India welcomed the Goods and Services Tax (GST) on 1 July 2017, sixty-three years after France first adopted it. In his Parliament speech, Prime Minister Narendra Modi said, "GST marks the economic integration of India." It is expected to unify India through the creation of a single market for goods and services—as the GST slogan goes, "one nation, one market, one tax." Moreover, it is expected to increase the tax base in India where less than 1% of people pay income tax and close to 90% of the workers are in the informal sector. Both these perceived benefits, according to the government, are expected to accelerate India's economic growth by making it easier to do business and increasing public investment (financed through increased tax revenue).

The second volume of the Economic Survey 2016-17 released earlier last month—another first for India—argues that the introduction of GST partly contributed to "optimism about the medium term." One hopes that the optimism is well founded and not "irrational exuberance", to borrow Robert Shiller's phrase. Was the introduction of GST aimed at raising tax compliance by simplifying the indirect tax structure with the aid of information technology? Or, did it aim to structurally reform the Indian economy with a view of increasing employment and reducing inequalities? There is also another important question: is a uniform tax a good policy move in an economy like India where the intra-state and inter-state differences are significant?

Is a uniform tax a good policy move in an economy like India where the intra-state and inter-state differences are significant?

Amidst his discussion on inequality, Thomas Piketty rightly writes in Capital, "Taxation is not a technical matter. It is pre-eminently a political and philosophical issue, perhaps the most important of all political issues." Hence, it is important that the political economy of GST is rendered transparent. After the introduction of GST, several Indian states have lost their autonomy in public policy owing to a reduction in their tax revenue because the GST subsumes state taxes such as the value added tax (VAT), sales tax, and luxury tax. [The service tax belonged to the centre.] In fact, as GST is a destination tax, Tamil Nadu, a manufacturing state, had opposed it because of a potential revenue loss of around ₹9270 crore. Additional reforms are necessary to ensure that the state's economic policies are not throttled.

If simplification of the tax structure was a central goal, the four tax slabs of 5%, 12%, 18%, and 28% do not make sense. However, if the government has an additional goal of influencing consumer choices, different tax slabs make sense. Yet, our current GST tax structure eludes easy interpretation. For instance, why should pens be taxed at 18% and now cost more? And why should sanitary napkins be taxed at 18% and now cost more? There appears to be no obvious economic or social logic behind this classification.

On looking closer, the GST classification for goods and services appears to be based on the "ability to pay" principle and is therefore progressive in spirit. Hence, non-AC train travel is GST exempt while AC train travel is taxed at 5%. Similarly, while non-AC hotel services are taxed at 12%, the services in AC hotels attract a tax of 18%. From the perspective of the consumer, it is indeed the case that those who consume "luxuries" (e.g., services in five-star hotels and restaurants) have to pay a higher GST than those who consume "necessities" such as education and health services. But how are the producers affected?

While "one nation, one market, one tax" sounds alluring, it presupposes an economically homogenous nation and a uniform market for commodities and labour.

During the VAT regime, handmade products were tax exempt but they are now taxed at different rates in the GST regime. If one adopts the sole principle of 'ability to pay' in the matter of taxation, taxing handmade products might not seem to economically unjust. As a government official put it, "a machine-made shawl is priced at ₹500 and a handmade one at ₹5000. If a person can shell out so much for a handmade item, they might as well pay a higher tax on it." This is a good example of myopic thinking because we need to ask what happens to the handloom sector (employment and wages) once the market price rises.

As I write this, a meeting has been organised to protest the taxing of handmade products. The problem is aptly captured in this statement by one of its organisers: "Handmade products such as khadi saris are already expensive as compared to machine-made products. With imposition of GST, a khadi sari has become costlier." It is elementary economics that this can lower demand for handmade goods and negatively affect employment in this sector. India's recycling sector has also been adversely affected due to GST implementation.

Economic policies or reforms cannot afford to be short-sighted either intentionally or out of ignorance. The second volume of the Economic Survey proudly states that the GST regime has formalised the informal textile and clothing sector. But at what cost?

Just like demonetisation, the GST is yet another bad economic "reform" with detrimental impacts on India's poor and vulnerable.

It is true that the big firms will benefit from lowered transaction costs and will be able to enjoy an increased volume of inter-state business. Small firms mostly buy their inputs and sell their output within their own state. In short, the lower transaction costs benefit big firms.

While around 160 countries have implemented GST, its effects have been varied. In Malaysia, household consumption reduced after the implementation of GST; in Australia, the burden of GST was more on the poor than the rich; whereas the weaker sections of the populace benefited from GST in Ethiopia, Pakistan, and Vietnam.

To conclude, while "one nation, one market, one tax" sounds alluring, it presupposes an economically homogenous nation and a uniform market for commodities and labour. Is one tax justified in India, which has several many different labour markets, each with its own "equilibrium" price? Or do our policy makers think that imposing "one tax" can transform India into a single market? Just like demonetisation, the GST is yet another bad economic "reform" with detrimental impacts on India's poor and vulnerable.

Acknowledgement

This is a condensed version of a talk I gave at National Public School, Indira Nagar, Bengaluru on August 11th. I thank the students for posing interesting questions.

Originally published: http://www.alexmthomas.com/2017/09/06/the-political-economy-of-gst/