Financial Express, July 1, 2013

A reform success story for India

 We are used to highlighting the shortcomings of economic reform in India, both in process and outcomes. These shortcomings are particularly apparent now, when the economy is struggling on several fronts: growth, inflation, and the external balance. In this context, it is good to revisit an ongoing success story of Indian economic reform: its tax system. In the last two decades, India has made tremendous strides in terms of reforming income taxes and consumption taxes. These reforms have included improvements in tax policy as well as in administration. The former has helped the latter: rationalising tax policy has made tax administration easier to conduct effectively, but there have been direct improvements as well in the technology of tax administration.

Better tax policy has meant cutting inefficiently high rates, whether in the income tax structure, or in areas such as import tariffs. In the case of consumption taxes, it has meant replacing a complicated tangle of sales taxes and duties, often piled on each other, with a simpler, more transparent value added tax (VAT). As the VAT nomenclature implies, this avoids the problem of taxes being applied to quantities that already include other taxes—a cascading effect that can create unintentionally high rates, and multiple inefficiencies. Better tax administration has been built on the foundation of new information technology systems, which support mechanisms such as deducting income taxes at source for those who pay them, and tracking of purchases and sales required for VAT credits along the value chain. 

The goods and services tax (GST), which is inching toward implementation, represents an important new step in the process of Indian tax reform. The sooner it is put in place, the better for the economy. In particular, there is some reason for thinking that the GST will give the central as well as state governments a firmer, broader revenue base, which is less subject to political distortions than is the income tax: the GST is a VAT, better coordinated than the present system, and applied more broadly and consistently. A key institution in the process of introducing the GST, as it was earlier for introducing the VAT and for managing state sales tax incentives, is the Empowered Committee of State Finance Ministers (EC). This EC met in May, and then, on June 7, its chairmen met with representatives of industry associations and consulting firms, where an EC paper formed the basis for discussion. This discussion paper is a model of clarity, and illustrates how this complicated process of introducing a major overhaul of the tax system is proceeding. There are several facets of the process worth noting.

Technical policy formulation: There is a clear understanding of the technical issues involved in introducing the GST, including changes in revenue receipts at different levels of government, trade-offs involved in specifying tax bases in different ways (based on turnover levels), and mechanisms for administration (especially across different levels of government). One might expect this clarity, given the time it has taken to get where we are, but time has not been a guarantee of quality in other cases of policy formulation. There is also a clear use of technical inputs from the main national source of such expertise, the National Institute for Public Finance and Policy.

Political management: There is a clear understanding of the constitutional issues involved in introducing the GST, of course, but also a polite and pragmatic statement of the needs of the states in terms of some protection against revenue uncertainties that might come with the reform. In this context, the national government appears to have been somewhat lax in its political management of a complex Centre-state issue—the compensation being requested by the states seems to be quite small relative to central tax receipts, or even as a percentage of the fiscal deficit.

Institutional innovation: The creation of a GST Network (GSTN), which will be a non-profit company with ownership shares of the Centre, states, National Securities Depository Limited, and three selected financial institutions. The GSTN will provide a common IT infrastructure to support the introduction and implementation of the GST. As the EC discussion paper elucidates, issues of monitoring and control versus costs of compliance, can all be dealt with effectively with a combination of the right policy framework and a solid information infrastructure.

One hopes that the EC discussion paper, which distils many years of discussion and analysis, marks the end of the process of agreeing on the details of the GST, and the beginning of efforts to make it happen. The GST will be a major milestone in Indian economic reform. Tax reform has not been perfect. There is much left to do. For example, the GST, in coordinating taxes on the same bases (in this case, business sales) may provide a model for reform of the income tax system, allowing States along with the Centre to tax personal incomes. The GST use of information infrastructure might point the way to methods for strengthening property tax systems across India’s creaking, bursting cities, as well as other aspects of local tax systems. Tax reform is important, and it is very much alive in India.