India: Parliament approves landmark Goods and Services Tax Bill
August 19, 2016
India’s Parliament approved an overhaul of the indirect tax system on 3 August, in one of the most significant economic reforms since the country became independent. The upper house of Parliament passed the Goods and Service Tax (GST) constitutional amendment bill—first proposed a decade ago—which is designed to streamline the country’s fragmented tax system and bring significant efficiency gains to the economy. In the short term, the economic impact of the bill is likely to be mixed, but in the long run the reform should boost growth, widen the tax base and improve the country’s business environment.
While the exact impact of the GST Bill will depend on many details which have yet to be determined, at this stage, a number of broad benefits can be seen for the economy in the long run. First, the reform will streamline the country’s current burdensome tax structure, replacing a number of state and central government levies with one unified sales tax, improving the ease of doing business in India. The measure should also end tax cascading, the piling-up of multiple taxes, which can distort incentives within the economy. In addition, the bill will turn the country into a single customs union with a single tax used across states, reducing business costs and removing the need for state customs checks. Finally, the reform should lead to better tax compliance as companies will receive offsets for taxes paid at different points of the supply chain, providing an incentive to ensure that taxes are paid at each stage. These factors together will provide a significant boost to India’s growth trajectory in the long-run.
In the near-term, the picture is less rosy. Currently, services in India are taxed at around 15%, much less than goods at approximately 25%. Under the GST Bill, both groups will be taxed at the same rate, which is expected to be in the middle ground (a government panel has recommended 17–18%). This will result in a one-off rise in services prices, which account for a larger proportion of GDP compared to goods. This one-off impact could temporarily push up inflation and reduce consumption. Regarding government revenues, the short-term impact is unclear. The central government has promised to compensate states for any lost revenues during the first five years of implementation, so any temporary disruption in tax revenues will be borne by the central government.
The GST Bill had been held up for months in the Senate and has now overcome the largest roadblock to implementation. That said, a number of steps remain to be taken and the government’s target to implement the tax by April 2017 is ambitious. Several changes have been made to the legislation that must go back to the lower house for approval and the bill needs to be ratified by a majority of state assemblies. In addition, three pieces of enabling legislation must be passed and a GST council must decide on key aspects of the new tax structure.
The recent passage of the GST bill confirms the government’s commitment to reform implementation, which is supporting India’s bright outlook. FocusEconomics Consensus Forecast panelists’ foresee GDP expanding 7.5% in FY 2016, which is unchanged from last month’s forecast. For FY 2017, the panel also expects the economy to grow 7.5%.