When I was about 14 years old, my parents decided to shift from the home where I was born. I resented it, but had no casting vote, and had to reluctantly make the move with them. I’m not sure how many of you would have felt the same way had you been in a similar situation. Looking back, I believe my reluctance was borne out of the obvious—being uprooted from familiar surroundings, primarily my routine and friends, and the fear of the unknown.
It is my sense that state governments are reacting somewhat similarly to the Union government’s proposal to enforce a single goods and services tax (GST) by 1 April. With less than six months to go, the murmurs have grown louder and the states have discussed every other option except the one that the Centre has placed on the table.
While some of their concerns are obvious—providing for compensation in the event of a loss of revenues—and will have to be addressed, the real stumbling block is the fear of the unknown.
The net result: In the run-up to the meeting between the representatives of the state governments and the finance ministry due in the first week of October, battle lines have been drawn opposing the idea of a single GST. If not resolved, India would, borrowing a cliché, miss its tryst with destiny.
The introduction of GST, if it does happen, will be the single biggest tax reform initiative—a culmination of the incremental tax reforms that commenced with the publication of the Long-Term Fiscal Policy in 1985. The move to a value-added tax (VAT), both at the Centre and state level, was a key incremental step.
By giving credit at each level of the production/distribution process, the undesirable effect of cascading taxes was avoided. But this covered only goods, the production of which include a lot of services on which taxes are levied but do not get a set-off.
Not only will GST address this, but it will also replace the myriad set of Union, state and local level levies with one single rate for both goods as well as services. This rate will be inclusive of the share of the Union as well as state/local governments—this division of tax spoils is also a bone of contention.
At present, state governments are not allowed to tax services. The transition to a GST will entail an amendment to the Constitution that will empower state governments, but also at the same take away their present powers to tax since it will now be subsumed into one national rate.
The uniformity of the rate across the country is the political economy of GST. It would in one stroke economically unify the country. For the first time since Independence, the country will be bound together on economic terms, rendering the politics of competitive populism—offering tax sops to lure industrial investment—meaningless. And, of course, consumers like you and me would be delighted.
Economic unity will also ease the pace at which goods will move in and out of states and reduce the incidence of taxes on a range of commodities (but also increase it for a few). Vijay Kelkar, chairman of the Finance Commission, estimates that implementation of GST will give an additional boost to the economy of 1.4% of gross domestic product every year.
Now all of this is at risk.
The state governments have, as reported in Mint on 17 September, for the moment effectively stayed plans for a single GST.
Instead, they have proposed three rates: a lower GST rate for items of mass consumption, a regular rate for other goods and a nominal charge of 1% on precious metals.
There are several reasons why this should be rejected. First, a consensus will have to determine the basket of so-called mass consumption goods (in any case, several services such as healthcare are already exempt). In a country so culturally and ethnically diverse, it will be difficult to imagine defining a set of common mass consumption goods that will leave everyone satisfied.
Second, the myriad structures would be retained. Not only will it complicate things administratively, there will be enormous incentives for producers of goods and services to seek out lower duties—ideal circumstances for triggering litigation.
Third, failure to implement GST at a time when the government is moving swiftly on signing free trade agreements with trading blocs and countries will be disastrous for Indian industry. None of the local levies can be countervailed in the form of additional duties on imports, which means domestic industry will have to absorb more levies.
It is clear that the states are being driven by the politics of implementing a single GST. This has to be addressed. One way out would be for the Centre to underwrite any losses in revenue arising out of the transition.
It could offer a halfway house deal by suggesting that the state governments fix a sunset clause on the differential rates—that is, they gradually converge to a single rate after a few years.
The bottom line is that both sides have to move swiftly and pragmatically to ensure that the GST dream does not sour. Therein lies the global good of the country.
Anil Padmanabhan is a deputy managing editor of Mint and writes every week on the intersection of politics and economics. Comments are welcome at firstname.lastname@example.org