India: important consumer tax reform initiated

India’s upper house of parliament has finally enacted a constitutional amendment to pave the way for Prime Minister Modi’s draft reform on a uniform national consumer tax. The uniform goods and services tax was at the very top of his agenda and is aimed at ending the confusing coexistence of central government consumer tax, regional taxes and levies with some very different tax rates in part for individual goods and services, and replacing these with a uniform value-added tax system. The reform also includes national rules for the deduction of tax at source. Up to now, each of the 29 federal states could raise their own consumer taxes and levies, so that different product groups were subject to very different charges. This impacted severely on India’s domestic trade – through controls, additional costs and bureaucracy.

The law and the corresponding constitutional amendment were approved by the lower house of parliament last year. However, it also needed the approval of the upper house, in which the 29 federal states are represented and where Modi’s BJP party does not have a majority. Modi had to offer a number of concessions before resistance to the new tax concept could be removed. After all, the individual states are losing an important part of their own fiscal sovereignty. They must now act together with the central government to arrive at the actual amount of the new uniform tax. There are still some issues that need clarifying, as individual federal states are demanding very high tax rates. A rate somewhere between 17 and 27 percent is being debated. While 27 percent would be at the top spot internationally, 17 percent would equate to that of China. The distribution of the receipts, which should replace the previous regional revenue, has not yet been definitively finalised. Modi wants the new consumer tax to come into force at the start of the new fiscal year (April 2017). However, it must be ratified beforehand by at least half of the federal states.

When the first draft law regarding the uniform consumer tax was introduced in the lower house in December 2014, Finance Minister Jaitley called it the „single biggest tax reform since independence in 1947“. He is quite right about that, especially if one considers the potential implications of this tax reform. The new tax is likely to be just as important for the subcontinent as the creation of the set of rules for the single market was for the EU at that time. Equal tax treatment of finished consumer goods nationwide has the effect of „opening“ the markets, where production and growth are stimulated by a better division of labour.

Positive effects for India will be generated via several „channels“. The new, national consumer tax will facilitate a reduction in bureaucracy, create more transparency and legal certainty, as well as saving costs in relation to levying and collecting taxes. The abolition of extensive federal state border controls will reduce the cost and stimulate trade across the entire subcontinent. It will also increase the variety of goods available locally and facilitate a more efficient production structure which results in new cost savings. India has namely been at a disadvantage for quite some time, in that excessive tax or administrative hurdles have artificially restrained the sales markets for many small companies at a local level, therefore preventing them from developing into what would be their optimum size.

A single consumer tax with a nationwide uniform deduction of tax at source would likely lower the previous incentives to avoid paying tax. When all is said and done, the state should see higher tax revenues, thus opening up possibilities for budget consolidation. If Modi really does succeed in implementing the new „goods and services tax“ next year, it would represent a major success for him and proof that India really is „capable of reform“. The new consumer tax reform should also accelerate economic growth noticeably and serve as a starting point and model for further reform projects. This consumer tax reform alone could lead to an annual increase of at least one percent in gross domestic product.

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