GST: Unity in Diversity

IN THE DAYS after the Goods and Services Tax (GST) was launched, scenes that were once unimaginable in Independent India were witnessed across the country. Once infamous octroi barriers that held up snaking lines of trucks at state borders vanished almost magically. From Dahisar in Mumbai to the outskirts of the National Capital Region, goods began moving freely like never before. There were lighter moments too: social media platforms were flooded with pictures of bills from roadside eateries, proudly showing central and state GST added to the tax tally.

If all this were not enough, in the tense days after the midnight launch of GST to mark the turn of date to July 1st, 2017, the equity market signalled its approval with a price appreciation of stocks that were expected to be thumbed down due to high rates under the new tax regime. From automobiles to FMCG companies to bellwether infotech stocks, all had investors cheering. These came as welcome signs after a barrage of negative publicity about imperfections and compromises in the GST rollout.

It is early days, of course, and there is plenty that can still go wrong. A large number of small businesses are yet to migrate to the new tax system; there are doubts about the nuts and bolts of the rollout machinery, and from the Finance Ministry down to grassroots tax officials, everyone is busy issuing clarifications and denying rumours swirling around GST. A watchful group of Union Government secretaries is keeping a daily vigil on prices and quantities of various goods in different states and markets of the country. But as far as launches go, the GST has made its debut with relatively few glitches.

It will be a while before ‘one nation, one tax’ becomes a full reality. In some states, GST legislation is yet to be passed by their assemblies. In Jammu & Kashmir, the debate over the law has been fractious to the point of fistfights in the House. In Srinagar, the PDP- BJP state government has moved a resolution in the Assembly in favour of GST with an understanding of the implications of being left behind as the rest of India shifts to it. In Tamil Nadu, the state government has imposed a 30 per cent local-bodies tax on film screenings in what appears to be a violation of its basic principle. The boycott by some opposition parties of the GST launch in Parliament, perhaps the most important tax reform since Independence, topped all this and left a bitter aftertaste.

Globally, the reaction has been largely positive. In a world of economic gloom, India is seen as a bright spot. The tax reform is considered a force multiplier for an already fast-growing economy. In its comments soon after its launch, Fitch Ratings, a credit assessment agency, said, ‘The unified national system should offer significant opportunities for productivity. For example, it will become much quicker and less costly to move goods across the country now that trucks will not be held up at checkpoints at state borders. Smoother logistics should reduce retailers’ need for working capital and allow them to operate centralised warehouses, rather than in every state.’

The contrast between global optimism over the tax reform and domestic pessimism—or even envy—in some quarters is striking. Much of this is clearly political, even if some rough edges are still to be smoothened. The fact that GST finally became a reality in India’s otherwise fragmented political system is impressive in itself.

If the boycott of the GST launch and the constant nitpicking during its formulation—such as the demand by the Congress party to include the rate of taxation in the Constitution—were jarring, it is important to understand why these controversies emerged in the first place. This is not just another ambitious tax reform which will enable India to grow at a higher pace; it has political implications as well. For starters, ‘one nation, one tax’ is not a mere slogan: GST binds the entire country into a single, seamless, indirect tax network, something that could not be achieved for 70 years after Independence. This has not only led to a scramble for a share of the political spoils, like credit for the achievement, but it also has a bearing on the future political success (or failure) of various parties.

The entire controversy about GST rates, its date of launch and the haggling between the Centre and states is a product of political calculations by various parties. All these issues are linked. They are not just matters of historical curiosity, but could also affect how GST evolves in the years ahead.

Much before the midnight launch came the issue of the GST rate. In an ideal world, a single rate would have prevailed, in contrast to the four under GST as it exists currently. A committee led by Chief Economic Advisor Arvind Subramanian undertook a detailed study of what the rate ought to be. It also looked at the vexed matter of a ‘revenue neutral rate’. These two issues were at the heart of the bare-knuckled fight between the Union and state governments. A revenue neutral rate is one at which the sum garnered under GST remains the same as the money collected under the earlier system. Addressing this issue was crucial if GST was to see the light of day. On one hand, the states alleged there was a ‘trust deficit’ between the Centre and them and unless a ‘sufficiently high’ rate was set, they would lose revenue. On the other hand, for the Union Government, it was important to keep the rate low and ensure that not too many rates prevailed. Otherwise, the purpose of the reform—to simplify and consolidate an unwieldy mass of indirect taxes—would be defeated. Worse, a higher rate would stoke inflation, making the task of macroeconomic management tougher.

In the event, Subramanian outlined various scenarios based on data on Value Added Tax (VAT) collected from 16 states that amounted to almost 79 per cent of VAT in the country. On this basis, a rate of 11.6 per cent was suggested for revenue neutrality. While this calculation was based on impeccable economic reasoning, it would have cut little political ice with the states; protests that their tax base was much lower would have sunk the GST even before a Constitutional amendment for it could be drafted. So the committee outlined other scenarios—based on the assumption that states collected much less tax—and suggested an upper limit of 15.5 per cent for GST. It stated: ‘[A revenue neutral rate] of anything beyond 15-15.5 per cent will likely result in a standard rate of about 19-21 per cent which would make India an outlier amongst comparable emerging economies.’

Finally, after much hand-wringing, that rate was not accepted. The standard rate for GST now varies from 5 to 28 per cent. On paper, most inflation-prone goods—including food items—have been either left untaxed or bear a low rate of taxation. This does not mean that their prices will remain untouched: any good sold in a market does not exist in isolation. It uses raw materials and intermediate products for its manufacture. It also needs various services for production and then needs to be transported to a market. These ‘invisible’ items can increase its final price. It is for this reason that secretaries in Delhi and the network of field officers across India have their eyes glued to spreadsheets of output, availability and prices. Even a slight price shock can have a magnified political effect.

Another worry that had pit the Union Government against opposition parties was the alleged ‘under preparedness’ and ‘unseemly hurry’ in launching the GST. On paper, the opposition’s claims appeared sound: why undertake such a massive exercise without all its systems well in place? Among the issues at hand are the teething problems of the GST Network (GSTN), the countrywide database that is at the core of implementing the tax. There have been suggestions of vesting the network’s ownership with a private company that would have a 51-per cent stake in it. More pressingly, it has been argued that small traders and other businesses are not ready with all their GST requirements. These range from getting an identity number and accessing the internet for the filing of returns to understanding various processes under the new tax regime.

There is, however, more than just plain concern for small traders and businesses. The issue is also linked to the tactical nature of Indian politics. Globally, experience shows that inflation rises in the first six to eight months after the launch of a GST. In a price-sensitive country where rising prices of common commodities—onions are a good example—can unseat ruling governments in elections, the timing of GST is important. If under the assumption of ‘full preparedness’ the launch of GST were delayed by another year or so, the political effect of a possible inflationary spike would have put the NDA Government in a tough situation while landing the opposition in a sweet spot. The unfolding of events around the reform over the last 18 odd months illustrates this consideration. Eventually, the NDA managed to take all its partners—state governments, the key bearers of India’s fortunes—along with its plan.

The start of GST is only the first step in what is a long journey. At the moment, everyone—Centre, states, tax officials—is busy managing a smooth transition. This is probably not the right time to look at policy shortcomings. But sooner or later, the GST Council will have to take a hard look at reducing the number of tax slabs and, when it is politically feasible, bring down the peak rate. That is the only way to widen the tax base under GST and reap its full benefits. Fulfilling the promise of GST is a story that is yet to be finished.

Arun JaitleyeconomyGSTParliamenttaxation