Recent economic news headlines signal a strong optimism relating to the Indian economy being on the upswing.

Recent economic news headlines signal a strong optimism relating to the Indian economy being on the upswing. Last week, the IMF, at its annual Spring Meetings, had stated that the structural reforms and other measures taken by the government—including digital ID technology and recapitalisation of banks—have started bearing fruit, making India a veritable “economic power-house” with inclusive growth. RBI has also forecast GDP growth to strengthen, to 7.4% in FY19, establishing India, again, as the fastest-growing major economy in the world. In all of this, GST is also a factor of some reckoning.

There is no gainsaying that GST has been a game-changer for Indian economy, and its 1.3 billion people. Nonetheless, such an pan-economy change—especially when the economy is of the size and scale as India—was bound to encounter some bumps. Globally, too, the first-round effects of disruptive fiscal reforms have resulted in transient adjustment costs. A recent Tax Policy Research Unit (TPRU) analysis of countries with VAT showed that in 80% of these countries there was a sharp decline in economic growth in the quarter in which VAT was introduced, with the adverse growth effects tapering off after four quarters.

India is no different. In fact, with the quarterly GDP growth rate picking up pace just two quarters after the roll-out of GST, India seems to be ahead of the global average recovery curve following a major fiscal shock. The starting point for the reform process is also of significance. Different incentives drive the negotiating strategies of predominantly goods/services-producing states and predominantly goods/services-consuming states. To finally agree both on the benefits of a common market and the five-rate structure (including a zero rate)—the previous structure had a multiplicity of rates—is certainly a Pareto improvement.

While a single-rate structure might have made the tax system simpler, it would neither have been equitable and revenue-neutral nor would it have been acceptable to all states. The World Bank in its March bi-annual India Development Report had endorsed the GST as a “historic reform” with the long-term benefits far outweighing the short-term adjustment costs. At the same time, the report had also commented that India’s GST multiple rate structure was complex. However, it should be pointed out that trying to compare a country of India’s size, diversity and complexity to 115 “comparable” countries that include Aruba, Barbados, Curaçao, Niue (a Pacific island with a population of 1,600), Samoa, Sint Maarten, Rwanda, Suriname and Zimbabwe may not necessarily shed light on the most relevant international best practices in VAT rates.

Most large countries that implemented VAT have now settled on having multiple rates. A multiple-rate structure is less regressive, with the higher rates on some commodities compensating for reduced rates on others. Amongst similarly placed federations, Argentina has six rates, from 0% to 27%; Brazil has four rates, from 4% to 18%; China has eight rates, from 3% to 17%; and Russia has four rates, from 0% to 18%. Australia is the only single largest comparable country which has just two rates (0% and 10%), and Canada also has two rates at the federal level (0% and 5%), though there are different additional provincial rates (equivalent to India’s SGST) ranging from 11% to 15%. The United States, a federation of 50 states, has no value-added taxes at all.

What also needs to be kept in mind is that finalising a GST rate is an iterative process as lessons are continuously being learnt. The GST Council, at its 23rd meeting on November 10, 2017, decided that highest rate, 28%, would be applicable only on luxury and “sin” goods. This resulted in a major shift of 177 items from the 28% bracket to the 18% bracket. Changes in the rate structure to simplify the framework, or on equity and efficiency considerations, are not uncommon and demonstrate the flexibility and responsiveness of the tax system.

For instance, between 1999 and 2015, Portugal had 10 VAT reform periods affecting the standard rate on 242 commodities, reduced rate on 20 commodities and reclassification of 9 commodities. During this same period, France had six, Belgium had four and Ireland had seven VAT reform periods. The Indian tax system’s deftness at adjusting its rate structure is seen in a steady improvement in GST collections since November 2017, despite a cut in tax rates. GST collections are expected to increase further in the coming months due to an expanding tax base and better compliance, with more states using the e-way bill system.

History and economics remind us that momentous reform measures usually have a positive impact after the initial shock. Going by the current positive trends, and barring significant global set-backs, patience is the order of the day as the economic gains of GST are reaped.

By Indira Iyer

Chief director, Tax Policy Research Unit, Ministry of Finance. (Views are personal)