighted that GST’s implementation negatively impacts the real estate market by adding up to 8 percent to the cost of new homes and reducing demand by about 12 percent. 

“India has opted for a dual-GST model which is a new avatar of the Central Excise/Service Tax, VAT and CST and hence it brings nothing new to the table,” said Vivek Bhateja, a Mumbai-based tax consultant. “The GST is a regressive tax, which will consume a higher proportion of poor people’s income, compared to those earning large incomes.”

One size may not fit all

Be that as it may, the new tax regime will change the game for the Indian economy. “Even assuming the GST delivers on the revenue front after an initial lag, one has to realize that it goes counter to the long-term trend of devolving greater powers to states,” according to an editorial in the right-wing Swarajya magazine. “It centralizes in the GST Council the powers of indirect taxation, and could thus be a constant source of friction between center and states, or between states if some gain or lose more than the others.”

Some chief ministers of Indian states have already expressed their dissent. “How is one-nation-one-tax good politics for all 29 states and several Union territories and the center given the fact they all have diverse economic strengths and weaknesses?” asked a senior Congress Party opposition politician.

Nor is it good economics, opine say. “If in the initial years, the government has to provide full compensation for revenue losses and 14 percent growth every year to every state, never mind whether you have a drought year, an industrial recession, or deteriorating bank balance-sheets? Will the blank cheque to states not make the fiscal deficit worse?” the Swarajya editorial asked.

The magazine goes on to quote the example of the European common currency, once lauded as path-breaking, which is now causing rancor in the European Union. Lesser-developed economies like Portugal, Italy, Greece and Spain have had to adopt extreme austerity measures that has sent unemployment soaring all over southern Europe. This has led many of the anti-EU states to consider a referendum on exiting the union a la Brexit.

In India too, there is a strong chance that the GST, the country’s boldest and riskiest tax reform yet, may give the ruling political establishment a greater headache than it may have bargained for. 

Neeta Lal (neetalal@hotmail.com) is a Delhi-based editor and journalist and a regular Asia Sentinel correspondent

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