India’s Less-Than-Perfect Tax That’s Still a Game-Changer

(Bloomberg) -- India has backed a multi-tier national tax regime that even in its not-so-perfect form will be a game-changer for Prime Minister Narendra Modi, who is trying to revive manufacturing and boost foreign investment in the world’s fastest growing major economy.

Moving away from the ‘one market, one rate’ tax model, the Goods and Services Tax Council decided on standard rates of 12 percent and 18 percent and two more rates of five percent and 28 percent for the tax’s implementation. Officials are still meeting to finalize details of which goods and services will fall into each bracket.

Finance Minister Arun Jaitley said a zero tax rate would apply to 50 percent of items in the retail inflation basket to protect consumers from price rises on goods such as food grains. Tobacco products will continue to be taxed at 65 percent, he said, adding luxury goods will also be taxed at a higher rate.

The taxes will replace a welter of state levies that imposed heavy burdens on commerce that crossed domestic borders, creating a single market of 1.3 billion people.

And while the ideal single tax rate system is a long way off, a multiple-rate GST was the only way a complex, politically diverse country like India could proceed, Pratik Jain, Indirect Tax Leader, PricewaterhouseCoopers, said by phone.

"It will appear that the Indian government is serious about reforms and that gives confidence to investors," he said, noting many companies had put investment decisions on hold until the path of the GST was clarified.

"While it’s not perfect, the government should attempt over a period of time to consolidate those four slabs into two." 

The progressive nature of the GST structure should temper any adverse short-term inflationary and growth impacts, said Tamara Henderson, an economist with Bloomberg Intelligence. 

"Excluding half of the items in the CPI calculation will protect the spending power of lower income households, which tend to have a higher propensity to consume disposable income than wealthier groups," she said.

Given Modi’s earlier promises to reform India’s land and labor laws had failed, the success of the GST was even more of a priority, said Michael Kugelman, a senior associate at the Washington, D.C.-based Woodrow Wilson International Center for Scholars.

"This is a big achievement for Modi’s economic reform plan," Kugelman said. "Now that it’s gone through, it’s an important for the government to get it right. And that entails being appropriately pro-business while not penalizing the poor. The stakes are quite high."

The government confirmed it was intent on meeting its self-imposed April 1 deadline for the tax’s implementation, close to the crucial elections in the state of Uttar Pradesh.

"Next year, we’re going to see elections. At the moment, they made sure that the inflation basket –- one of the key worries –- would be impacted minimally with the implementation of the GST," said Tirthankar Patnaik, India Strategist with Mizuho Bank Ltd.

"Political exigencies have forced the divergence between essential goods and so-called ‘sin’ goods," he said, adding luxury and ‘sin’ products such as tobacco subsidize the tax exemptions on basic food, such as grains, for the poor.

Shares of cigarette makers rose after the government said a tax on these products will remain unchanged at 65 per cent when the GST is implemented. ITC Ltd., Asia’s second largest cigarette maker by market value, rose 4.8 percent to 251.75 rupees at 11:09 a.m. in Mumbai. Golden Tobacco Ltd. jumped 5.6 percent and VST Industries Ltd. gained 3 percent.

However until the government releases the rate structure for the proposed list of goods it will be difficult to say who will gain and who won’t, Krishan Arora, Partner, Grant Thornton India LLP, said by phone. 

Ultimately, it is a significant reform that will allow India to form one common market, Arora said. "Indirect taxes today lead to multiple administrative burdens. A GST will make India a competitive market for exports globally."

Political bickering had held up the constitutional amendment in India’s upper house of parliament for more than a year until it was approved in August. The GST, initially proposed by the main opposition Congress party a decade ago, is expected to lower the cost of doing business in India.

There will inevitably be teething problems, Patnaik said. "The first two years, you’ll have mighty chaos. Once those basic troubles are ironed out, I think we should see a significantly easier flow of goods between states."

--With assistance from Siddhartha Singh Shruti Srivastava and Abhijit Roy Chowdhury To contact the reporters on this story: Vrishti Beniwal in New Delhi at vbeniwal1@bloomberg.net, Iain Marlow in New Delhi at imarlow1@bloomberg.net. To contact the editors responsible for this story: Ruth Pollard at rpollard2@bloomberg.net, Unni Krishnan, Daniel Ten Kate