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I had a bad dream the other night. I dreamed that I was an intern at the Income Tax Department
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of the Government of India and my boss told me to go and make a list of every tax that
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was applied by either the states or the center anywhere in India. So I went to the auditing
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department and the guy across the table looked at me and sniggered. What's so funny? I asked.
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Nothing, he said and he opened the drawer. Then he took out a big roll of toilet paper
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and handed it to me. What's this? I said. It's a list of taxes, he said. And indeed
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in very small font size there was a list of Indian taxes on it. I started reading and
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as I did so the roll of toilet paper started unspooling. The list went on and on and on
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and soon the whole room was covered with toilet paper. Welcome to the scene and the unseen,
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our weekly podcast on economics, politics and behavioral science. Please welcome your
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host Amit Varma. Welcome to the scene and the unseen, my weekly podcast on the seen
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and unseen effects of public policy. In the Lord of the Rings, the real hero of the story
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is not Frodo Baggins but the ring he is after, the one ring to rule them all. Well today's
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episode is about the one tax to rule them all, the GST. The GST or the goods and services
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tax is one central tax that is meant to replace a massive list of many other taxes at the
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state level. On the face of it, it's a great idea. So many different taxes create compliance
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issues and thus avenues for corruption. They drive up prices and hurt the consumers. They
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create friction in trade which hurts the economy. So here's the seen effect of the GST. The
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GST consolidates a whole bunch of different taxes. It simplifies life for businesses thus
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potentially lowering costs for consumers. Now the GST hasn't been passed in India yet
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and what was just described as the seen effect of the GST is essentially the intended effect.
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And the unseen effects I will now talk about also haven't happened yet but are some of
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the possible unintended consequences that might just take place given the way things
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are unfolding. To discuss this, I've got as a guest on the show today, Devang Shu Dutta,
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an economic analyst who is also a columnist for the business standard. Devang Shu, tell
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me what's so great about the GST? Look, in theory it's an extremely nice idea. It's
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probably the best thing to have come out of the European Union in the sense that you take
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10 countries, 12 countries, 20 countries, whatever it is now, and they all have borders,
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they all have internal checkpoints, they all have different tax and excise systems. So
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the brilliant idea here is that you impose one tax and excise system across these 11
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countries. You no longer need the internal borders. And if you don't have the internal
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borders, your goods can move faster and with much less in the way of paperwork and friction.
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So for example, if say the Poles are sending something to Belgium, it might be crossing
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three countries on the way but the truck wouldn't be stopped anywhere in those three countries.
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To make it work, you need a very good computerized backend where everything can be reconciled
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and handled. But India does have that. We have 23 states and I think umpteen Union territories
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as well and each of them has a different internal state excise and tax system. In fact, it takes
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longer to send something from say Bangalore to Bombay directly by road. And that's just
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one border, essentially the Karnataka-Maharashtra border that you're crossing and the Bombay
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-Oktroy at city limits. Then you know, you could actually send goods quicker to Colombo
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and let a ship take it out from Sri Lanka and drop it in Bombay harbour, then directly
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send it by road. And that sort of problem multiplies when you're talking five states
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sending something from again, let's say from Kerala to UP is an insanely complex thing
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because you have trucks held up at every state border. You have local state excise officers
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insisting on inspecting every cargo, every manifest. A lot of speed money has to change
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hands and there's a lot of friction in the system. Now, if you could get rid of this
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friction it would be for the first time India would actually be one market. So in theory
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it's an extremely good idea. The thing is of course that India is also a federal state.
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It has, the states have specific powers to raise taxes and to a degree their financial
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independence depends on their ability to raise taxes. So by imposing a centrally administered
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tax rate, you are essentially asking the states to give up a certain amount of their financial
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independence and the carrot here is that you can tell them that eventually you will gain
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because as trade improves every state in the nation should eventually be gaining and also
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a commitment from the centre to divide the revenues from the central tax equitably.
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These are again in theory very nice things in practice with half a dozen regional parties
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and a lot of political, let's say a shifting flow of political alliances. It's taken six
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or seven years to work through this and one of the problems with GST is that unlike its
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younger brother value added tax, you actually need to get more or less every state on board
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to start making this thing work. With VAT you could actually say that okay six states
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make it work and then the other states came on board slowly. Here unfortunately if you
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are transporting goods from Kerala to UP, even if UP and Kerala agree to be part of
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the GST, if Andhra Pradesh and Karnataka which come in between on Chhattisgarh do not want
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to be part of GST, they'll go through the same issues of being stopped at borders. So
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you need it to essentially be an all India scheme. They've managed to get that finally
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to sort of happen. It's still not clear whether that will happen but at least the constitutional
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hurdle of states being willing to give up their powers that has gone through. Now you
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are only fighting about the rather important details of what exactly this tax will be and
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that is where the next set of problems in negotiations arise.
