The Tax Overreach

Recent moves by tax authorities signal overreach and packs the potential to roil ease of doing business and public sentiment. EPISODE #134

Dear Reader,

A very Happy Monday to you.

Little under a fortnight ago, the Goods and Services Tax Council (GST), convened its 50th meeting—a remarkable milestone, especially given that, barring one, all its deliberations ended in consensus conclusions.

While acknowledging this achievement of cooperative federalism, it is also important to put the spotlight on growing contradictions in this marquee indirect tax regime. This is particularly true with respect to the constant tinkering of rates, some of which sound ludicrous.

So, this week I explore this challenge to India’s most significant tax reform. Do read and share your feedback.

The cover picture is sourced from Unsplash.

A big shoutout to Kamal, Vandana, Monica, Gautam, and Premasundaran for your informed responses, kind appreciation and amplification of last week’s column. Once again, grateful for the conversation initiated by all you readers. Gratitude also to all those who responded on Twitter and Linkedin. 

Unfortunately, Twitter has disabled amplification of Substack links and content—perils of social media monopolies operating in a walled garden framework. I would be grateful therefore if you could spread the word. Nothing to beat the word of mouth.

Reader participation and amplification is key to growing this newsletter community. And, many thanks to readers who hit the like button😊.

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Photo by CTRL - A Meal Replacement on Unsplash

The Ghost of Sales Tax

Last week the Goods and Services Tax (GST) Council met for the 50th time. As mentioned earlier, this is a remarkable milestone. The GST Council is the apex body guiding the implementation of this tax.

Not only is it a tribute for cooperative federalism—both centre and states sacrificed their sovereign rights to tax to productionise the idea of ‘One Nation, One Tax’—it is also the most marquee tax reform undertaken in modern India.

However, this moment was marred following the announcement of some odd tweaks to existing GST rates for some items.

The standout example was the lowering of rates on food items sold inside cinema halls. A screen grab of the story reported by Times of India and shared below sums up the twisted logic.

Essentially if you buy the food items at the hall then you pay a GST rate of 5%. However, if you purchased it online along with the movie tickets you pay a rate of 18%. Seriously!

Sadly, this is not an exception. There are several such examples. For instance, you pay a lower rate of duty on chappatis and a higher rate on parothas—guess the use of ghee is serious value addition that deserves a higher levy!

Similarly, if an individual chose to stand in a queue and book a non-AC bus ticket they will be exempt from GST; however, if the same transaction was carried out using an app, then it was taxed at 5%.

One can simply go on. Frankly, this is nothing but the ghost of sales tax, wherein babus spent all their waking hours micromanaging the tax laws with a gazillion variations, converging with the nightmare of the Licence Raj era. There was a time when the Union Budget speech was dominated by the various changes to the excise levies on commodities—including toothpaste.

Regulatory Overkill

Just to jog your memory, till they were dismantled in 1991, the Licence Raj throttled enterprise, distorted investment and thereby stymied economic growth.

Basically, the ideology prevalent at that time believed that the most efficient allocation of scarce resources could only be managed by the union government—the framework was spelt out in the Five-year Plans issued by the erstwhile Planning Commission.

As a result, whether you wanted to produce heavy industry machinery, nuts and bolts, consumer goods, name it, you had to line up outside the door of the Industry Ministry for a licence. Very akin to queueing up for a driving licence—before the onset of the online era that is.

With the advantage of hindsight, the outcome was disastrous. This kind of command-control opened the doors for crony capitalism—the unholy nexus between industry, bureaucrats and politicians. It was par for the course for industrialists to claim preemptive capacities to block potential competitors.

If production was a challenge, the task of selling it was even tougher. Businesses had to negotiate a myriad range of central as well as local taxes that varied with states—effectively, they were negotiating over 30 sovereign tax regimes.

Not only did this foster corruption, it also opened the door for tax arbitrage, further distorting resource allocation.

The associated laws like the Factories Act were even more draconian and the enforcers were feared.

An industry insider recalled how there was a rule that every toilet needed to be white-washed annually. This was kosher till the time that bathroom tiles became an option. Factories that opted for the more efficient alternative were penalised by inspectors. Why? Because they did not have a white-washed toilet facility!

Likewise there was another rule requiring factory establishments to provide drinking water in earthen containers (or matka) with a steel glass secured with a long chain attached to the vessel. Their replacement with a water cooler, invited censure during routine inspections!

The past era is a colourful history about how not to conduct public policy. Tragically, it was heresy to even question the wisdom of this economic regime. Those who cry for the lack of press freedom today will presumably feel as morally outraged to learn how critics were treated then.

The first person to challenge this dogma—the late Isher Ahluwalia made out an empirical case in her book, Industrial Growth in India: Stagnation since the 1960s—was shouted down by the cabal of left wing ideologues who dominated public conversations. I was an undergraduate then and vividly recall my professors running down Ahluwalia’s claims as right-wing lunacy.

Unfortunately for these ideologues, and mercifully for India, this was an idea whose time had come. Critics of Licence Raj began to steadily chip away at the edifice, leading to its formal dismantling by the Congress regime led by Prime Minister Narasimha Rao in the aftermath of the 1991 economic crisis.

The move breathed life into the Indian economy. Unfortunately, the legacy of the Licence Raj endured. The private sector that launched itself with renewed vigour got engaged in resource capture—the scams that rocked India till as recently as 2010, only reinforced this mindset both within the government and with business.

It is no coincidence that the modern economic history of India is replete with scams driven by crony capitalism. In fact, popular cinema use to love to caricature big business as morally deficient. Not surprising then that politicians were loath to openly support business as a legitimate stakeholder in the Indian economy.

