Blog Post

GST The Transformational Fiscal Reform

Rajiv Kumar July 2017

The new Goods and Services Tax (GST) will help neutralise the centrifugal forces in the Indian economy, writes a policy expert.

The historical project of transforming India from a conglomeration of sub-national identities and interests to a modern nation state began with our Independence. The assimilation of more than 500 princely states, which had been rather ingeniously given the choice by the departing British colonial administration to either secede or join the Indian Union was the first major step in this direction. That process of creating a unified, coherent and efficiently working nation state has been given another hefty push by the implementation of the Goods and Services Tax (GST) from 1 July 2017.

GST will help neutralise the centrifugal forces that are constantly in operation in this continental sized economy, with its unparalleled diversity and heterogeneity across multiple dimensions. This critical politically and socially unifying role of GST has been consistently underplayed and not received due attention in the hullabaloo of assessing its significant impact on economic activity. Let us recognise that in the Indian context the politically unifying role of the GST is as important, if not even more so, as the economic impact.

GST, as it has been passed with its architectural weaknesses and complications, will of course also hugely facilitate India’s transition to a modern formal economy. It will achieve this through its multi-dimensional impact on several economic fronts. First, its expected positive fiscal impact. It will help widen the tax base with all indirect tax now being unified and a link being established between the indirect and direct tax identities through Aadhar. The substantial widening of the tax base will permit the lowering of tax rates both for direct and indirect taxes. This will also include a convergence of several rates as presently featured in the GST. Lowering of tax rates while at the same time ensuring higher public capital expenditure will boost growth and employment.

Second, GST will hasten the formalisation of the Indian economy and help eliminate the rather pernicious dualism that characterises the Indian economy. This dualism has meant that nearly 80 per cent of our industrial workforce is engaged in production units that are neither covered by any industrial regulation nor captured in the indirect tax net. This also keeps them out of the direct tax system. The direct adverse impact is reflected both in India’s low tax to GDP ratio and also in the abysmal working conditions that continue to prevail in the Indian industrial sector across provinces and regions. GST with its rather strict requirements for disclosing the
GST, as it has been passed with its architectural weaknesses and complications, will of course also hugely facilitate India’s transition to a modern formal economy.
entire production and value addition chain in order to claim input credits will ensure that these informal sector units can no longer remain below the regulatory and indirect tax radar. This will result in slow but steady erosion of dualism that has so adversely impacted growth and global competitiveness of Indian industry.

Third, by helping eliminate the dualism that impacts nearly 40-50 million units that operate in the so called informal sector, GST will bring them into the formal economy, thereby facilitating technology absorption and productivity enhancement in medium and small enterprises. This is critically required for Indian industrial units getting integrated in regional and global production networks that are increasingly the drivers of global trade and technology flows. The low level of formalisation has meant that India has not been successful in taking advantage of distributed production capacities, which are at the core of bilateral regional economic formations. Though indirectly, GST will have a positive impact on India’s foreign trade flows and exports.

Fourth, and perhaps most importantly, the prospect a unified market extending across the entire Indian economy should provide a powerful fillip to potential investors, both domestic and foreign. Investors will benefit by substantially lower transactions costs as state borders are eliminated and along with that will disappear the octroi and border tax collection posts with their interminable delays, harassment and corruption. The elimination of state borders and free flow of goods and services will enable large corporates operating on a pan-India basis to better plan their logistics and transport systems, cutting costs and downtime considerably.

Fifth, GST will subsume 17 existing taxes that were levied by the Central and State governments and required submission of separate returns to these authorities. By unifying these in to one and greatly ramping up the role of IT in filing tax returns under the GST network, ease of doing business will be further enhanced. Let’s not make any mistake that this is a transformational move, which will surely encourage investment thereby putting India on sustained higher growth and employment generating trajectory.

Yes indeed the design of the GST as rolled out on 1st July is not perfect. Ideally there should have been only a single rate across all commodities, products and services and exemptions should have been completely eliminated. Those entities operating on a pan-India basis should have been given the facility to obtain a unique national registration number and not have to register in every state they have operations in. The entire mindboggling inventory of products with even minor differences should have been classified and left no room for any interpretation and mis-classification. And the e-way bills should have been designed more rationally and with least complications.

But the Prime Minister has clearly decided that he would not allow the perfect to be the enemy of the good. He decided to take the plunge with the understanding that the GST framework will evolve and be de-bugged over time as new facts and nuances come to light. It was important to start because in India, given its peculiarities, real work often starts after the launch. Faced with even an iota of uncertainty, the Indian bureaucracy, as perhaps in other countries, simply chooses status-quo.

We all know that politics is the art of the possible. It became clear early on that States were unwilling to surrender their ‘fiscal sovereignty’ to the Center and were considerably wary of losing revenues by switching immediately to a full blown single rate GST. Therefore, political pragmatism demanded that the States fears be adequately addressed rather than be steam rolled by the Centre looking for a perfect GST. In any case, the GST Council as presently structured can only work through a consensus as the Centre does by itself have the votes to push through any measure or change.

Consequently, GST has already played a role in the maturing of Indian democracy. This role is bound to be reinforced in the future as the GST Council continues to search for consensus for further fine tuning this historical fiscal reform.

Rajiv Kumar is Director, Pahle India Foundation, Delhi

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