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Jul 1, 2017 | 13:08 GMT

3 mins read

India: Sweeping Tax Reform Takes Aim at Black Economy

(Stratfor)

Leaders rarely find it easy to impose new taxes. When a new levy is designed to take on the might of the black market and to increase revenue considerably, the road is guaranteed to be bumpy. And that is before taking into consideration the challenge of rolling out any controversial reform to a population of almost 1.3 billion people. Given the hurdles, it is hardly surprising that Indian Prime Minister Narendra Modi chose to commemorate the nationwide launch of the new Goods and Services Tax (GST) with a special midnight session in the parliament's historic Central Hall on June 30.

A value-added tax levied on the consumption of goods and services, the GST is a milestone in the broader arc of economic reforms in the world's largest democracy. It will replace a bevy of indirect taxes and simplify India's convoluted system of indirect taxation to ease the compliance burden in Asia's third-largest economy. It also aims to promote transparency and efficiency by digitizing the tax system with the support of a nationwide information technology system called the Goods and Services Tax Network.

The GST will rely on a system of tax credits to reimburse businesses that pay tax at repeated points along the supply chain, leading to higher final prices. It will also offer tax credits for transactions between states to help tackle India's economic fragmentation along state lines. Taken together, these initiatives ultimately service the bigger aim of boosting tax revenue and broadening the country's meager tax base by bringing more of the small and medium enterprises that have long orbited beyond the tax net into the country's formal economy.

To get to the point of launch has been no easy task, and the politics of passing the laws making the GST possible were contentious. After being blocked by the parliamentary opposition in December, the government eventually managed to guide legislation through the lower house in March, at which point each of India's 29 states were required to approve state-level versions. Except for Kashmir, all states have done so, even including West Bengal and Tamil Nadu, two of the most strident critics of the GST in its current form.

Many challenges remain, and implementation will be a messy affair in a country as populous and stratified as India. Disagreements between the federal government and states abound and scattered strikes have already broken out in three of the most populous — West Bengal, Uttar Pradesh and Madhya Pradesh. Additionally, businesses have complained about not having enough time to prepare and invest in the necessary hardware for the GST. Though change is always a halting process in a country of nearly 1.3 billion citizens, ultimately the new tax may offer a critical case study in India's ability to move from policy to implementation and then to consolidation on a massive scale.

The wider significance of this reform is what it reveals about the success of the government's political strategy. While Modi's Hindu nationalist platform is widening the social and religious fissures in Indian society, it has also worked as an electoral approach that continues to win Modi's Bharatiya Janata Party national and state polls. This, in turn, gives the party the capacity to legislate reforms such as the GST as part of a broader project to streamline India's $2 trillion economy.

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