India’s tax reforms have built-in lacunae

Any system which empowers bureaucrats with oversight will not ease matters

hecking out of a hotel in the southern Indian state of Kerala took so long that I almost missed my flight. It wasn’t the hotel staff’s fault; their work, temporarily, had been doubled.

As a polite note in my room reminded me when I checked in, they would have to present two invoices to me when I left — one for the days before July 1, and one for the days after. For at midnight on July 1, India migrated to a new, more comprehensive indirect tax regime, known as the goods and services tax, or GST.

The scenes of chaos at my hotel’s reception will have been repeated, to a greater or smaller degree, in countless shops and establishments across India. The transition to the GST — which aims to unite multiple federal and state indirect taxes into a single system — isn’t likely to be easy. That the government has rushed into it will only exacerbate the pain.

That said, the GST is a major step forward, one of the few real efforts in recent years to reform the Indian economy. The transition might be chaotic and the current GST itself may fall well short of what it should be. Nevertheless, it represents the hope that India will, in its own muddling way, continue in its efforts to build a modern, competitive economy.

And these efforts depend crucially, as with the GST, on reforming the Indian state.

Does the passage of GST mean that such reforms are more or less likely now? Well there’s some good news, some bad news and some pretty appalling news.

First, the good news: It seems the government at least recognises that the Indian state is — in the words of Harvard political scientist Lant Pritchett — “flailing”. The central idea behind the GST is to privatise tax enforcement.

This is not in fact as shocking as it sounds. Now, if you have to pay indirect taxes, you will only receive tax credits for your inputs if your supplier has also paid his or her share of taxes. Over time, it’s hoped, this will mean that larger businesses will pressure their smaller suppliers to enter the tax net.

I’ve already heard multiple stories from executives in larger businesses about how they’ve struggled to educate their suppliers about the GST. Some online shopping portals have had to remove suppliers that didn’t seem ready to comply with the new rules.

Bureaucrats hope that this kind of pressure will succeed where enforcement has failed: It should create an incentive for small and medium-sized enterprises to sign up as GST payers. If they don’t, they could lose business rapidly.

While this will make life more difficult for companies, the logic is at least grounded in an incentives-based view of the world. It’s worth a shot.

But it’s too soon to claim that Indian policymakers have suddenly become more realistic about the state. Here’s the bad news: The introduction of the GST doesn’t necessarily mean that tax administration — currently split up between various state agencies and the central government — will be reformed or unified.

Falling short

Indeed, the need to placate civil servant lobbies is one reason why the final GST falls so short of what it should be. Banks, for example, are expected to register for the “single” tax in each state rather than centrally.

And now we come to the truly appalling news: the GST’s infamous “anti-profiteering clause”. In effect, the new law insists that all benefits from the GST be passed on to consumers in the form of lower prices.

If a new “anti-profiteering authority” determines that any company hasn’t done so, it can levy fines or even force the company to shut down.

Think about this for a moment: A new tax regime that is supposed to make businesses more competitive insists that additional profits should be passed on, regardless of demand and supply conditions. The government says that it doesn’t intend this clause to be used, that it will be temporary and that it’s meant only a “deterrent”.

Yet which bureaucrat is going to resist the opportunity to make an example of companies? The “examples” chosen will be, in and of themselves, arbitrary — and who can believe that there will be no bribery and corruption involved in the choice?

How will the facts of any case be determined without confidential information about costs and so forth being turned over to the authorities — and what are the chances that that information will remain confidential?

This sort of clause shows the Indian state at its worst: It is, in fact, one of the most intrusive rules introduced in the decades since liberalisation. The GST is a big reform.

Whether it signals that India’s leaders now have the instincts of reformers is another thing entirely.