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Can India Tax Itself to Prosperity?

By Chandrahas Choudhury
November 13, 2012 10:50 AM EST

India's central and state governments are edging closer to an agreement on a design and deadline for the Goods and Services Tax, a comprehensive value-added tax that will replace many smaller taxes and levies and will make India a unified market. The proposed tax reform has been described as having the potential "to be the single most important initiative in the fiscal history of India."

Long in the pipeline, the Goods and Services Tax has been on the to-do list of the current government, the UPA, since it came to power in 2004. Finance Minister P. Chidambaram laid out the need for the switch in 2006, saying in his budget speech that year:

It is my sense that there is a large consensus that the country should move towards a national level Goods and Services Tax that should be shared between the Centre and States. I propose that we set April 1, 2010 as the date of introducing GST. World over, goods and services attract the same rate of tax. This is the foundation of a GST.

But that date has come and gone without the impasse over the GST being solved, and so have further deadlines. The implementation of the new system has been held up on many fronts: disputes over its precise shape, resistance on the part of some state governments because they fear a loss of revenue from the levy of state taxes, the need to amend the Constitution (which has a different view of taxation powers divided between the central government and the state than the one the GST envisages), and the absence of any concerted pressure from the citizenry. Tax reform is a subject less conducive to strong feelings than, say, the proposed anti-corruption bill that has generated so much sound and fury in India.

But not only would the implementation of the Goods and Services Tax increase government revenue, it would have a tonic effect on the battle against corruption, too, by simplifying a byzantine tax system and encouraging what economists call "virtuous growth." A strong case for the GST was made recently in Tehelka by Jaitirth Rao, who pointed out that the current system of multistage taxes on the manufacture and sale of goods and services in India often has a cascading effect, and unfairly penalizes tax compliance and rewards evasion. This system could be rationalized by a sophisticated last-point retail tax like the GST. Rao also argued that interstate taxes have created barriers to trade that are holding back the prosperity potentially available to a vast country that works as a unified market, and pointed to the contrast between the U.S. and the smaller economies of South America as an example:

The US is one large market for goods, services, capital and labour. The countries of Central and South America are all relatively ‘small’ markets and they all have barriers to trade and investment in small or large measure. Just imagine if there had been trade barriers between New York and New Jersey or between Pennsylvania and Virginia. That is how Latin America is organised. The existence of a large market without trade barriers has been perhaps the single most important reason for the economic success of the US. ...

The structure of sales tax in India has a built-in inflationary bias also. There are repeated instances of double or triple taxation as raw materials are turned into intermediate goods and then into final consumer goods. In any intelligently designed indirect tax system anywhere in the world, cascading of taxes and the consequent price escalation is avoided by allowing each seller to take into account the taxes he/she has paid while buying the inputs and “offsetting” the taxes paid earlier in the supply chain. But given that the taxes are levied by different states, this has not been possible in India. ...

For so long now, we have known that the multiple state sales tax process is bad news. It makes us poorer as a country; it is inefficient and inflationary; it encourages criminal activity as people take recourse to smuggling rather than legitimate inter-state trade; it reduces state revenue in more ways than one and it penalises honest citizens. ...

Our large population and large market are strategic assets for India. They can be a source of competitive advantage. We are in danger of frittering this advantage away by perpetuating the existence of “mini markets” and internal tariffs.

In a recent address to the Indian business confederation ASSOCHAM, the economist Vijay Kelkar, chairman of a government-appointed committee that produced a 2009 report on GST, pointed out the inefficiency of a tax system that required a freight truck travelling by road between Delhi and Chennai "to cross five state borders and 10 checkposts." He gave a sense of the thicket of taxes that would be swept out in one go by the implementation of the proposed dual-GST model, one designed to ensure that the central government and the states received equal shares of revenue from the tax:

Apart from VAT, stamp duty, vehicle tax, taxes on goods and passengers, taxes and duties on electricity, entertainment tax, entry tax, luxury tax, taxes on lotteries, betting and gambling, purchase tax as well as all State cesses and surcharges will be subsumed into the State GST. Central Sales tax will stand abolished. From the government of India side, Central excise, additional excise duties, service tax, Additional Customs duty (CVD), and all cesses and surcharges (other than educational cess) will be subsumed into the Central GST.

Kelkar has also suggested that GST implementation would increase India's gross domestic product by 1 percent (this contention is supported in a working paper by the economists Ehtisham Ahmed and Satya Poddar), bring down real-estate prices and make Indian manufacturing more competitive in the global market.

Many of the authors of op-eds or academic papers on the subject of the GST have quoted from the ancient Indian thinker Kautilya's text on statecraft, the Arthashastra, and especially his observation that "all undertakings [of the state] are dependent first on the treasury." (A full account of Kautilya's thoughts on economics can be found in this essay, whose authors describe the text as a "neglected precursor to classical economics.") Currently the treasury of India, a country that is home to more than a sixth of the world's population, is messily and inefficiently run, both on the side of personal income-tax -- India currently has a tiny base of no more than 35 million taxpayers -- and on the side of taxes on manufacturing and supply. P. Chidambaram, the country's finance minister, and the finance ministers of India's states now have a chance to push through a foundational reform, one that would impact the economic life of every Indian citizen, over the next three months after the GST plan is vetted and refined by two committees.

(Chandrahas Choudhury, a novelist, is the New Delhi correspondent for World View. Follow him on Twitter @Hashestweets. The opinions expressed are his own.)

To contact the author of this blog post: Chandrahas Choudhury at Chandrahas.choudhury@gmail.com

To contact the editor responsible for this post: Max Berley at mberley@bloomberg.net


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