A `Tax Revolution’ Set to Sweep India’s $2 Trillion Economy


May 24, 2017

New Delhi – Prime Minister Narendra Modi’s government is set to dramatically reshape Asia’s third-largest economy with the biggest tax reform since independence in 1947.

May 24, 2017

New Delhi – Prime Minister Narendra Modi’s government is set to dramatically reshape Asia’s third-largest economy with the biggest tax reform since independence in 1947.

After finding common ground among India’s 29 states, the finance ministry on Friday released detailed rates for the incoming goods and services tax, slotting more than 1,200 items — from sugar to steel pipes and motorcycles — into five tax brackets between zero and 28 percent. With that done, India is almost ready to implement a tax code that unifies more than a dozen separate levies, effectively creating a single market with a population greater than the U.S., Europe, Brazil, Mexico and Japan combined.

"It is a tax revolution, in many ways, because the indirect tax structure in India was hopelessly chaotic," said Raghbendra Jha, head of the economics department at Australian National University. "It’s mind boggling, the sheer magnitude of the reform taking place."

The sweeping tax reform will gradually reshape India’s business landscape, make the world’s fastest-growing major economy an easier place to do business and is likely to raise government revenues by widening the tax net in the country’s largely informal $2 trillion economy. That means India could spend more on desperately needed infrastructure and training programs for a workforce that is growing by 1 million people each month, laying the groundwork for longer-term growth.

Commuters walk along a bridge at the Kurla railway station in Mumbai, India, on Saturday, Jan. 28, 2017. India's Finance Ministry will recommend bold tax reform to ensure that Prime Minister Narendra Modi's growth-crimping cash ban wasn't in vain, people familiar with the matter said.

With tax experts praising the rates as moderate and generally lower-than-expected, it seems possible Modi might be able to roll out this reform without a politically damaging rise in inflation. However some economists and analysts see a July 1st deadline as unrealistic, raising the possibility that less than 10 months after demonetization, India’s economy could again be upturned as businesses struggle to comply with the new tax code.

Chaotic Implementation

Business groups, fearing a chaotic implementation, have lobbied the government for a September 1 roll out. They argue that companies — particularly small-and-medium-sized enterprises that contribute more than 30 percent of India’s GDP — need more time as they struggle to become tax compliant in the new system.

"To expect that the rates are out on the 18th, 19th of May, and everyone will be able to plug in and run with it by July 1 is very far fetched," said Dinesh Kanabar, the Mumbai-based CEO of Dhruva Advisors LLP and former deputy CEO of KPMG India.

Still, lower-than-expected rates mean that there may be little or only mild inflation, less than in other countries that have implemented a GST, he added.

There "was an expectation that the government would jack up the rates from the effective rates, which could lead to a huge amount of inflation," Kanabar said. "What we see today is very different. The rates are moderate. And in most cases, the rates are consistent or lower."

The tax reform, however, is far from perfect as it should only have had one rate, Jha said. Instead, there are four divergent rates and multiple exemptions. Air conditioners, refrigerators and makeup will be taxed at 28 percent, for example, while toothpaste lands at 18 percent and fruit juice at 12 percent.

Plane tickets attract a 5 percent GST rate, but business class tickets will be taxed at 12 percent, finance secretary Hasmukh Adia said. Staples such as food grains, fresh vegetables and milk are not taxed at all, while Finance Minister Arun Jaitley said education and health services will continue to be exempted.

Political Win

For Modi and his Bharatiya Janata Party, the release of detailed GST rates is a big political win. It’s the relatively calm culmination of months of political wrangling with state governments all trying to shape the country’s new tax code in their own favor.

"The process of agreeing the GST rates for individual items has been remarkably smooth considering that the overall GST negotiations for India has been a tortuous political process among national and state legislatures that has taken a decade," said Rajiv Biswas, IHS Markit’s Asia-Pacific chief economist

Tax Base

Importantly for India, a country in which fewer than 1 percent pay income tax, the GST will broaden its tax base, according to University of Melbourne economist Nathan Taylor.

"It will have profoundly positive implications for the economy," Taylor said.

Jha, the ANU professor, said India’s enhanced tax revenues should be used to boost spending on health and education, which is significantly lower as a percentage of GDP than many other countries.

"The paucity of tax revenue has been a plague for India," Jha said. "You have a population that is young, that is waiting to be trained and educated, and you don’t have the resources to attend to them. Any increase in tax compliance, in government revenues, can’t come too soon."

Courtesy: Bloomberg