The UPA government has been a reluctant reformer in both its first and second innings. As we have argued in these columns, India needs a dose of significant economic reforms, in product markets, in labour markets and in land markets, if growth has to touch double digits. But there is one crucial area of reform where it seemed that the government may achieve some success?tax reform. Now, even that is looking uncertain. The revised version of the direct taxes code (DTC) dilutes the original draft and allows a number of exemptions in response to pressure from special interests. The government?s surrender to vested interests on DTC is a missed opportunity for lower tax rates, greater compliance and more revenue for the government, all at the same time. But that is only the DTC. The other half of tax reform lies in the overhaul of an unnecessarily complicated and cascading structure of indirect taxes. Unfortunately, as reported by The Indian Express on Friday, the government is veering around to a less than optimal compromise on the issue of a single goods and services tax (GST) regime as well.
An ideal GST regime would involve only one rate of tax (divided, of course, into Centre and state components), at a rate that is reasonable and not too high. The entire purpose of the GST is to increase compliance and that will not happen unless the rate is reasonable. The importance of one rate stems from the fact that two rates will encourage lobbying and rent seeking, with various interests trying to get their products and services included in the lower rate category. Now, it seems that the government is ready to accept two rates?one for standard goods and services and another for ?essential? goods and services. Worse, states have put pressure on the government to consider granting exemptions from GST to commodities like fuel and alcohol. Once a precedent is set for exemptions, any number of commodities will seek to be put outside the ambit of the GST under some pretext or the other. States also continue to pressure the Centre to have a rate higher than the 12% recommended by the Finance Commission. That will defeat the purpose of GST. The Centre must, even at this stage, resist demands from vested interests. This is likely to be the only opportunity to overhaul taxes completely for a long time. The government cannot afford to distort it.