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So to sum it up essentially you would say the scene effect or the intended scene effect
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of GST would just be to reduce all the friction along borders and while India has been one
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country since 1947 we've been a whole bunch of different markets and by turning it into
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one market we'll make it cheaper for the consumer and easier for businesses to function. One
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of the unseen effects you pointed out is that states lose some of the independence and competitiveness
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they get from a federal structure where they can compete with each other and set their
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own taxes and so on. Do you feel that this is per se regardless of consequences on principle
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or bad thing because governance as we have seen through history works best when it is
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as local as possible. So to actually centralise something like this and not allow states to
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I agree that there is always going to be a large problem with an imperial centralised
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structure but if such a system can be made to work across Europe which don't forget
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had so many internal wars as well happening over such a long period and it's worked pretty
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well it would be the best reason for the European Union to exist would be the fact that you
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have essentially a GST type system. So I suppose if sovereign nations can decide that we will
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live with this you can probably make it happen in the Indian context but yes it has to be
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voluntary and it has to be carefully negotiated so that you know the states feel comfortable
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In theory GST sounds great but implementing it in practice A, it's taken many years to
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come to where it's at, it's gone through many compromises in the political process,
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the political economy is messy and complicated with so many states and parties and competing
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interests. What are the sort of unseen effects that this can lead to?
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Well first even Europe went through two years of chaos putting it together. We have arguably
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as good computer systems and we have that experience to say that there are certain mistakes
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maybe we won't make because the Europeans made it and you know we'd look at best practices.
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However that apart what we are going to end up with for a while is an extremely compromised
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system where first of all states do not want to get rid of their right to tax specifically
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high value items like alcohol, tobacco and petroleum products. Those three things they
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would like exemptions on and if you have that then in a sense if you look at the Indian
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revenue the indirect tax revenue breakups those three things are extremely important.
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And instead of having essentially the European GST works because they have very few tax slabs.
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They have I think a total of three slabs which is one for goods, one for services and a third
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In India we already have four slabs plus a commitment to a fifth slab and in effect a
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sixth slab and maybe a seventh. So if you have a GST which is spread across seven different
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slabs and I'm not including zero tax items in this it will be incredibly messy and complex
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system to implement because in a sense any sort of GST works on a VAT principle that
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I pay for a car but and the chap who manufactures the car is taxed on the value of what he's
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adding to the 30,000 or 50,000 parts which he's bought and sourced from the market and
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the expenses he's had in terms of labor to put it together blah blah.
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So if you have that sort of thing happening and every one of those 30,000 items then have
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to be classified under seven different categories and taxes calculated on that. Again in theory
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yes of course a computer can do this but in practice it will be an extremely complicated
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and very AI artificial intelligence dependent process where in a sense even an assessing
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officer will not be able to tell you off and what is going on. That's one problem. The
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second thing is that you have exemptions where essentially state governments are still going
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to be imposing their own taxes which means that in a sense lorries will be stopped at
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the border of every state and this whole process of checking your manifesto and a five kilometer
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long queue while manifests are being checked and cargoes are being inspected visually etc.
