High hopes — and fears — over Modi’s tax gamble

NEW DELHI — At a crucial moment during the 16th meeting of ministers convened to thrash out the details of India’s biggest tax overhaul since it became an independent nation, the infuriated finance minister of West Bengal state began to read out names of successful Indian film directors.

“Adoor Gopalakrishnan, Satyajit Ray, Mrinal Sen: all the Indian film directors who have won international awards have been from regional cinema,” Mr Amit Mitra told his fellow finance ministers.

“If we tax cinema tickets at 28 per cent (the top rate under the new tax) we are going to kill off this industry, and then there won’t be any more awards.”

His impassioned plea worked. That evening, cheaper cinema tickets were included on a list of 66 items on which tax rates would be cut under the new goods and services tax (GST).

The new tax regime, which comes into effect on Saturday, is meant to scrap a tangle of statewide levies and turn the country into a single market for the first time.

If the ambitious rollout goes smoothly, India’s reams of red tape will be slashed, doing business will become dramatically easier and growth could be increased by as much as 2 percentage points a year, according to economists.

Proponents say the GST — which covers everything from chewing gum to private aircraft — could be the catalyst that finally unleashes India’s potential.

If all goes well, it could also secure the country’s prime minister, Mr Narendra Modi, a place in the history books as an economic moderniser.

Having tried and failed to implement the reform for over a decade, its proponents are comparing the move to India’s independence itself.

Mr P Chidambaram, who as finance minister in the previous government championed the GST, wrote a paean to the tax last weekend entitled “a tryst with destination tax” — a take on Jawaharlal Nehru’s “tryst with destiny” speech given on the eve of independence in 1947.

But critics warn that the past three months of political jostling and negotiations have led to a raft of compromises that weaken the impact of the reforms.

Rather than a single national rate, there will be six, and state-level tax authorities will have jurisdiction alongside national ones. Companies will have to file three tax returns a month in all states in which they do business.

Less than a year ago Mr Modi carried out a similarly bold economic move, unexpectedly scrapping 86 per cent of the country’s cash.

That plan, which now appears to have slowed growth considerably, was announced overnight with little consultation, and some worry that the GST could also become victim to Mr Modi’s impatience.

Mr Mihir Sharma, senior research fellow at New Delhi’s Observer Research Foundation, says the GST could reduce the “excessively high” cost of doing business in India.

But there are risks for Mr Modi and the broader economy if it is executed poorly.

“Modi sold himself as an exceptional manager and poor implementation of the GST, after the botched demonetisation exercise, will damage that claim beyond repair,” he says.

Others are concerned that the last-minute changes — such as the film tax cut, secured less than two weeks ago — show the plans are still not fully formed, and that the system could collapse as soon as it is implemented. This could risk higher inflation and a drop in consumer confidence.

“I am scared that if industry sentiment falls after this, India will see a lot of job losses, people will stop purchasing and the economy will slow down,” says Mr Manish Sisodia, deputy chief minister of Delhi and one of Mr Mitra’s fellow members of the GST council.

But he adds that he is optimistic the plan will work. There is widespread agreement among Indian companies that India’s sales tax system is a mess.

The Lohasmith is a start-up online furniture company based in Uttar Pradesh that has customers across India.

When the company buys a piece of raw metal, it pays 12.5 per cent value-added tax (VAT) and a central sales tax of 2 per cent. After weeks of bashing, twisting and polishing, the metal is formed into a vase and displayed on the company’s website.

A customer in Mumbai orders the vase, so the company packs it up and loads it on to a truck to leave its factory.

First it has to stop at the Madhya Pradesh border and pay a border tax, which can vary.

Then when it gets to Mumbai it pays another entry tax, this time of 5.5 per cent. If The Lohasmith were to charge for delivery, it would also pay a 15 per cent service tax.

Many of these rates are levied on a valuation of the goods that includes tax already paid by someone else in the supply chain, pushing prices for customers even higher or cutting into companies’ profits.

The customer buying the vase pays 14.5 per cent tax — all the other charges are absorbed by The Lohasmith.

The GST aims to do away with all that, introducing a single rate for goods that will be the same no matter where they are made and where they are sold.

It will also mean larger companies will encourage their suppliers to sign up to pay tax possibly for the first time ever, as certain tax rebates can only be claimed if every stage of the supply chain has been logged on the central GST portal.

“The GST is great, at least on paper,” says Mr Karun Malik, co-founder of The Lohasmith. “It will be much clearer and mean we don’t have to worry about where our orders are coming from.”

After becoming prime minister in 2014, Mr Modi soon became a champion for the new system, saying he had rectified what had always been his main concern, which was how states would be compensated for lost revenue.

Whatever his motives, his conversion to the GST cause was the crucial missing piece. After a few more delays — one caused by the chaos surrounding the demonetisation move — he was able to forge a cross-party consensus and pass the necessary legislation in April.

As soon as those laws were passed, the government convened a council of ministers to figure out the details. The resulting discussions were, according to the accounts of several people who attended, a masterpiece of political negotiation.

The role of Mr Arun Jaitley, the finance minister, has been key with even his political opponents praising his flexibility and negotiating skills.

“The council initially proposed taxing human hair at 28 per cent,” says Mr Mitra, who hails from the left-wing All India Trinamool Congress.

“What they didn’t realise is that poor men and women clean human hair — they bleach it and dress it, and then they export it to Gujarat and Maharashtra.

“In Midnapore (in West Bengal), there are 100,000-200,000 people employed doing this, it is very labour-intensive. Mr Jaitley understood the argument and we got the rate down to zero.”