The former chief economic adviser Arvind Subramanian argued that this cramped public policy. In his exit interview granted to a colleague and me and published in Mint, he said:

“My hypothesis is that India is affected by stigmatized capitalism, where there is not enough trust in the private sector or in the ability of the state to regulate the private sector.

It is making it much more difficult to give the private sector a bigger role. It is easier to give a public or a quasi-public entity a bigger role rather than getting more private sector participation."

Break from the Past

It is to the credit of the Bharatiya Janata Party (BJP)-led National Democratic Alliance (NDA) that they showed the courage to deploy their hard earned social capital to end this hypocrisy—of shunning business in public and engaging them in private.

In fact, Prime Minister Narendra Modi formally endorsed this rethink at a public meeting with industrialists in Lucknow in 2018. Modi argued that akin to labourers, farmers and bankers, India Inc is a key player too in nation-building.

Alluding to Mahatma Gandhi, who was publicly associated with big Indian industrialists, he said:

“When one’s conscience is clear and intention is noble, you don’t get tainted by standing with anybody."

This boldness was backed up with the slogan that the NDA was “pro-poor and pro-business”—preempting any efforts by the opposition to score political brownie points. The rollout of the GST, which economically unified the country, sustained efforts to improve ease of doing business, only reaffirmed that the earlier characterisation of business was history.

Return of Red Tape

Given this backdrop, the recent moves by the tax authorities are baffling.

You may recall that little over a month ago, the Income Tax department decided to impose a hefty 20% Tax Collected at Source (TCS) on overseas travel tour packages, regardless of mode of payment.

In other words every time you charged your card for $100 abroad, the bank would deduct $20 as TCS—a prohibitive charge. Only solace was that this could be reclaimed at the end of the year when an individual filed their tax returns.

After several confusing flip flops, the decision, which has triggered a lot of push back, has been deferred till 1 October.

The driving logic was that there were a few bad eggs who were evading tax. This is precisely the cause for worry. The bad ones among us are driving these bizarre tax tweaks, while the honest tax payers have to the burden. It is time to decouple enforcement from the law. Leave it to the tax sleuths to track down the evaders and stop overloading the law with this additional task.

One fallout is the growing number of legal challenges. It is no coincidence, as the graphic above shows, that the Finance Ministry is the top litigant in cases pending in various courts. To be sure, all these cases are not arising solely from challenges to the GST. Besides distracting from governance these cases further clog the judicial system—justice delayed is justice denied.

In the case of the GST a cautious Council initially preferred to go with higher rates and multiple slabs, largely to lower the risk of any revenue loss. Better safe than sorry. Six years down the line, these legitimate fears turned out to be misplaced with monthly revenue collections topping Rs 1.5 lakh crore.

Indeed this was the perfect time to take a crack at the long pending reforms, particularly with respect to slabs and rates. The Finance Commission led by Vijay Kelkar had proposed a revenue-neutral rate of 12% with minimum slabs. I recall he used to emphasise that the key was to get the “right model”.

One can understand the nervousness when the GST was launched. Not today. Instead, what we have is the bureaucracy steadily restoring the sales tax mindset—undermining the idea of ‘One Nation, One Tax’.

Maybe they are well intentioned, but the damage it is causing to the tax framework has to be called out. As they say don’t shoot the messenger.

My worry is that it won’t be long before opportunistic politicians start to build a negative narrative around GST—they way they did with the Farm laws. Some political parties are already demanding a roll back. You may recall a previous attempt to give this marquee tax reform a moniker: Gabbar Singh Tax.

Anecdotally, we know small businesses are hurting. And, let us not forget that the Indian economy is only just about recovering from the devastation triggered by the covid-19 pandemic, Russia-Ukraine war and rapid tightening of interest rates by the US Fed.

This may well be the moment for introspection. My own sense is that the tax authorities are trying hard to push the envelope to minimise revenue leakages. While this is justified, there is a downside risk of viewing all tax payers as potential evaders. This assumption is flawed. Simply because if everyone was corrupt this nation would have collapsed into anarchy long ago.

The incumbent regime, both at the centre and states, need to realise that the country is readying for the next general election and and is also assiduously being sought out for a spot on the global high table—where the calling card is the rule of law. Both counts warrant a rethink.

They should be mindful that this will probably be the first general election wherein so many stakeholders (Labarthis, beneficiaries of the social welfare programmes) will be voting—previously, they were economically disenfranchised and hence mostly outside the economy looking in. Regulatory overkill by tax authorities could roil public sentiment, already under pressure after a prolonged phase of inflation and economic pain.

Forewarned is forearmed.

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Recommended Viewing

Sharing the latest post of Capital Calculus on StratNews Global.

Little over a fortnight ago, PRICE or the People’s Research on the Indian Economy, released its latest report titled ‘India’s Middle Class’. The report, discussed in a previous edition of this newsletter, argues that the growth of India’s middle class has crossed a tipping point.

It is estimated at 432 million and is projected to grow to a staggering 1 billion by 2047. This amazing transformation can be traced back to the 1970s when a little scooter, Hamara Bajaj, dared the Indian middle class to dream. The launch of the Maruti 800 in the mid-1980s was the tipping point in middle class mobility.

This cohort never looked back after that as the Indian economy gradually unshackled, providing new opportunities for the middle class to grow and aspire. It is poised to be the single biggest demographic cohort in India, displacing the poor.

What does this mean for the consumer economy?

Given that this cohort is not homogenous, with varying household incomes, how will this play out for FMCGs? To answer all this and more we spoke to Nikhil Ojha, senior partner at Bain & Company.

Sharing the link below:

Till we meet again next week, stay safe.