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And of course the associated corruption that goes with this whole process that doesn't
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disappear. The state excise and revenue departments remain live departments. It isn't as though
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the officers are going to be given a pension and told to go away or absorbed in different
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departments. They will stay in uniform and they will continue to hold up trucks. So those
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frictions will remain for a while at least for the next three to five years. Second given
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demonetization this entire process of negotiation may well break down and break down for very
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rational reasons. One of the areas which the center does not have any sort of say in is
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stamp duty. That's imposed on land and it's collected by every state which sets its own
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circle rates and things and for reasons which we all know but let's not elaborate. The real
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estate market has frozen. The secondary real estate market essentially does not exist at
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this point of time and whenever it does come back there is a fairly good chance that it
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will be depressed in terms of value for a while. If that happens the states lose stamp
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duty revenue. If they lose stamp duty revenue and they anticipate losses of revenue at least
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for the first couple of years on GST most of them do not want to be placed in a position
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where they'll be running at fiscal deficits which will actually erode their bargaining
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power versus the center. A state which has, in fact we've seen this, a state which has
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reasonably sound finances at Tamil Nadu or Maharashtra has, regardless of the government
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at the center vis-a-vis the government at the state, it has a lot of bargaining power
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because they can manage their own finances. Essentially Tamil Nadu or Gujarat or Maharashtra
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could be independent countries, maybe not very prosperous independent countries but
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they have run reasonably balanced budgets. They earn their own revenue and in that sense
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they do not need central intervention. A Bihar can't. A Bihar or a Jharkhand is much more
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dependent on the center and if you have a scenario where quite rationally a lot of states
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anticipate a crunch in terms of internal revenue collections they would rather not have the
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GST happening. So I think there will be a further sequence of negotiations where it
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could break down and of course a redefinition of powers as it happens. So what if it is
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implemented at all it will be a very messy implementation otherwise if there's a breakdown
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in negotiations well essentially as the bill stands right now if it's not implemented
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by 30th September 2017 they would need to run a new set of bills through Parliament
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and again it is going to be touch and go because this is a constitutional bill you are dealing
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with center-state relationships the Rajya Sabha has to vote on it separately. It's not
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a money bill even though it's all about money it is not a money bill you have to push it
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through the Rajya Sabha where the state representatives have to agree to give up their power and whether
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you can make that happen a second time if this bill lapses is well let's say it's likely
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to be doubtful also likely to be doubtful whether any same central administration will
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want to impose GST going into a general election because you have a huge problem if you know
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if you anticipate even one year of chaos and at the end of it you don't know where your
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finances will be and you don't know what sort of impact that will have on specific
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areas why would you want to take the risk going into general election.
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So let me let me try and sum up the sort of unseen effects that you've spoken about number
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one is because of the potentially seven different kind of categories and because of the multiple
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numerous exemptions that exist the process will actually become even messier than it
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is now perhaps it will be a lot of discretion given to government officials the rent seeking
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will continue the friction at the state borders will continue you will still know when you
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approach a state border by car by the line of trucks that you see this must be a state
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border and the second unseen effect is really where the states fear losing their independence
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because they're already hurt by the loss of stamp duty due to demonetization and if they
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can't maintain a balanced budget they lose a lot of the bargaining power they have vis-a-vis
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the center and you almost reach an imperial sort of system where the states have less
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Now so my question to you is that given that within the political economy we are in with
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so many states and so many parties and so many different competing interests that this
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kind of messy process was almost inevitable was the GST a good idea in India in the first
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place and if so how would you how would you have done it differently.
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I think you'd have had to find a way to live with three rates and note that right now I'm
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just talking about the G they still haven't worked out what the S rate is going to be
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and that is also going to because can you elaborate on that G and S yeah of course they
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worked out goods rates they worked out a zero rate four rates of five percent twelve percent
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eighteen percent and twenty eight percent there will be another rate which will be imposed
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specifically on bullion and special pressure stones that has not yet been negotiated there
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will be a cess on top of the twenty eight percent items which are luxury items etc.
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Which will be imposed in order to raise money for the anticipated losses that states will
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face in terms of revenue for the first two to five years that is supposed this cess is
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supposed to have a time-bound thing that it will only happen for two years or whatever
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but you know what happens in India reservations were supposed to be done about so we don't
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know how that will happen and they haven't yet gotten on to brass tacks working on the
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service tax rates now the service tax rates as you all know is about fourteen and a half
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percent however you have perfectly rational people saying that well you know there is
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a difference between say an oncologist versus civil engineer versus a pizza delivery guy
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they're all performing services of undoubtedly but there is pretty much a difference so should
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that be reflected in a service tax rate if you decide that it should be reflected in
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a service tax rate well again do you arguably a flip cart which is based in Bangalore if
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it's if it's acting as a delivery boy and delivering something to you in Delhi it is
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a service so it should have a service tax component but if you have a service tax component
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what should that service tax component be so this back and forth is going on so they
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don't even know apart from the goods rates which are still subject to reclassifications
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they haven't yet worked out the service tax rates at all so I think that is where you
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have a real problem happening now in that you need to sit down and say look you cannot