But while the government has forged a consensus from dozens of interested parties, the result is a tangle of contradictions and compromises. Under the new system, paint and shampoo are rated as luxury items at 28 per cent.

Soap and toothpaste will be taxed at 18 per cent, while mobile phones will attract a 12 per cent tariff. Gold, one of the most popular ways for Indian families to store their wealth, will have its own special tax rate of just 3 per cent.

Four items — tobacco, chewing tobacco, luxury cars and fizzy soft drinks — will incur “sin” taxes, which on tobacco products could be as high as 290 per cent.

The estimated US$4.8bn (S$6.64bn) a year raised from the sin taxes will go to help compensate states for lost revenue.

“There are too many rates right now,” says Mr Arvind Subramanian, the government’s chief economic adviser. “But hopefully over the next five years we will get these six rates down to two or three.”

Rates are not the only problem, experts say. Other compromises have been made, such as excluding land and real estate — the most common route for laundering money — as well as allowing states to continue claiming a portion of the GST.

As a result of all these changes, HSBC — which is far less bullish than some forecasters — has halved its estimate for how much the GST will boost the Indian economy, from 0.8 percentage points a year to 0.4.

Businesses have been frantically updating their systems while also trying to keep up with the last-minute changes.

Ms Nupur Nagpal, co-founder of Chalk Studio, a Delhi-based online shoeseller, is one of the thousands of entrepreneurs who are having to implement the reforms without the support of a big accounting or tax department.

“Every day there are new things we get to know,” Ms Nagpal says. “Now we have been told we have to file returns three to four times in a month. But when you are selling online, we have a lot of returns and everything comes back. It takes two to three weeks for everything to come back, so we don’t know what our sales are until at least the end of the month.”

“It’s very rushed,” she adds. “This is a very stressful situation and nobody is happy.”

The idea of simplifying the system is not new and efforts to do so have been going on since the 1980s.

The government led by Mr Modi’s Bharatiya Janata party first proposed a form of the GST in 2003, but after losing the election in 2004 it then set about opposing it at a regional level, led by the then chief minister of Gujarat — Mr Modi.

Larger companies also worry about the new tax. Many say they are concerned that the system will make them pay excise duty and then claim it back if it has already been paid by the supplier.

These concerns have prompted a sudden fire sale as many retailers look to clear stock where there is no proof that excise duty has already been paid.

“They say we will get our money back on taxes already paid such as excise duty in seven days, but will we?” asks Mr Gautam Nair, managing director of Matrix Clothing in northern Haryana state, which makes garments for western fashion labels such as Ralph Lauren.

“We don’t want to move to a system that doesn’t function properly.”

Officials and ministers in Delhi are aware of the kinds of complaints coming from businesses and say they are willing to carry on tinkering with the system even after it comes into force on July 1.

“The only solution is flexibility,” says Mr Sisodia, the deputy chief minister. “The council has to be flexible by nature. Even if we see a single negative thing, we should have emergency meetings. We should not hesitate to turn around all our decisions.”

Mr Subramanian, the chief economic advisor, agrees. “I have no doubt there will be glitches. But if we didn’t have these glitches it would probably mean we weren’t being radical enough. We will just have to make sure we are flexible enough to deal with them.”

He adds: “The really astonishing thing about this whole process is that we’ve got it done at all.” FINANCIAL TIMES

SIDEBAR:

Implementation: Work put on hold for repricing exercise

Meghna and Karun Malik sit in their hot and dusty factory, surrounded by open boxes and piles of bubble wrap. The husband and wife team set up The Lohasmith, an online furniture retailer, last year, and now process a dozen or so orders a week.

But recently the Maliks have spent much of their time opening boxes, carefully removing the products and changing the price tags.

“In the process of preparing for GST (India’s goods and services tax), what we have realised is that we are going to have to repackage all of our products, because every single price is going to change,” Mrs Malik says.

The only problem is, they are still not sure what tax rate their metal-based furniture will fall into — some pieces could end up falling into the 18 per cent category while others could incur a tax of 28 per cent. Newly produced items have remained unpacked while the Maliks try to find out what their prices should be after the GST is introduced on July 1. “I will lose my mind if I have to work with two tax brackets,” says Mr Malik. “It will be an operational nightmare.”

Mass repricing of goods is just one of the operational challenges that the move to the GST has thrown up, alongside migrating to a new digital tax platform and having to file more frequent tax returns.

The Maliks are happy to do it, given the benefits the new system should bring, but say the rush to implement it has meant other work having to go on hold while they work out what they need to do. “We will be able to sort it,” says Mr Malik. “It will just mean we have to run around like the Energiser bunny sticking new stickers on boxes.”

PULLOUTS:

Lowest tax bands

0% Milk, fruit, newspapers, children’s picture or colouring books, silk fibre, human hair, hotel rooms below Rs1,000 (S$)

3% Gold

5% Packaged food items, clothing worth under Rs1,000, insulin, postage stamps, railway transport, small restaurants without air conditioning

Medium tax bands

12% Animal fat, toothpaste, umbrellas, cutlery, mobile phones, state-run lotteries, medium-sized restaurants without air conditioning, hotel rooms without air conditioning

18% Biscuits, cakes, tampons, notebooks, bamboo furniture, restaurants with air conditioning, hotel rooms between Rs2,500 and Rs7,500

High tax bands

28% Chewing gum, deodorant, paint, shampoo, privately-run lotteries, hotel rooms above Rs7,500 or in 5-star hotels

Liable for extra ‘sin’ taxes Aerated soft drinks, cigarettes and other tobacco products, chewing tobacco, luxury cars