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January, 15th 2010

The Maoists are not the only ones engaged in effecting a revolution in India. Another revolution too is taking place, through the proposed deus ex machina of the goods and services tax. Once this legislation enters the statute book, several provisions of Article 246 and the Seventh Schedule of the Constitution will be shown the door. It will be a revolution since the cataclysmic change will be brought about without the bother of a constitutional amendment.

What is being done is part of the reforms considered integral to the grand process of economic liberation initiated in the 1990s. The aim was to usher in the capitalist era in the country. Capitalism flourishes in an ambience where the market is free and subject to a minimum of distractions and constraints. Paying taxes is a necessary evil, for the government has to maintain law and order and needs resources on that account. Capitalists would, however, like the tax system to be smooth and seamless: there should not be a multiplicity of taxes or a multiplicity of tax rates; plurality of taxing authorities is an equal nuisance.

A federal financial structure is, not surprisingly, not the cup of tea for capitalist entrepreneurs. The Indian Constitution, however, made a stab at precisely that kind of a thing. Since the banking system is under full control of the Union government, thank heavens, there is a centralized monetary policy. In the fiscal arena, the regime for direct taxes is not so bad: the Centre collects the taxes on income accruing to both individuals and companies; it also decides on the rates structure for these categories. Excise on production too is mostly at the Centres bidding. But the problem lies with indirect taxes, such as sales taxes. The Constitution has allocated the prerogative of imposing taxes on the sale of commodities to the states. Different states could set different rates of sales tax for the same commodity, and there could be varying schedules of rates for different commodities. Besides, each state might tend to have its own distinct modes of tax administrations. All this, entrepreneurs complained, amounted to fragmentation of the national market, which impeded development by affecting adversely the tempo of production and distribution. In this context, reference was constantly made to the example set by Europe. The European countries retain their separate political entities, but, to foster accelerated growth, they have gone ahead with economic integration, creating the common market, introducing a common currency and substituting national-level sales taxes by a value-added tax on commodities and services applicable uniformly to all countries belonging to the European Community.

What Europe has done, the authorities over here have decided, India too must do. The first giant stride towards that direction was taken half a dozen years ago with the abolition of the system of state sales taxes and its substitution by a value-added tax with a schedule of standard rates enforceable in all the states; the tax rates were kept low to the delight of manufacturers and traders. Low tax rates, it was argued, encourages sales and therefore stimulates production and growth.

Whether the hypothesis is right or wrong is yet to be seen. What, however, intrigued was the modality chosen to get rid of state sales taxation and introduce the value-added tax instead. Abolishing a tax that was inscribed in the Constitution as well as inserting a new tax instrument not hitherto mentioned in it should, on the face of it, necessitate a constitutional amendment. That route was not taken: the state governments were simply advised to amend their respective sales tax laws in a manner that would transform them into a regime of value-added tax. Whether this procedure was constitutionally valid was a question that was not seriously raised. No public litigation case got filed, neither did the judiciary choose to consider the matter suo motu.

It has not hit them yet, the states are yet to realize what they have deprived themselves of by giving up their sovereign right to impose sales taxes. The states are now without any effective fiscal device to encourage investment within their territories. In the past, they could offer a tax holiday either time-bound or indefinite to lure entrepreneurs to come and be their guest. They can do so no longer. Practically the only incentive a state administration is now in a position to offer is the prospect of satisfactory economic infrastructure. Developing infrastructure, however, itself calls for huge investment funds. A relatively backward state suffers from a built-in disadvantage here. Because it is underdeveloped and poor, it lacks the resources necessary to set up an adequate economic infrastructure and is therefore unable to compete with the relatively more resourceful states in attracting investors. The Fiscal Responsibility and Budget Management Act, thrust upon them by the Centre, had already weakened the capability of the states, especially the poorer ones, to offer development subsidies or spend on social welfare measures. The deprivation of the tax incentive instrument is likely to cause a further setback and aggravate, inter alia, the trend towards widening regional inequalities.

The goods and services tax might make things even worse. The states had till now little say in taxing services, barring a few items such as entertainments; the Constitution has by implication left this matter to the purview of the Centre. In the six decades since the Constitution came into place, the Indian economy has grown and grown and services have emerged as its fastest growing as well as the most important sector. When the Centre had persuaded the states to abandon sales taxation and adopt the uniformly enforced value-added tax, the bait offered was of their being allowed a liberal share from out of the burgeoning receipts accruing from the taxation of services. That assurance, it is claimed, is being fulfilled by the goods and services tax. The overriding reason for introducing this new tax measure is, nevertheless, to satisfy the demand of the entrepreneurial class for a seamless tax structure. The tax intends to bring all forms of indirect taxes and all commodities and services, under one umbrella. The jurisdictional division of fiscal powers between the Centre and the states will be wiped out; there will be a unified and uniform rates structure for the entire country. The tax administration too is proposed to be harmonized. The schedule of tax rates is expected to be on the low-to-moderate side so as to add to the jollity of the capitalist order.

The state governments have been fed on hopes that they will be net beneficiaries from the new fiscal arrangement. But nobody really knows how the cookie is going to crumble. One thing is however certain: it is bound to crumble in a way that will badly hurt the poor and backward states, if only for the reason that they have as yet few service activities taking place within their borders.

And there is, of course, the very big issue of sidestepping the Constitution. The fiscal texture woven in Article 246 and the Seventh Schedule will be comprehensively destroyed with the legislation of the Goods and Services Tax Act. Is overhaul of such a major order valid in the absence of an amendment to the Constitution? The misgivings expressed at the time of the introduction of the value-added tax system need to be re-echoed. This is a matter which should have caused concern to savants in jurisprudence. But jurists are possibly less excited over fiscal issues than over human rights or environmental problems.

Even so, whether a unitary fiscal framework is a sustainable proposition for a multi-party democracy like India is a question that will not fade away. For consider the total landscape that is fast emerging. Neo-liberal policies have yielded high gross domestic product growth, but have been accompanied by increasing income inequalities and acuter regional imbalances as well. Conventional political parties are seemingly unable to grasp the significance of these developments. The army is under the exclusive jurisdiction of the Centre. The so-called war on terror has again vested the central police and security personnel with immense power in the area of maintenance of law and order, nominally the responsibility of the states. Now a big effort is on to concentrate all fiscal and monetary powers in the hands of the Centre. It is a big country with a complexity of problems. True, China is bigger, but it has a regime under the total command of the communist party whose writ is enforced with cool efficiency all over the country. India, in contrast, has a pluralistic arrangement with dozens of parties and a Constitution allowing the right of uninhibited expression of views. A polity, featured by a highly centralized fiscal and monetary discipline as well as an extreme concentration of military and police power, has to grapple with the phenomenon of remorselessly growing horizontal and vertical inequalities. Such a system could be in constant danger of coming apart. Even if it does not come apart, it is likely to spawn big and small pockets of intense discontent that Maoist-kind of formations will lusciously take advantage of.

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