The game-changing tax4 min read . Updated: 29 Dec 2009, 09:04 PM IST
The game-changing tax
Quite often while discussing the progress of India’s bilateral or regional free trade agreements (FTAs), I have argued that first and foremost India needs to sign an FTA with itself! Our domestic markets and economy remain far too fragmented for us to seriously benefit from FTAs with other countries. A universal goods and services tax (GST), then, is a major and long-awaited step in creating a unified domestic economy.
The recently released report of the task force on GST of the 13th Finance Commission rightly remarks that the flawless GST, when in place, will be “an economic game changer". In my view, there are strong political externalities as well, because a universal GST, managed by a council of finance ministers, will strengthen the federal institutional structure and create another strong unifying bond across this diverse and pluralistic democracy.
By helping to bring down prices of wage goods, improving farmers’ incomes and generating additional employment by accelerating gross domestic product growth by 0.9-1.7 percentage points, GST will hugely improve inclusion. By bringing large chunks of the informal and the unorganized economy into the tax net, it will help reduce the chasm between Bharat and India, which is a desirable goal. For all these reasons, and others cited in the report, GST must be implemented soonest. The report suggests that the measure be implemented not from 1 April, as originally envisaged, but from 1 October to ensure that the design and implementation plans are not compromised. Will these additional six months suffice to pass the necessary legislation, set up the council of ministers and have all the information technology issues resolved? I am not so sure, unless the finance ministry asks the task force itself to help draft the necessary legislation and produce a detailed implementation plan.
For me, however, one of the most important implications of switching over to GST at the rates recommended by the task force is the impetus this will provide to the domestic manufacturing sector. By recommending a flat and universally applicable rate of 12% (5% for the Centre and 7% for the states), the task force is, in effect, bringing down the incidence of indirect taxes by more than 50%. The recommended rate—which, the report takes pains to demonstrate, is revenue-positive and not merely revenue-neutral, as is the general requirement—will be 5 percentage points below the applicable rate in China! This is revolutionary and indeed visionary.
The lower taxes on manufactured goods will bring down prices and usher in a new demand upsurge. This will finally allow domestic producers to exploit the economies of scale that their Chinese competitors have been enjoying over the past three decades. Indian manufacturing could hope to become globally competitive. Moreover, by doing away with the current multiple and complex indirect tax structure, GST will allow investment to flow into sectors in which the country has a true comparative advantage. I am convinced that this will promote labour- and skill-intensive sectors where our exports can expand further. This has significant employment -generating potential and will yield a much more inclusive growth.
If in the future, revenue realized from levying a 12% GST is seen to be insufficient, the rates can surely be hiked up. This will require only the approval of the chairman (the Union finance minister) and two-thirds majority of the state finance ministers who are members of the recommended council of finance ministers. While the revenue shortage is only a remote possibility, the lower recommended rate should be implemented to provide the necessary fiscal support to domestic producers, especially in the manufacturing sector. A decade of rapid manufacturing sector growth, with the necessary World Trade Organization-compatible support, can transform the economy and release massive growth impulses. So we should persist with the recommended 12% GST even if the Central and state governments have to impose additional direct tax levies to make up for any possible, though improbable, revenue shortfalls.
For me, the suggestion to subsume the real estate sector within GST’s ambit, and do away with stamp duty over three years, is very attractive as it will cut at the roots of hugely corrupt practices and generation of “black money" in the economy. But for this reason, as also for its effect on bringing above ground the large numbers of producers that operate in the grey zone, this measure will be opposed by well-entrenched vested interests. This has to be resisted.
I am a bit disappointed that the financial media has not taken up the cause so far. This is a crucial reform that must go through. Let us hope that all segments of the industry will champion the cause and not allow this measure to be delayed. After all, we have already spent 26 years in modernizing our indirect tax structure. Is this not a sufficiently long gestation period, even in India, where we know gradualism works better than the big bang?
Rajiv Kumar is director and chief executive of the Indian Council for Research on International Economic Relations. These are his personal views. Comment at email@example.com