The national tax will leave Indians much poorer by ending tax competition among states
The debate on the goods and services tax (GST) in India has now grown beyond the merits of the tax and forayed into the question of its proper implementation. The unanimous support for the idea of a national tax seems to be based on the benefits of a nation-wide, single integrated market. But this badly mistakes uniformity in tax rates for a healthy competitive market that is the ultimate end of good policy.
The merits of an integrated market derive from the benefits of free movement of goods, labour and capital without the restrictive barriers imposed by the state. Competition without barriers—not uniform rules—thus defines the actual spirit of a truly integrated market that can foster economic prosperity. The question facing policymakers, then, is how such a relatively more free market could be brought about with respect to fiscal policy: through a single national tax or multiple state-level taxes.
This is exactly where a single national tax system works to be antithetical to the spirit of competition that is crucial to lowering tax rates. For a central authority—in this case the Union government—would possess little incentive to keep taxes low. On the other hand, taxation powers decentralized in the hands of the state would allow much-needed tax competition that is crucial to achieving lower tax rates.
The race among Indian states competing to attract private investment in the last two decades led to better conditions to do business and aided economic growth. It was the threat of labour and capital flowing out in search of better pastures that kept a check on predatory tax policy, not sudden economic enlightenment on the part of politicians that taxes discourage economic activity. This is also exactly the kind of healthy competition that led corporate tax rates in developed countries to drop too.
The modern era of tax competition began in the 1980s with the tax cuts brought in during the rule of Margaret Thatcher in Britain and Ronald Reagan in the US. In the European Union in particular, average corporate tax rates have reduced to below 20% thanks to the competition developed European nations face from less-developed but attractive tax destinations in Eastern Europe.
It is worth noting that the drop in corporate tax rates in Europe has been in the range of several percentage points in a matter of just over a couple of decades. The fruits of tax competition have been particularly high in a highly globalized world with relatively open borders that has allowed the free movement of both labour and capital. This has punished high tax countries while rewarding low tax countries providing the right conditions for economic activity to flourish without state-imposed barriers.
The competition faced from low-tax countries has obviously upset many developed countries which have had to increasingly tax more to fund their welfare programs. Thus many of them, with support from bodies like the European Commission and the United Nations, have tried to bring about tax harmonization. But as with any cartel, a tax cartel too can only turn out to be a bane for productive citizens. Fortunately though, these attempts have failed to form an international tax cartel.
India today is in a similar position, with imposition of the GST threatening to kill competition among states. Finance minister Arun Jaitley has quite clearly been worried in recent times about bringing about a consensus among states with regards to the tax. But if he truly understands the folly of a nation-wide tax authority, he would stop trying at once to convince the states and concentrate on better things. GST has lied in the backburner for too long. It is time to scrap the idea once and for all.
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