At 5 years, India’s landmark tax reform is running out of fuel

Five years ago, the federal and state governments of India reached a historic agreement. Since July 1, 2017, a uniform goods and services tax – marketed by Prime Minister Narendra Modi as “One Nation, One Tax, One Market” – has replaced a bewildering array of local sales and import duties. hall. But the many compromises that have been struck to bring over a billion people living in 29 states on board undermine revolutionary reform.

At first glance, nothing seems terribly out of place. After years of collecting 1 trillion rupees ($13 billion) a month or less, GST collections are now consistently 50% higher. Technology has stabilized. Uniform taxation throughout the country has largely contributed to making India a common market; logistics and e-commerce have benefited; Besides checking for fraud, real-time supply chain data promises to help small businesses access cheap financing. Yet for all its apparent success, the GST is running out of fuel – or more accurately, fuels are out of its reach. As a result, high indirect taxes continue to overburden consumers and producers and hurt competitiveness. State support will be needed for further reform, but subnational governments controlled by opposition parties fear New Delhi will skimp on them.

The chances of a bold solution seem slim. Instead of new thinking, what emerges from the GST Council — a constitutionally established joint forum of federal and state authorities — is ad hoc incrementalism. Take, for example, the council’s latest recommendation to impose a 5% tax on hospital beds that cost more than Rs 5,000 per day. Hospitals cannot deduct this tax from the GST they already pay on treatment inputs. Which means they will have to pass the extra burden on to patients, including those with Covid-19.

At a time when consumers are already squeezed by high inflation, forcing them to fend for more medical emergencies, this smacks of overreach. Moreover, it is not even a GST, except in name. As economist Vijay Kelkar and others point out, the simple theory that “works wonders in other tax jurisdictions” is that a value-added tax should allow businesses to claim an input tax credit. on most of the goods and services they buy along the way. The Indian reality is very different. Airlines cannot get credit for taxes embedded in jet fuel because most petroleum products are not covered by the GST. Neither does electricity, an input for all industries. Completed real estate, a cesspool of tax avoidance, is also left out. “End-to-end tracking of the money involved, from landowner to sand supplier to interior designer, is needed to plug endemic tax leaks,” Kelkar and his co-authors note in their paper. November 2021, optimistically titled as “Towards a World-Class GST”.

A world-class GST cannot operate with five different rates: 5%, 12%, 18%, and 28%, plus zero for unpackaged food. Luxury cars, which are in the highest bracket, are subject to a new “sin” tax that puts half the purchase price of an SUV in the government’s pocket. Automakers complained bitterly of being bludgeoned with cigarettes. But the sin taxes helped New Delhi run a “compensation” fund, which effectively guaranteed the states 14% annual revenue growth for the first five years under GST. This was decisive, as it persuaded states to waive most of their own taxes. These five years have just come to an end. But because the pandemic had depleted the fund in its last two years – forcing New Delhi to borrow to fulfill its promise – cars may have to remain very expensive until the debt is paid off by March 2026.

The end of compensation does not, however, mean fiscal autonomy. Over the past three fiscal years, only one major Indian state – Odisha – has seen an annual growth of more than 14% in its GST collection. Four other states recorded growth rates between 10% and 14%, while 16 others recorded single-digit growth. Uttarakhand, which depends on tourism in its resorts, has seen a decline. It is for this reason that “compensation has become such an important source of revenue for states,” says Indian Ratings and Research, a unit of Fitch Ratings Ltd. “Without it, most states’ GST revenue growth will not reach 14%. »

Now is the perfect time for the Modi team to negotiate a new deal, which will give states reasonable assurance in exchange for expanding the GST to include alcohol, gasoline, diesel, jet fuel, electricity and real estate. Three industries with long supply chains – textiles, automobiles and building construction – will be boosted to create much-needed jobs. Even more, if the revamped tax cancels three of the five rates and becomes a real value-added levy: companies that pay the GST should be able to claim a maximum credit on inputs.

The current inflationary environment bolsters tax revenues and breeds complacency. The May GST, collected last month, jumped an impressive 56% from a year earlier to reach 1.45 trillion rupees. Part of this growth is an optical illusion: May 2021 was a particularly bad month for consumption in India due to a massive outbreak of the delta variant. Beyond the temporary boom, however, there is simmering unease in states like Tamil Nadu, Kerala and West Bengal, where Modi’s Bharatiya Janata party is not in power. At present, GST collections are shared equally between New Delhi and the states. But the latter want the split to be modified in their favor if there is no longer any compensation through “sinful” taxes, which until recently were entirely reserved for them.

The dissatisfaction runs deeper than bickering over a formula. A consumption tax is, by definition, regressive: it hurts the poor more than the rich. The overreliance on the GST has reached the point where even the fees charged by banks for a new checkbook will now be taxed at 18%. Meanwhile, direct taxes on corporate profits have been reduced by the Modi government. Opposition politicians who want to be re-elected on the basis of pro-poor policies find themselves with their hands tied. Since the GST is highly correlated to gross domestic product, more than half of a state’s tax revenue is on autopilot. If they give up taxes on alcohol, electricity, petrol and diesel, they will lose control of another third party. “You have effectively turned states into municipalities,” Tamil Nadu Finance Minister Palanivel Thiaga Rajan, a former Wall Street banker, told the Hindustan Times recently.

This is when Indian municipalities need their own fiscal negotiation to accelerate urbanization minus pollution and misery. According to Kelkar and his co-authors, a revamped Indian GST, with expanded attributions, could stabilize at 14% — 6% for New Delhi; 6% for states and 2% directly for civic administrations. But it will weaken Modi’s near-monopoly grip on the voting potential of social projects. This is perhaps the #1 reason why the prospects for another sweeping Indian excise tax reform are virtually non-existent.

More from this writer and others on Bloomberg Opinion:

• India cannot be a superpower if it cannot create jobs: Mihir Sharma

• A little epoxy can loosen India’s welfare system: Andy Mukherjee

• India’s sticky inflation savvy magic prices: Andy Mukherjee

This column does not necessarily reflect the opinion of the Editorial Board or of Bloomberg LP and its owners.

Andy Mukherjee is a Bloomberg Opinion columnist covering industrial companies and financial services in Asia. Previously, he worked for Reuters, the Straits Times and Bloomberg News.

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