BANGALORE, India — Lawmakers
cleared the way on Wednesday for India to forge a single economic
zone from its thicket of overlapping federal and state taxes, the most
important economic measure since India opened its markets in 1991.
Potentially one of the most
dynamic economies in the developing world, India is hampered by a bewildering
array of state-by-state tax codes that discourage doing business across state
borders.
The Goods and Services Tax is
widely viewed as a breakthrough that will allow the authorities to confront the
problem, eventually creating a more unified economy that will allow businesses
to expand nationwide far more easily.
“This is long overdue but
hugely consequential for the ease of doing business, and for demonstrating to
the outside world that India is dragging its economy into the 21st century,” said
Milan Vaishnav, a senior associate in the South Asia program at the Carnegie Endowment for
International Peace.
Economists forecast that the
new tax scheme, which replaces 15 existing state and federal taxes, could
increase the country’s economic growth rate by between 0.5 and two percentage
points.
The tax patchwork dates back
to 1991, when the government embraced
free-market policies and devolved power to the states, including authority
over taxes. For more than a decade, as it became increasingly clear that the
overlapping tax codes hampered growth, Indian leaders have pushed for a radical
simplification, only to be halted by political opposition. That hurdle now
seems to have been cleared.
Though a long series of
legislative steps must be taken before the new tax system goes into effect,
Wednesday’s approval of a constitutional amendment by the upper house of
Parliament, which Mr. Modi’s party does not control, was seen as the most
daunting obstacle.
The move, described by one
executive as “India’s reverse Brexit
moment,” is a significant victory for Prime Minister Narendra Modi. Elected in 2014 with a
promise of bold economic transformation, he had been unable to marshal
parliamentary support to pursue several of his central initiatives, such as
overhauling land and labor laws.
“It’s important for Modi,” Mr.
Vaishnav added, “who has been reeling under this criticism that he hasn’t done
enough in terms of big-bang reform. It completely reshapes how business is
going to be done.”
The benefits of the new tax
regime are likely to emerge gradually, and may not be evident before Mr. Modi’s
party seeks re-election in 2019.
It is likely to lead to an
inflationary bump. And the government’s chief economic adviser, Arvind Subramanian, warned that the single tax
will be “fiendishly, mind-bogglingly complex to administer.”
Over the long term, though, it
is expected to attract foreign investment and bring down the cost of capital
goods, lift manufacturing and exports, increase tax collections and — perhaps
most important, in a country where one million young people enter the work
force each month — create jobs.
“This will be the mother of
all economic reforms in India so far,” said Sachin Menon, who oversees indirect
taxes at KPMG India, an accounting and consulting firm.
Business leaders said the
change would have a profound effect on their daily lives. Praveen Khandelwal, a
senior leader of the Confederation of All-India Traders, said businesses
currently were “harassed and victimized” by the cascading demands of multiple
tax authorities.
“Most of the time we are busy
in complying with those taxation formalities, collecting taxes, depositing
taxes, submission of forms, our money stuck in the system, and other issues,”
he said. “We don’t find time to do business.”
Sachin Bansal, the co-founder
of an e-commerce site, Flipkart, described the idiosyncratic
tax codes that his business must work around: double taxation in Karnataka
warehouses; a $75 limit on shipments to Uttar Pradesh; confiscation of goods
and cash in Kerala.
In a recent editorial, he
described the vote as India’s reverse Brexit moment. “Because of geographical
constraints and artificial restrictions placed by the current tax regime,
quality products are expensive and affordable products suffer from poor
quality,” he wrote in The Economic Times.
The drawbacks of
state-dictated tax policies have long been recognized, but lawmakers were
stymied. Simplifying the system required the political muscle to persuade
states, especially large, wealthy ones like Mr. Modi’s home state of Gujarat,
to surrender control over tax revenues.
A Goods and Services Tax bill
was first introduced by the Indian National Congress party in 2011, but has
since been blocked by whichever of the two main parties was not in control of
Parliament. Before 2014, it was Mr. Modi’s Bharatiya Janata Party, commonly
called the B.J.P., that disapproved of the measure. The Congress Party has
opposed it since then.
Resistance to the plan had
eased in recent months, as the B.J.P. put greater effort into winning over the
smaller regional parties that had opposed the bill. Meanwhile, the Congress
Party’s share of seats in the Parliament’s upper house, the Rajya Sabha, has
been shrinking.
“I think the logjam broke now
because the Congress found it was largely isolated,” said Mihir Sharma, a
columnist and senior fellow at the Observer Research Foundation.
Introducing the new system
will not be quick or easy, and the government will be hard pressed to put it in
place by the current deadline of April 1, 2017.
Technically, the parliamentary
vote on Wednesday approved only a constitutional amendment on the new tax
system, the first of many steps needed to enact the tax measure, usually
referred to by its initials, G.S.T. The constitutional amendment must also be
approved by a majority of India’s state legislatures and by the president. Once
it is approved, which is expected, Parliament must enact legislation to create
the new tax system, and individual states must pass their own laws.
Still to be settled is the
thorny issue of tax rates. States will want high rates, to maximize revenue,
and the central government will push for lower rates to avoid sparking
inflation, said Pranjul Bhandari, the chief India economist at HSBC bank in
Mumbai. “You have to tread the very thin line between making political parties
happy and making the state governments happy,” she said.
India’s economy is growing at
a robust 7.6 percent while enjoying the lowest inflation in decades. But job
growth has been sluggish, and the corporate sector remains starved of cash.
Tension over the economy’s
performance came to a head this summer, when India’s respected Central Bank
governor, Raghuram Rajan, who had resisted pressure from right-wing leaders to
make deep cuts to interest rates to spur growth, decided to return to academia
after his term ended in September. Mr. Modi’s government followed up, almost
immediately, by throwing open new sectors to foreign investment.
Surjit Bhalla, a macroeconomic
adviser on India to the Observatory Group, a consultancy in New York, compared
the new tax regime to the industrial deregulation of 1991 and said it should
put to rest any doubts about Mr. Modi’s credentials as an economic modernizer.
“It’s a mega-reform, and it comes under his leadership, which is why he and the
B.J.P. were very keen to get it passed,” he said.
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