Bribes, borders and middlemen: Why India's tax reform is a game changer

Seized vehicles. Bribes. Days-long delays. Moving goods across Indian states isn't exactly easy - and that's a major barrier to economic growth.

Rolling a truck of vegetables into Gujarat, the state once governed by Prime Minister Narendra Modi, requires a bribe of 500 rupees to 2,000 rupees (S$11 to S$44) even with your papers in order, says Mr Rakesh Kaul, vice-president of Caravan Roadways, which has about 400 trucks plying India's potholed roads.

But getting past the state tax collectors into Uttar Pradesh, India's most populous state, will cost you more: Upwards of 20,000 rupees, Mr Kaul says. The penalty for not paying off the right people is steep fines from factories whose raw materials are stuck at state borders - sometimes for as long as five days.

That's why he and other firms are cheering the July 1 implementation of India's biggest tax reform since independence in 1947.

The move will replace more than a dozen levies with a new goods and services tax (GST). That should help reduce the huge power India's myriad middlemen wield at state borders, free up internal trade, make it easier to do business and widen the country's tiny tax base.

"Even if your documents are correct, they will find some small error and hold your vehicle," says Mr Kaul in his New Delhi office, located in a dusty trucking depot where hundreds of drivers sit near their brightly painted trucks in the 42 deg C heat. "Once GST is there, all that is gone."

The new tax would be Mr Modi's most significant economic reform since taking office in 2014. Yet with less than a week to go before its implementation, the government is still refining the details, announcing last week that it would relax initial filing requirements for next month and August amid concerns businesses were not ready.

LONG-TERM GOOD

As in the case of the recent demonetisation gambit, any disruption in commerce and economic activity is likely to be short-lived, while the longer-term benefits could be significant.

PROFESSOR ESWAR PRASAD of Cornell University in Ithaca, New York.

Despite the last-minute tweaks, Finance Minister Arun Jaitley confirmed that the tax would roll out on July 1.

While India already boasts one of the world's fastest-growing major economies, architects of the reform say it will stoke efficiency and growth by creating a common market of 1.3 billion consumers - a population greater than the United States, Europe, Brazil, Mexico and Japan combined.

Take the border crossings: Lorry drivers in India lose 60 per cent of transit time to road blocks, tolls and other stoppages, which means logistics costs are up to three times higher than international benchmarks. While truck drivers may still need to stop to have their goods checked, cut that time in half, and logistics costs could fall by up to 40 per cent, according to a 2014 World Bank report.

There's no shortage of hyperbole when it comes to describing the GST changes, which took more than a decade of protracted negotiations before Parliament pushed it through. The government's chief economic adviser Arvind Subramanian has called it "transformational".

"The GST is super important," he said in an April interview. "It is also a daring, bold experiment in what I call the good governance of cooperative federalism."

The GST rollout comes less than a year after the government's surprise move last November to remove 86 per cent of currency in circulation - which contributed to a sharp slowing in growth during the January to March quarter. While the GST is seen as a leap forward in simplifying India's system, getting the reform across the line has required compromises: India will have four tax brackets instead of the flat rate that many other countries have.

Air-conditioners, refrigerators and make-up will be taxed at 28 per cent, for example, while toothpaste lands at 18 per cent. Plane tickets attract a 5 per cent GST rate, but business class tickets are 12 per cent. Staples such as food grains and fresh vegetables are not taxed, while education and health services will continue to be exempted.

"India is obviously a huge and complex country in which government's ability to successfully implement major reforms is limited," says Griffith Asia Institute's acting director Ian Hall.

The GST will also force companies to consolidate their supply chain among fewer, larger facilities, says Mr Vineet Agarwal, managing director of Transport Corp of India, which has about 10,000 trucks and around 11 million sq ft of warehouses.

Companies now operate smaller factories and warehouses to take advantage of tax breaks offered by various states, as well as to avoid transporting goods over too many borders. "Almost all states act like different countries," he says.

One of the biggest goals of the GST is to widen the tax net in an economy where more than 90 per cent of workers are employed informally. Companies will need to be in the tax system and prove they paid taxes to claim a credit against their costs.

Pressure to comply will increase along the line and the black economy should shrink.

Still, the tax may throw up losers.

Manufacturing states may initially suffer as the extra revenue is generated in more populous consuming states. There are also sectors untouched by the new tax, including alcohol and real estate. Thousands of tax staff will also need to be trained and complex new IT systems adopted. "There will inevitably be disruption as a result," says Mr Samir Saran, vice-president of the New Delhi-based Observer Research Foundation.

To be sure, India isn't alone in introducing a new tax that crosses jurisdictions and territories. More than 150 countries have a GST or value-added tax, including Canada, Australia and the European Union, according to Deloitte.

The optimistic case is that initial ruffles are soon smoothed over, says Professor Eswar Prasad of Cornell University in Ithaca, New York. "As in the case of the recent demonetisation gambit, any disruption in commerce and economic activity is likely to be short-lived, while the longer-term benefits could be significant."

Big companies will be prepared, says Mr Agarwal at Transport Corp, but he frets about the smaller, informal businesses. "There's going to be chaos," he says.

That informal workforce includes Mr Babu Ram Rajput, a 28-year-old trucker in jeans and sandals who regularly drives goods across a vast swathe of North India.

"I have not got any training," he says, holding up a sheaf of tattered, dirty documents related to his current cargo. "I only know that GST is coming."

WASHINGTON POST

•Bloomberg's Bibhudatta Pradhan and Hannah Dormido contributed.

A version of this article appeared in the print edition of The Straits Times on June 26, 2017, with the headline 'Bribes, borders and middlemen: Why India's tax reform is a game changer'. Print Edition | Subscribe