If you’re looking at tax reforms, the GST will be a big step, but don’t forget bigger reforms like the Tax Information Network and implementing VAT.
Somehow, many of us seem to believe Indian institutions cannot be successful and if we find some success stories, we either look at them in disbelief or eulogise them. Arvind Subramanian’s recent fascination about the success of GST as an institutional success story is a case in point (BS, Feb 24). Surely, there are several success stories of institutions in India and GST is not an isolated case. Further, GST, which is yet to be implemented, is only the next stage of perhaps the most successful tax reform in India, of replacing the cascading type sales tax with 14-16 tax rates with the value added tax with two rates in April 2005.
Surely, GST, if properly implemented, can be an institutional success, but the story that Arvind Subramanian tells is more a fiction than real. The problem is not with the GST reform, but with his understanding of the reform process. Understanding GST reform requires caring for history and this cannot come from conjectures and hearsay. The least Subramanian could have done is to check the facts and do some serious research on how the institution of ‘Empowered Committee of State Finance Ministers’, which has spearheaded the reform, came into being. We know that success has many fathers and failure is an orphan. Nevertheless, if we have to learn from history, we need to identify the right father.
The history of tax reform to replace the cascading type sales tax with several rates with a value added tax goes back to the seminal report by the Report of the Study Team on ‘Reform of Domestic Trade Taxes in India’ in 1994, of which the late Amaresh Bagchi, the then Director of NIPFP, was the convenor. The report was submitted by the Study Team to the then finance minister, Dr Manmohan Singh, and it provided the blueprint for transforming the prevailing cascading type sales tax system with 14-16 tax rates into a value added tax. It goes to the credit of Dr Manmohan Singh for appointing the State Finance Ministers’ Committee comprising of 11 states to harmonise the process of sales tax reform with Dr Raja Chelliah as its Convenor. One of the first tasks of the Committee was to arrange the visit of the states’ finance ministers to the countries which have successfully implemented the VAT. The finance ministers were divided into three groups, to visit (i) Belgium and France led by Raja Chelliah, the then advisor to the finance minister; (ii) Spain and United Kingdom accompanied by Amaresh Bagchi, Director, NIPFP and (iii) Thailand and Indonesia, accompanied by yours truly, who was the Secretary to the Committee. The Committee prepared the report which detailed the blueprint for VAT reform and NIPFP continued to be its secretariat. The committee’s recommendations were endorsed in the Chief Ministers’ conference, which constituted a Standing Committee of State Finance Ministers comprising of finance ministers from seven states in November 1999. The West Bengal finance minister was appointed as the Convenor of the Committee and in this Raja Chelliah played an important role. This was later converted into the Empowered Committee of State Finance Ministers on 17th July, 2000 by the government, and by this time the finance minister of West Bengal had emerged as a natural leader. In addition to the finance ministers from seven states, the membership included Delhi and Meghalaya. Subsequently, in August 2004, membership was extended to include finance ministers from all the states — the West Bengal finance minister continued to chair the Empowered Committee.
In the entire exercise, Raja Chelliah played a stellar role in providing the background research at NIPFP and educating the finance ministers in the virtues of having a destination-based VAT and the benefits of having seamless trade in the federation. The clear evidence of this is the fact that even after the Constitution was amended (46th amendment) to treat consignment transfer as ‘sale’ and levy the tax on it, it was never operationalised despite tremendous pressure from the states. Had this been implemented, it would have choked the economy by creating several impregnable tariff zones and made phasing out of the tax on inter-state sale extremely difficult. It goes to the credit of Chelliah and his colleagues at NIPFP in persuading the policy makers in the finance ministry of the perils of taxing consignment transfers. Surely, the Empowered Committee did a commendable job of bringing about consensus first, to harmonise and reduce the number of tax rates to five and later introducing the intra-state VAT with two main rates. That is a landmark reform and hopefully, we would see a broad-based GST in not too distant a future.
Most, including Arvind Subramanian, consider the GST to be the ‘game changer’, and one reason for the optimism is that “it could generate additional annual revenue of 1.5 per cent of GDP”. I do not know where the estimate comes from, but from this, if he means that the governments will garner additional revenue amounting to 1.5 percentage points every year, then we are in for trouble; there will be government everywhere! If on the contrary, the revenue will increase by 1.5 per cent of GDP due to GST reform, then it is not really much. I would like to point out to another institutional reform initiated in 2004, of instituting the Tax Information Network (TIN) with NSDL entrusted with the task of implementing it. The reform resulted in the income tax revenue as a ratio of GDP increasing from a mere 2.8 per cent in 2003-04 to 6.5 per cent in 2007-08, a clear increase of 3.7 percentage points, before marginally declining to 6.1 per cent in the wake of the economic slowdown. Here is an unsung institutional success story, which actually helped the Centre to compress the fiscal deficit from 4.5 per cent in 2003-04 to 2.6 per cent in 2007-08 before the benefits were squandered away.
For the successful calibration of VAT and the efforts put in to evolve consensus on the GST, a lot of credit must be given to the Empowered Committee of State Finance Ministers. It also goes to the credit of the successive finance ministers at the Centre, irrespective of their party affiliations, for ensuring unfettered functioning of the Empowered Committee. This gives the hope for what Lord Keynes said: “…ultimately, it is the ideas and not the vested interests which are dangerous for good or evil.”
Views are personal. The author is Director, NIPFP