Tax Analysts Blog

India’s Long Journey to a VAT

Posted on Jan 14, 2016

One of our favorite discussion topics is the VAT -- more specifically, whether the United States will ever adopt a federal consumption tax. In that regard, much can be learned from looking at the experiences of other countries. What’s happening in India – the world’s largest democracy -- is noteworthy because it underscores some of the difficulties in harmonizing a federal VAT with preexisting taxes at the state and local levels.

For nearly a decade India has been on the verge of implementing a goods and services tax. (The concepts of GST and VAT are interchangeable.) This process has been unnecessarily drawn-out. In Delhi there’s a common joke that it took less time to build the Taj Mahal than to enact a GST.

India’s GST would replace the convoluted patchwork of taxes, surcharges, duties, and levies now in force. The rates and bases of these taxes vary significantly across India’s 29 states and seven territories, fragmenting the national economy to the point where it ceases to function as an integrated single market.

For example, the tax burdens on interstate trade greatly exceed those on intrastate trade. Vehicles carrying commercial goods between Indian states may be required to stop for hours at local checkpoints and pay transfer duties, as if they were clearing customs at an international border crossing. For a country that desperately wants to modernize, the current tax structure is an embarrassment.

A secondary benefit of the GST is that by allowing businesses to claim input credits, it encourages merchants to generate a paper trail of invoices sufficient to appease tax auditors. That would significantly shrink India’s informal economy, in which profits are easily concealed and tax evasion is rife. In short, the GST would deliver both efficiency and fiscal transparency. For all those reasons, a GST has become a priority for Prime Minister Narendra Modi.

The country’s two major political factions -- the majority Bharatiya Janata Party and the opposition National Congress Party -- each support a GST, although they disagree on details. Their squabbling has caused GST legislation to stall in Parliament. Admittedly, the bill under consideration is deeply flawed in that it needlessly excludes certain categories of goods.

The whole concept of a VAT or GST is that it should reach as many sectors of the economy as possible. Exemptions and zero rating must be kept to a minimum, although politicians are often unable to resist the temptation to tinker with the tax base. That’s certainly true in India, and I have no doubt that it would be equally true in America – should we ever find ourselves in a similar position of structuring a federal consumption tax.

You can find excellent coverage of India’s push for a GST from our reporter Stephanie Soong Johnston here and here. As Johnston points out, India’s path to the GST is especially cumbersome because it requires constitutional amendments that not only must be approved by Parliament, but also must be individually ratified by at least half of the country’s states. And that’s no small task.

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