India had an opportunity to implement a tax code that would limit market distortions, be transparent, and keep compliance costs low. But that opportunity may now be lost.
On Wednesday, West Bengal finance minister Asim Dasgupta announced that a proposed goods and services tax (GST) for India—a kind of uniform value-added tax—will have three state-level GST rates for goods: a lower rate for mass consumption goods, a normal rate, and a nominal tax on precious metals.
Illustration: Jayachandran / Mint
A uniform, single-rate GST was the opportunity for Indian companies to move beyond the complexities of disparate tax regimes; and the economy would have been unified under a single Indian market, with limited distortions.
The major issue is that different tiers of tax rates create a host of market distortions. This problem stems from the complexities associated with classifying goods. What will be classified as a mass consumption good, and what will be taxed at a normal rate?
If similar, and competing goods are set at different rates, that will create market inefficiencies. Consumers may be inclined to substitute to the product that is cheaper—after taxes.
And these distortions from classification will exist in other realms as well. Composite goods—or a bundle of different goods—will be difficult to parse across different tax rates. For example, how will a mobile phone with a camera be taxed? As a camera, a phone, or as a different category altogether?
The point of a GST was to give Indian firms respite from the distortions and complexities of India’s tax regime—and the complicated webs of tax codes, which are vastly disparate across states and regions. Not only could GST have simplified compliance costs, but it would have also limited the market distortions caused by taxes.
Different states had different stakes in GST because of their levels of consumption, and because of the perceived fear that essential goods would become costlier under a GST regime. What is most troubling about the GST plan is that states will be given free rein to exempt goods—that they perceive of local importance—from GST, some of which are major tax revenue generators.
It remains to be seen what GST for services will look like. But hopefully, GST reforms can be reconsidered in the near future so that the imperative of a unified market in India can actually be realized.
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