Unless the Goods and Services Tax emerges out of a process of consensus, it can have adverse long-term effects.
Italy’s electorate did not endorse policies that virtually every economist, banker and expert declared to be the right course of action. The technocratic darling of the financial press and the intelligentsia came fourth in the election.
Votaries of democracy find themselves in the difficult position of criticising the electorate. In Britain, Prime Minister David Cameron has announced that he will (if re-elected) hold a referendum on whether the UK should continue in the European Union. Meanwhile, it is not even certain there will be a ‘united’ Kingdom by then, with Scotland contemplating full independence.
In Greece, the imposition of austerity through what is perceived as the central diktat of Europe, has led to the rise of a neo-fascist right wing party. In all these cases, the political legitimacy of economic arrangements is being seriously questioned.
The push towards greater economic integration and eventually a single currency was led by intellectuals and economists, with politicians and the electorate following at a distance.
With considerable brain power and analytical ammunition at their disposal, the advocates of European integration did not seriously worry about the ‘democratic deficit’ which has always been a feature of recent European integration: the bid for ever-closer integration had ‘obvious’ benefits and it would have been such a waste of time and energy (not to speak of lost GDP) to engage in the slow and messy process of consensus building (so the thinking went).
Today, however, that very deficit is beginning to affect Europe and both the break-up of the Union and the giving up of the single currency are no longer unthinkable. Countries like Turkey are wondering whether they are better off outside. As India continues to grapple with the proposed Goods & Services Tax (GST), there are lessons to be learnt from the European experience.
When the US, the country which holds the strongest intellectual attraction for many Indian experts, had spent about 7 decades under its Constitution it almost broke up and was held together only by a bloody civil war. The absence of adequate avenues for local self-rule caused havoc in Pakistan (leading to its break-up) and Sri Lanka (leading to massive death and destruction for three decades). Yet, most economic commentators take political unity for granted in the modern day. The success of India as a federal democracy is explained by the fact that it offers a sufficient degree of local self-rule at the state level. The system enjoys strong popular legitimacy and people of most States broadly see the structure as a good balance between local and central tendencies. Apart from Jammu & Kashmir, there have been problems from time to time (most prominently in the North East and Punjab) but the level of constitutional autonomy has been sufficient for most people and most parties to ultimately accept the structure as legitimate.
Regional self-rule implies a sense of being in charge. It includes the right for local politicians to exercise power and discretion — that is, what politics is about everywhere in the world. A State which has no discretion in crucial economic decisions is not a true ‘State’; it becomes at best a local body.
One may argue that discretion brings with it the potential for corruption, because vested interests will, say, lobby for tax concessions; for this reason, one could argue, centralisation is desirable and local discretion on tax rates and definitions needs to be curbed. This implicitly assumes that the local executive is corrupt, but the central one is not.
There is hardly any evidence to support this. More pertinently, the possibility of corruption is no reason to deny political autonomy. Winston Churchill had argued that the Indians would be unfit to run their own government— surely we would not accept that as an argument against independence?
Corruption might have been less under colonial rule than under a democratic Indian one, but that is hardly a ground for Indians to prefer colonial rule. The short point is that a small improvement in one aspect of economic performance is unlikely to outweigh the importance of political autonomy.
Under the Constitutional scheme, Indian States (many of which are larger than countries in the European Union) have no right to borrow beyond a ceiling fixed by the Centre. Unlike American states, they have no right to impose income taxes (outside agriculture). They have no seigniorage (i.e. income from printing money) unlike European Union members like the UK, because they are under the common currency. Even their expenditure policy is constrained by the large number of centrally sponsored schemes which follow a pattern decided from Delhi.
The only two real levers of fiscal policy they have are indirect taxation and non-Centrally sponsored expenditure. In the standardised one-rate-across-India form that many economic experts advocate (which does not exist in the European Union or the US), GST would effectively remove one important lever of fiscal policy from the state governments.
It is in that context that purely economic arguments for an ultra-standardised GST have to be viewed. A GST that is ‘pushed through’ by intellectual sleight of hand and arm-twisting may not be in India’s long term interests. Unless the GST emerges out of a genuine voluntary consensus of the States with, theoretically, the option of staying out, it could create tendencies that may be more harmful in the long run than any benefits of a standardised but imposed GST.
Sales tax has been an important determinant of inter-State variation in fiscal policy; advocates of tax reform who generally focus on national issues and the difficulties encountered in inter-state commerce, may not understand this well. In the early 1980s, Tamil Nadu embarked on a then-reviled comprehensive Noon Meal programme (condemned by Indian and foreign experts alike) financed primarily by local tax increases. This was done by a Chief Minister with no think tank papers or expert input. Yet it was a great success, now copied across India. With a GST of the standardised variety, it may not have been possible because there would have been no fiscal room to raise rates.
The contrary point can be made that States have sometimes used the flexibility to spend money on ‘unproductive’ schemes; therefore whether this loss of autonomy is a price worth paying for the benefits of a standardised GST is something on which economists can argue. But it is beyond argument that fiscal autonomy allows a Chief Minister greater room to pursue locally a policy which has no Central support but which his or her own electorate endorses.
A uniform and inflexible GST would clearly reduce the political freedom available to all State governments to follow policies of their own. It would also reduce innovation: the history of many schemes which are now Centrally-sponsored is that they were first tried out by one or other State using its own resources. Because India is one nation, we tend to forget that, in terms of population, the Indian Union is larger and more diverse than the European Union. Europe’s travails suggest that the interests of India may be best served by a consensual move to GST even if it is slower, messier and less aesthetically pleasing.