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India’s Taxing Pains

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India’s Taxing Pains

Confused implementation reminds some of the the day after demonetization, but there’s hope for the future.

India’s Taxing Pains
Credit: Flickr/ Andrea Kirkby

India’s biggest tax reform since independence was launched Saturday to a mixture of protests and confusion among businesses and consumers. Yet despite the initial implementation dramas, analysts have pointed to potential longer-term gains for Asia’s third largest economy.

Formally enacted in a late-night session of parliament Friday, the new goods and services tax (GST) has unified 29 states and 1.28 billion people into a single market for the first time. The move is expected to strengthen government finances, reducing complexity and boosting foreign investment, among other economic benefits.

“This will lead to increased compliance and give us an opportunity to make tax rates more reasonable, apart from leading to higher collections and providing strength to the economy,” Indian Finance Minister Arun Jaitley said Saturday. “It is my belief that there will be some pain when there is a change and one where technology is involved.”

However, the first day of implementation brought protests from some concerned about the effects of the new regime. Businesspeople and traders in the northern state of Uttar Pradesh claimed they were poorly equipped to deal with the new system, given its need for monthly online returns. For smaller merchants, such transaction documentation has traditionally been prepared manually, with millions lacking the necessary computerized systems.

“The GST is full of flaws. We welcome it but it’s full of problems. We’re protesting against it and we request the prime minister and the finance minister to bring in a simple GST, ending all complexities,” a protester told NHK World.

“It’s like the day after demonetization,” computer trader Praveen Arora told Bloomberg News. “People are confused. And the way the rates of IT products have been raised, it’s hit sales very hard — people are expecting to be billed at the old rates.”

A random sample taken by the Nikkei Asian Review of a market in Raipur found only two in 20 people able to even name the new tax, pointing to a general lack of information dissemination concerning the reform.

According to the Times of India newspaper, retailers ranging from electronics stores to gyms were deserted Saturday due to the higher costs imposed by the GST, with many closing or others using manual billing to escape the new rates.

Under the previous system, India’s central government and 29 state authorities all levied their own sales taxes at different rates, using varying procedures. Yet rather than a simple flat rate, such as Japan’s 8 percent or Australia’s 10 percent, India’s GST comprises four rates ranging from 5 percent to 28 percent, with numerous exemptions.

For example, fresh vegetables and newspapers are not taxed, while tea and coffee attract a 5 percent rate, fruit juices 12 percent, toothpaste and ice cream 18 percent, and cars and refrigerators 28 percent. There is also an additional levy on cigarettes and motor vehicles, while the liquor industry has escaped the GST entirely.

“The fact that certain industries have been left out of the GST is also going to be a major implementation issue,” Jagatjit Industries’ Roshini Sanah Jaiswal told Bloomberg News. “Hopefully, over the period of time the Modi government will have a uniform GST policy.”

‘Perfect’ Environment

However, the Associated Chambers of Commerce of India (ASSOCHAM) said low consumer prices made the current environment “perfect” for the launch of the GST.

“Retail inflation, measured by the consumer price index, was at a four-year low of 2.18 percent in May, 2017. Likewise, the whole price index measured inflation was [a] mere 2.17 percent for the latest month, providing an ideal platform for the GST. With [the] monsoon showing a good spell in its initial phase, the prices should further ease for a large number of items,” ASSOCHAM said.

According to the business group, “it all boils down to implementation. If we can make it smooth, hand holding the traders and increasing awareness at the consumer end, the dramatic shift in India’s taxation should be a happy experience for the industry, trade and consumer.”

India’s latest inflation data pointed to the lingering effects of demonetization, amid excess capacity and a mixed economic recovery. According to ANZ Research, the lackluster inflation could even allow for a “modest easing” of 25 to 50 basis points by the Reserve Bank of India, “should the monsoons pan out to be normal.”

The nation’s latest gross domestic product (GDP) data showed an economy still recovering from the “shock” of demonetization on consumption. India’s economy expanded by 6.1 percent in the fourth quarter, below market expectations for a 7.1 percent gain, amid sluggish private investment and a slowdown in real estate and construction.

The new GST may add to the slowdown in consumption and investment, at least in the short term, according to Kotak Institutional Equities.

“We would be cautious on economic growth for next one to two quarters,” the stockbroker said in a June 27 research report. “The GST rate structure will be neutral to marginally disinflationary for CPI. We estimate CPI inflation to be lower by around 20 [basis points] on an average due to GST rates.”

However, once the new tax is implemented, efficiency gains and increased government revenues should boost the economy’s growth potential, Kotak said.

In a May 31 research note, ANZ Research said it expected GDP growth of 7.5 percent for fiscal 2018, compared to the 7.1 percent rate for fiscal 2017, making India the world’s fastest growing major economy.

India’s Economic Times has stated that the GST reform could increase GDP growth by a percentage point or even more, noting HSBC’s forecast of an 80 basis point rise in GDP over three to five years. It points to numerous benefits from the reform, including the replacement of 17 indirect taxes, thereby reducing compliance costs; enhanced government revenues; lower inventory costs; and an investment boost due to the reduced cost of capital goods.

As noted by The Diplomat, the reform could help bolster Indian Prime Minister Narendra Modi’s faltering approval ratings due to demonetization, or alternatively “prove to be a fatal source of dissatisfaction.”

Yet with millions of Indian businesses now joining the computerized economy, others are more optimistic about the long-term impact.

“It’s effectively India signing [a] free trade agreement with itself. That’s what it has done,” Apex Avalon Consulting’s Girija Pande told CNBC.

While far from perfect, Modi’s reform could help Asia’s emerging giant advance further toward its potential as one of the world’s 20 biggest economies, even if there are plenty of hiccups along the way.