GST will come on time, but multiple rates will dilute benefits: Analysis

India moved a step closer to creating a national sales tax but a deal on rates reached on Thursday will hit some businesses harder than others, while its complexity will dilute any boost to growth and undermine its reliability as a revenue generator.

The Goods and Services Tax (GST), due to be rolled out from April 1, 2017, had been billed as the one reform that could help Prime Minister Narendra Modi deliver on his jobs and growth agenda. In a key Modi win, parliament amended the constitution in August to clear the way for the GST, which would unify Asia's third-largest economy into a common market for the first time.

But Thursday's bargain between Finance Minister Arun Jaitley and his counterparts from India's 27 state governments has exposed the difficulties of dealing with so many stakeholders.

The GST Council, set up to oversee the tax, agreed on a more steeply progressive structure for goods than earlier foreseen with rates of 5, 12, 18 and 28 per cent, depending on the kind of product involved. The top rate, Jaitley said, would apply to the kind of goods bought by middle-class Indians.

On top of that, essentials like grains that make up half the consumer price index would not be taxed at all. Finally, a "cess" - a separate central tax - would be added to the top 28 per cent GST rate on luxury cars and harmful products like tobacco and fizzy drinks.

The total burden of this "sin" tax still has to be worked out, as does the rate applying to services that are now taxed at a rate of 15 per cent.

"India is like the European Union with a central government," said Harishanker Subramanian, head of indirect tax at EY. "This is fiscal federalism. It's not easy."

Despite the loose ends, it now looks increasingly likely that parliament, which opens its winter session on Nov. 16, will be able to pass key GST laws, as state assemblies must also do, to keep the launch timeline on track.

FOGGY OUTLOOK

The GST should be a positive development for Jay Kannaiyan, who runs a startup that makes and sells low-cost air purifiers, a product in big demand because of an air pollution crisis in the capital New Delhi and other Indian cities.

Kannaiyan backs the GST because it would free his firm, Smart Air Filters Pvt Ltd, from the red tape arising from value-added tax (VAT) that is currently collected by the states and is one of several levies due to be abolished under the tax reform.

VAT rules vary widely, and the tax can be levied at different times during the transfer of goods, depending on the state.

"It is a hassle as it slows down our operations," Kannaiyan, 35, said at his tiny workspace in a dusty commercial district on Delhi's southern fringes.

His greatest worry is the possibility that consumer durables will be taxed at the top 28 per cent GST rate, not the 18 per cent earlier foreseen, hurting his margins. Which product is assigned to which rate still has to be worked out.

The uncertainty "hurts us, it hurts our planning," said Kannaiyan, who plans to more than double sales in the next year.

RELABELED, NOT REFORMED

It's a far cry from the attributes of a so-called "good tax" - that is low, flat and broad. And advocates of a simpler GST have gone on the offensive, denouncing the current proposal as a mere relabeling; not a genuine reform.

Officials and experts involved in the policy process say Jaitley took the path of least resistance by pitching tax rates broadly in line with the existing burden to avoid any unwelcome spike in inflation when the GST comes into force.

"The approach outlined by the authorities signals a disappointing beginning which well could have been otherwise," said Vijay Kelkar, a former finance secretary who penned a landmark 2009 report on the GST.

Jaitley argues that multiple GST rates are needed to prevent the tax falling too hard on the poor. "Air conditioners and hawai chappals cannot be taxed at the same rate," he wrote in a recent blog post, using the Hindi name for flip flops.

GROWTH BOOST DILUTED

Business groups, tax experts and economists say the GST, if passed in this form, would generate less of a lift to economic growth and state revenues than a simpler tax.

"An ideal GST would have carried one single rate with very few exemptions - instead what we've got is a multiple tax rate structure and multiple exemptions," said Pranjul Bhandari, chief India economist at HSBC, who has halved her forecast of the GST's growth boost to 0.4 of a percentage point.

Where accountants do find fault is with the proposed cess that would raise funds for Jaitley to offset initial revenue losses to states arising from the GST.

"The concept of a cess is a distortion," said Sachin Menon, head of indirect tax at KPMG India. "The very purpose of the GST is to remove multiple taxes and to have a uniform law and uniform taxes across the country."