India’s GST, Complicated, Yes, but An Excellent Idea All The Same


It’s possible but rare enough for a tax system to be imposed for good economic reasons. More often than not we get a tax system which is swayed by peoples’ feelings, rather then the details of what we know about what makes a good tax system. We thus try to tax corporations, when corporations can never carry the incidence of a tax. We tax capital too much on the grounds of hitting the rich when in fact it is the wages of the workers in the future that suffer from our doing so. So when we find people doing something which does make great economic sense then we should be saying so–as I am with India’s Goods and Services Tax, the GST.

Parliament will today debate and vote on four supporting bills crucial to the implementation of the Goods and Services Tax, which will subsume a slew of indirect taxes currently levied by the centre and states. On the table in the Lok Sabha is the Central Goods and Services Tax (CGST) Bill, 2017, along with three other related bills, providing for a maximum GST rate of 40 per cent, an anti-profiteering authority and imprisonment for evading taxes.

I do not say the GST is perfect, that possible 40% rate looks to me to be too high to be supportable. Not because there aren’t things which might be usefully taxed at that rate, but simply because tax rates of that sort of level tend to produce wholesale dodging. They’re thus inefficient.

“These are four very important laws, and they are being taken together because the subject matter is the same. The system of indirect taxes in the country had given the Centre the power to levy some taxes and the States some taxes. So there was a decision to unify all these. With such a unification, goods will be able to move across the country. It would be easier for assessees, and the revenue would be divided between the Centre and States,” says the Minister.

That’s the bit that makes it good:

The GST, which the government expects to implement from July 1, is the biggest tax reform since independence.

Indian economic policy hasn’t been all that good since independence. This change will make it markedly better.

This will rub rather a lot of people up the wrong way but still, here goes. Gandhi’s economics were terrible and there’s still a bit too much lip service paid to those ideas today. The homespun and the direct making of salt were very powerful political arguments, successful actions against the British (yes, my forefathers, although the only known familial connection to the sub-Continent came post-Partition) most certainly, but as the basis of an economy they were and are ruinous. Because deciding upon an economy of local peasant production means that everyone has to live at the standard of living of a peasant. There’s just no way to escape this as Brad Delong points out:

Think of it: If international trade is bad–if we should be self-reliant at the national level–then the same argument applies at the state level. If interstate trade is bad—-if we should be self-reliant at the state level–then the same argument applies at the municipality level. If inter-municipality trade is bad–if we should be self-reliant at the municipality level–then the same argument applies at the neighborhood level. And so we get all the way down to the basic bedrock of human society: the hamlet or band community of less than 100, say 75. How much could any 75 of us produce as a group if we couldn’t trade with outsiders? About $1,000 a year per worker. A United States that tried to be self-sufficient at the hamlet or band level would be lucky to have a national income of $160 billion, one hundredth of the $16 trillion we have.

Nehru’s economics wasn’t all that much better. He was far too enticed by the ideas of the Fabian socialists, who thought that detailed planning would make everyone rich:

So they instituted the Licence Raj, which meant applying the tactics of Major Attlee and the Fabian socialists to grow the Indian economy. You know, plan and licence everything and the bureaucrats would create the wealth by telling everyone what to do. It worked there about as well as it did here.

Then, just as China’s growth finally happened when they dropped the Maoist idiocy in 1978 (that country at that point had, by Maddison’s figures, the same per capita income as England in 1600) leading to 10 per cent per annum GDP increases, the Indian economy was freed by Manmohan Singh and Narendra Modi and, hey presto: they’ve got 6 and 7 per cent growth, again running for decades.

So if we were to point a finger of blame, let’s ignore the protestations of Congress Party members, such as Shashi Tharoor, and think about those people who effectively kept India’s people poor after independence – Sidney and Beatrice Webb…

Which brings us to the GST which is really just finally understanding the point that Adam Smith was making about trade. And given that all economics is either footnotes to Smith or wrong that really is where we should be starting with the discussion of an economic problem. At this, very basic of course, level economic wealth is created by the division and specialisation of labour. Yes, it’s that damn pin factory again. So important is this that it’s actually on British money:

A portrait of Smith appears on the back of the new note, along with an engraving showing “The division of labour in pin manufacturing” with the parenthetical quote “and the great increase in the quantity of work that results” drawn from his major work, An Inquiry into the Nature and Causes of the Wealth of Nations.

The basic thought is that if we divide up tasks into smaller and more discrete ones then we can specialise in doing those smaller and more discrete tasks more productively. Thus division and specialisation of labour means that more is produced. Consumption will, of course, equal production, as will incomes equal either and both, that’s just the basic GDP definition there. So, if we divide and specialise our labour, trade around the resultant production, we’ll all be richer. Gandhi’s economics was essentially saying that this wasn’t true, that the household, or at most the small village, should be a near self-contained economic unit. This, as Delong points out, makes continued poverty inevitable.

For once we’ve grasped that division and specialisation then the only limit to how much richer it will make us is how many people can we divide, specialise and trade with? The more the merrier in fact. This does go to extremes–I spent a few years as just about the one and only person in the world doing a particular job. The end result of what I did turned up in just about every light bulb installed into a street lamp globally but in that one, very divided and specialised, job it was pretty much just me among all 7 billion of us.

Nehru wasn’t much better with that fascination with planning. But now to the GST. The problem being that India is not one integrated economy. The different tax rules (and they can vary dependent upon production in-state or across state lines, as with tariffs across national borders) mean that it is, to some extent, a collection of slightly to rather separated state ones. This is a limitation of that ability to divide and specialise over more people. And thus the value of the GST in these basic economic terms.

Sure, we can all argue about whether localities should be able to decide their own tax policies, perhaps this is a limit on local political power and so on. But having the one single tax system, at the same rates and not dependent upon locality of production–which is what the GST generally does–means that it will be more possible to divide and specialise labour with, trade with, all 1.2 billion Indians. India and Indians will therefore be richer as a result.

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