(Bloomberg View) -- As anyone who’s attended an Indian wedding knows, we far too often leave vital organizational tasks till the last minute, then tackle them all in an enormous, frenetic rush. The countdown to the July 1 deadline for the introduction of India's new goods and services tax, or GST, feels a lot like that. This is perhaps India’s most comprehensive and revolutionary tax reform ever. Yet till just a few days ago, nobody had any idea about what would be taxed at what rate, nor how inflation might or might not be affected.
Last week, central and state finance ministers from across India -- who comprise the GST Council, which under the new tax law has to make decisions about tax rates -- met for two days and thrashed out what almost all the rates will look like. But the long list of different taxes that emerged from their summit meeting is emblematic of how the economic potential of this tax reform has been watered down almost to nothing by successive political compromises and calculations.
There will now be four different rates for indirect taxes on goods and services: five, 12, 18 and 28 percent. Except, of course, there are actually five rates, since some things won’t get taxed at all, so zero percent should also be in that list. An additional surcharge will apply to some high-tax products -- and the rate of that surcharge could be anywhere from three percent (on personal jets) to 12 percent (on sodas), 17 percent, 21 percent, 61 percent, 72 percent, 142 percent, 160 percent, 204 percent or 290 percent (on pipe tobacco). For a reform meant to introduce a single, simple and low tax rate to India, this bewildering maze is a little farcical.
It’s also an invitation to rent-seeking and corruption. In some cases, very similar services are being taxed at multiple rates. For example, tax rates of zero, five, 12, 18 and 28 percent all apply to hotel stays, depending on how much you eventually get charged. This invites hotels to fiddle with their books; it incentivizes lobbying to move from one tax rate to another; and it opens the door for bribery, corruption and harassment, as India’s famously intrusive taxman will be empowered to determine whether some room rented years ago was taxed at the wrong rate.
So why precisely has the government signed off on this spaghetti tangle of rates? What could be so important that India’s most important tax reform needed to be gutted in its service? Well, the government’s political future, of course.
Unsurprisingly, the government wants all the praise for conducting economic reform without paying any of the cost: that cost being the temporary inflationary bump the new tax is likely to provoke. Across the world, similar bumps in inflation have proven politically disastrous: In many cases, governments that have introduced a GST have been voted out.
India’s government has been more canny, though at considerable cost to economic efficiency. Most components of the consumer price inflation index have been made exempt from the GST altogether, starting with zero taxes on food grains, cereals and milk. India’s top economic bureaucrat even claimed that introducing the GST would lead to a two percentage point drop in the rate of inflation.
That sounds like good news -- except, remember, the price index is an artificial construction. The amount the public pays is still likely to rise before the system settles down. It just won’t be reflected in the consumer price index because the GST Council has gerrymandered the tax rates to ensure it doesn’t.
Complying with the tax isn’t going to be much easier, either. In fact, as has been long feared, it may get harder, given that companies may have to submit monthly returns which they won’t get an opportunity to revise. The rules for settling disputes haven’t been ironed out either; many worry that tax authorities may be able to deny you input credits -- a crucial part of the GST -- just because someone you bought something from takes too long to enter that transaction into the centralized GST database.
The GST Council has at least one more meeting scheduled early next month. If the potential of this tax reform is to be realized, then it has more work to do. It needs to fix these procedural concerns -- and also lay out a timetable for reducing the profligate multiplicity of tax rates to a more manageable one or two rates over the next few years. Otherwise, India’s big new reform could create nearly as many problems as it solves.
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Mihir Sharma is a Bloomberg View columnist. He was a columnist for the Indian Express and the Business Standard, and he is the author of “Restart: The Last Chance for the Indian Economy.”
To contact the author of this story: Mihir Sharma at m.s.sharma@gmail.com.
To contact the editor responsible for this story: Nisid Hajari at nhajari@bloomberg.net.
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