India’s goods and services tax (GST) would have risked a rollback had it become associated in the public mind with inflation, as it had in Malaysia recently. Thankfully, although some Indians are grumbling about the tax rates, complexity and compliance costs, there is no major stakeholder calling for GST’s outright repeal.
At first glance, this is surprising. Indiais comparatively poorer than Malaysia, with its politics more contentious, its population less educated, and a larger informal sector. Upon closer examination, a major cause of GST’s success in India is the very aspect of its new tax regime that has been the most criticised: its introductory four-tier rate structure of 5%, 12%, 18% and 28%.
A single-rate tax structure is much loved by economists, and for good reasons. First, a singular tax rate is less likely to distort production and consumption choices. Second, it also closes off the possibility that producers would exert political pressure for their product to be put in a low tax category. Third, it precludes the possibility of ‘duty inversion’, a situation in which adomestically manufactured good is inadvertently made cheaper compared to a competing import because of a difference in the tax rates between the finished good and its inputs. Finally, a single rate avoids classification disputes — for instance, is coconut oil an edible oil subject to low tax rate, or a personal grooming product subject to a high tax rate?
But if India had adopted a single rate, it would have meant that goods that were taxed at a much lower rate previously would have experienced quite a substantial change in the amount of tax collected. GST would have been much more noticeable to consumers. The government matched closely the GST rate on each good to the effective rate of the pre-GST taxes being replaced. Consequently, the tax collected per unit on most goods remained more or less the same, leaving consumers unrattled.
The close matching of GST rates with the pre-GST effective tax rate also meant that the changes in tax revenue were rendered less unpredictable. Large changes in tax rates tend to change consumption patterns. If the difference between GST and pre-GST tax rates had been wide, then predicting the tax revenue would have involved a certain amount of guesswork. Any shortfall from the predicted revenue would have widened the budget deficit and stoked inflation, giving greater ammunition to the tax’s critics.
All consumption taxes tend to be regressive. But the four-tier rate structure made India’s GST a bit less so. It was an important feature for selling the tax to India’s majority who are poor. Also, by exercising its option to put certain goods in a lower rate category, GoI was able to placate several influential interests, whose disgruntlement would have otherwise jeopardised the entire tax overhaul and improvement in tax compliance.
Factors other than the four-rate structure were also helpful in allowing the overhaul to persist. Favourable economic currents kept overall inflation low, and the GDP buoyant. It also helped that the prime minister, who introduced the tax, has a strong clean image.
In Malaysia, the tax had been tainted by its association with a prime minister who had become embroiled in a corruption scandal. In India, the tax has become associated in the public mind as a measure against black money.
Several features of the current GST regime reduce the drawbacks of the four-rate structure. Many classification disputes have been deflected by adopting an internationally tried-andtested system of classification. Duty inversion has been made less problematic by giving producers a refund on unutilised input tax credits. Pressure from certain local interests for reducing the tax rate on their products has been blunted to some extent by tying the hands of individual policymakers and deferring such decisions to an all-India body.
The drawbacks that remain are small enough to be bearable until the GST regime becomes so firmly entrenched that its rollback is beyond the pale. GoI should be lauded for not letting the economically ideal become the enemy of the politically possible.