What's the big deal about India's Goods and Services Tax?

An Indian consumer goods trader shows letters GST at his shop in Hyderabad on Aug 3, 2016.
An Indian consumer goods trader shows letters GST at his shop in Hyderabad on Aug 3, 2016.PHOTO: AFP

NEW DELHI (BLOOMBERG) - India's decade-long wait for a national sales tax that will create one of the world's biggest single markets is almost over.

On Wednesday (Aug 3), lawmakers in the upper house of parliament voted unanimously to approve a constitutional amendment to enable the Goods-and-Services Tax (GST).

Once fully implemented, the tax will go a long way toward fulfilling Prime Minister Narendra Modi's pledge to make it easier to do business in the world's fastest-growing big economy.

What is the GST?

The GST will replace at least 17 state and federal levies, making the movement of goods cheaper and seamless across a market holding 1.3 billion consumers, about four times the US population. It would be far simpler than the current system, where a good is taxed multiple times at different rates. The underlying principle is to tax goods at the point of consumption rather than production.

What economic impact will it have?

GST can boost economic growth by as much as 2 percentage points, according to Finance Minister Arun Jaitley. Greater tax compliance has the potential to boost revenues for the government, helping narrow Asia's widest budget deficit and allowing more funds to be allocated to schools and highways.

How early could we see these results?

They may start to show up gradually in the fiscal year starting April 1, 2017. That's because there are still some steps before the GST can be fully implemented.

What obstacles are remaining?

The government will now seek to pass the revised bill in the lower house, where Mr Modi's ruling party has the numbers for approval. The legislation will then need to be ratified by at least half of India's states, which could happen over the next few months.

Once that is done, parliament needs to introduce at least one more bill detailing the structure of the tax, which includes a state GST and a central GST. The earliest this could occur would be the so-called winter session of parliament that normally starts in November.

What is the tax rate?

That won't be announced for months. The constitutional amendment bill would create a GST Council comprising the nation's finance minister as well as representatives from the states. This body will determine the final rate.

Mr Modi's top economic adviser and the main opposition Congress party want to cap the rate at around 18 per cent, while some states want a higher levy. Globally, rates for similar consumption taxes range from 5 per cent to 27 per cent, and the median for OECD countries is about 20 per cent.

Why didn't India's founders implement a national sales tax?

The constitution laid out the method of taxation in 1950, soon after several so-called princely states - territories ruled by a native monarch under the British Emperor - agreed to join the Dominion of India. Different levels of economic development and local sensitivities necessitated a two-tier system at the time.

Are all goods and services covered under the GST?

In negotiations over the GST, some state governments have managed to exempt chief revenue-generating products such as alcohol, petroleum and real estate. The GST Council may also decide to tax certain luxuries - such as a flat-screen TV, for example - at a far higher rate than food staples.

How will the GST affect companies?

Companies will have to overhaul their accounting systems, which may involve one-time investment costs. There may also be chaos in the short term as the government gets the computer software up and running.

Will the GST affect inflation?

Prepare for a short-term spike in prices. Citigroup Inc.'s economists say countries like Canada, Australia and New Zealand saw a one-time increase in inflation after GST implementation, which normalised in a year.

Mr Modi's advisers say the impact on India's consumer prices will be negligible if the GST rate is capped at 18 per cent. If the rate is around 22 per cent, then they project inflation to accelerate 0.3 per cent to 0.7 per cent - mostly due to education and health services.

What sectors will benefit?

Logistics companies stand to gain as it becomes easier to ferry goods across India. Other sectors largely depend on the fine print of the GST, including exemptions.