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have you know seven different rates or ten different rates just because the current system
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has seven different or ten different rates or twenty different rates GST works essentially
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because it simplifies the system you have to you know find a median rate whatever that
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median rate is which is reasonably satisfactory and crunch it and just let it happen I mean
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shrug your shoulders and say okay maybe service tax should be sixteen percent and let it
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go for a year if sixteen percent turns out to be too high and cut it back so just a further
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question to go back to the goods rates for example just a G part of it you said there
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are four existing rates with three more potential rates in three different categories possibly
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coming up now why is this who asked for these different rates because they tried to the
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essentially because our state excise systems have on even our central tax systems have
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these extremely complicated classifications and reclassifications of goods so when they
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started negotiating for this instead of throwing that out of the window and saying that let's
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have a simplified system they said no no no you know we call cars luxury items so we have
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to have a rate which but who said like who is the interest group which is protesting
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us well every interest group obviously is involved all the manufacturers associations
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and the traders associations have lobbied at the same time central and state government
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finance ministers of state finance have put their feet down and said that well you know
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we charge a lot we charge a high amount on let's say electronic items or cars so we want
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that to have that higher amount should be charged in in the whatchamacallit in the GST
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so it should be at twenty eight percent at the same time you know you have it's a classification
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which is electronic items but not computers and mobile phones so you are running into
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subcategories of classification because computers are I think charged at the lowest rate or
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at zero I'm not quite sure but it's an extremely low rate whereas I'll say a microwave oven
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could be having a thirty five percent or forty percent tax on it given the combination of
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central and state excises now essentially a microwave is a dumb computer it has a chip
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in it and you know the rest of it is it's just faff but you have at some stage decided
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to make these peculiar distinctions and you continue making these peculiar distinctions
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even though you had a chance and you could have actually said that let's converge to
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some average rate which seems reasonable let's cut it down to three different items you know
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sinful items non-sinful items and essential items essential items for example food has
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is zero tax books are zero tax physical books are now charging you for downloading Kindle
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books yeah this will bankrupt me yeah so I mean on there at least they're contemplating
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charging you for downloading Kindle books and again books are free but music cassettes
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are not a computer program is not well again certain categories of computer programs are
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free but games are not so I mean are zero tax versus games not being zero tax so if
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you have some man sitting there somewhere in a you know Sarkari office making these
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distinctions for what might or might not seem rational reasons right so one final question
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now given that we can't just create a utopian world where we design everything absolutely
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perfectly and we have to work within the limitations of the system supposing Narendra Modi was
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to walk in the door and say they want you I've made many mistakes but I finally met
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you so I'm going to take you to this time machine and you're going to come back in time
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with me to 2014 and you are going to run my GST policy should we have a GST should we
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let taxes stay there if we try to get a GST through how should we design it what are the
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kind of compromises we should we can make and we cannot make what would you then do
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as a policy maker what would you do differently I would have petted down to three days I would
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have told the states that we'll calculate a shadow rate based on the income you would
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have made on every item at the old thing and we'll figure out a way of compensating instead
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of looking for a constitutional amendment I would have made it some sort of tripartite
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deal with maybe the RBI or maybe even the World Bank standing in as an interlocutor
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and guarantor for this particular financial transaction that shadow tooling happens for
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example on roads where you say that well we won't make this a toll road because it's
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public policy we want to connect point A to point B and we're not going to toll it however
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the guy that builds it will count every vehicle that wanders down the road and we'll figure
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out at the end of the year or every quarter or whatever it is every two weeks as the case
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maybe how much revenue there would have been and we'll pay that revenue so shadow tolling
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I would have tried you're asking me this question out of the blue but I would have tried doing
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something like that figuring out a shadow tolling a shadow tax system where if it's
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stuck with the whole system this is what the and you have to anyway it may sound complicated
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but anyway this is the comparison you have to make to find out at some point to find
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out whether GST makes sense or not so I would have said that we'll do that and you know
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we'll compensate you if it turns out that you're making you know that you are forgoing
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revenues on the GST and if it turns out that you're not forgoing revenues and you're
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actually ending up better off or we are ending up better off at the end of it well then the
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centre keeps the money if you like this is a two-way bet if the GST works the centre
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actually ends up with a surplus and the states end up with the same money that they would
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have made anyway right and you remove the and if the GST doesn't work the states get
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the money they would have made anyway but the centre loses a little bit the centre loses
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something yeah so they take the owners of GST on themselves on the risk would make the
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state more agreeable to the risk the risk would be the centers and you'd ask them to
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you know to dismantle essentially dismantle your state excise services or cut it down
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to one chap who doesn't necessarily stop trucks you're going digital anyway so you know this
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guy as the truck approaches you he can basically SMS you his manifest and you enter it and
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you carry on thanks a lot they want your pleasure talking to you the GST is deeply complicated
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it may or may not actually pass this year but even if it does it's useful to remember
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that it's had such a convoluted development that it may not achieve much of what its designers
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would like it is always good to be forewarned on that note I shall sign off from the show
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I'm going to check it out.
