India Takes Major Step to Becoming a Single Market

Women laborers carry bricks at a brick factory on the outskirts of Agartala, capital of India's northeastern state of Tripura, on January 7, 2015. John Elliott reports that a new universal value added tax will radically change the way the Indian economy works. Jayanta Dey/reuters

This article first appeared on the Riding the Elephant site.

It has taken 16 years, which is sluggish even by India's dreadfully slow approach to change, but finally it has happened.

Late on Wednesday, the upper house of India's Parliament passed a Constitution amendment bill that paves the way for the introduction of an epoch-making tax reform known as the goods and service tax (GST).

The government optimistically hopes to introduce the tax at the start of the next financial year on April 1, merging myriad taxes into one value added measure that will straddle the whole country and abolish different tax regimes run by India's individual 29 states.

There will then be one national tax system for the manufacture, sale and consumption of goods and services, and India will in effect become a single common market.

This is being touted as the single biggest change since India's major burst of economic reforms in 1991, and it probably is, given its potentially enormous benefits for business efficiency and tax collection. Arun Jaitley, the finance minister, says it will add 2 percent to gross domestic product growth, which is currently just above 7 percent.

The business welcome was well summed up by Chanda Kochhar, CEO of ICICI, a leading private sector bank. She has described it as the "most important reform in indirect taxation in India ever," which would benefit all parts of the economy. "Consumers will see lower prices in the medium term, businesses will able to operate more efficiently and the government will see a broadening of its tax base along with ease of tax collection."

One of the biggest benefits will be faster road transport times, which are more than double those of developed economies, partly because trucks have to pay taxes at each state border. Companies' distribution and warehousing systems will also be simplified. It should also be possible for the government to restrict tax evasion.

Jaitley and Narendra Modi, the Bharatiya Janata Party prime minister, claim this as great victory for the government and proof that they are bent on economic reforms.

Such a claim is not wrong, but it is biased because both the BJP and the Congress Party deserve equal praise for backing the measure over the past 16 years—and both also need to be strongly condemned for blocking it when the other was in power.

Started in 2000

It was Atal Bihari Vajpayee who, then as the BJP prime minister, launched the first GST discussions in 2000 and set up a committee with states' finance ministers to design the tax and the systems required.

But the BJP refused to support Manmohan Singh, the Congress prime minister from 2004, when he tried to push the measure with a 2010 target implementation date. It then changed tack when the Modi government was elected two years ago, but that was met by obstruction from Congress, which wanted to build up its credibility in opposition.

The Modi style was arrogant, which made cooperation with other parliamentary parties, as well as Congress, virtually impossible.

In the past few weeks, however, the BJP has improved its political tactics. It won support from almost all regional political parties, which would have left Congress isolated had it not ended its opposition.

Consequently, the bill was unanimously passed last night after nearly eight hours of debate in the Rajya Sabha, where Congress has a majority of the seats. Opposition came only from Tamil Nadu's AIADMK party MPs, who walked out. The bill now needs to be cleared by the Lok Sabha (lower house), which is a certainty given that the BJP has a majority there.

State Laws Needed

But the bill only paves the way for change by authorizing the 29 states to draw up GST laws, which will be a substantial task. At least 15 of the states must do this for the measure to be implemented.

Most will fall into line, though states such as Tamil Nadu with strong manufacturing industries have reservations because they fear they will lose out, unless they are adequately compensated, by the benefit the value added tax brings to consumer-based states.

All the states, and individual businesses, need to prepare for what is in effect a totally new tax regime. That seems somewhat unlikely to be achieved by the government target date of April 1, even if the legislative process is completed with the central government setting the tax rates. Congress wants the tax capped at 18 percent.

The Business Standard, a leading Indian newspaper, said Thursday morning that almost 98 percent of Indian companies are not ready with the software infrastructure, accounting systems and human resources training that are needed to handle the tax.

The indirect tax regime "would require all companies, their suppliers/vendors, retailers, dealers and even shopkeepers/entertainment centres/restaurants to install computers, which could access the centralised GST network so that tax credits can be logged into the system," it said.

The GST will be collected at each stage of sale or purchase of goods or services and will provide funds for both the central and state governments. Nationally, it will subsume central excise duty, additional excise duty, service tax, countervailing duty and special additional duty of customs. At the state level, it will absorb state value added tax/sales tax, entertainment tax, central sales tax, octroi (state border tax), purchase tax, luxury tax and taxes on lottery, betting and gambling.

Government Veto

It will be run by a council where the states will have two-thirds of the seats, but the national government will have a veto because, while it will have only a third representation, decisions will need a 75 percent vote in favor. This strengthens the central government's overall powers because it will be able to control tax rates in the states, and this could lead to tensions and political clashes.

Critics have suggested that there are some inflationary risks and that states, which have always overspent in order to improve the political credibility of their ruling parties, will feel even freer to spend recklessly and wait to be bailed out by the council and central government.

So while there is much to celebrate today, now that the GST has crossed a major parliamentary hurdle, there is plenty of scope in the future for disagreements and lack of progress.

Successful implementation will test the government's political leadership and skill in the coming months. That gives Modi an opportunity to prove that he can do what he was elected to do and change the way India is run.

John Elliott is the author of Implosion: India's Tryst with Reality (HarperCollins, India).