The nationwide rollout of the new Goods and Services Tax (GST) is a historic occasion, however imperfect its beginning may be. It is the biggest reform in indirect taxes. It arose as a grand bargain reached by consensus between twenty-nine states of India and the Centre.

It represents the true spirit of cooperative federalism, a term popularised by Prime Minister Narendra Modi. Each party to the grand bargain gave up their respective taxation rights in exchange for a uniform countrywide system. The states gave up sales tax (also called VAT) and the Centre gave up excise and service tax. Most importantly, the central sales tax imposed on inter-state commerce is abolished, and so are most other entry taxes at state boundaries. This creates a truly un-fragmented and unified common economic market across India. This is the vision and ideal that we aim for.

The imperfection is that we have left out nearly one third of the economy and GDP outside the ambit of GST. Thus, taxes and duties paid on electricity, petrol, diesel, alcohol, tobacco and real estate transactions, do not earn any offsetting credit under GST. Hence, to that extent, the GST burden is on a smaller portion of the economy, and therefore likely to be inflationary in the beginning. The second imperfection is that instead of just one or two rates for all goods and services, we have introduced six rates of 0, 5, 12, 18, 28 and 43 per cent.

The so-called luxury goods attract higher rates, and essential goods a lower rate. But this classification is so complicated and at times inconsistent, and subject to the discretion of tax officials, that it might lead to disputes, litigation and worse, corruption. The third imperfection, hopefully temporary, is that India’s GST, unlike in any other country, is actually three simultaneous tax systems, viz, CGST, IGST and SGST. The compliance and filing burden can be onerous, although they have promised smooth execution of the online mechanism. But despite all the drawbacks, we must celebrate this landmark reform.

At the same time, we also must acknowledge that it is only half the job done, as far as tax reform is concerned. The two reports of committees chaired by Dr Vijay Kelkar back in 2002 were on indirect taxes and direct taxes. GST is an indirect tax. It is a consumption and transaction-based tax. The full impact of tax reform and attendant benefits are only possible when we implement both direct and indirect tax reform. The principle of optimal taxes requires efficiency and equity. The former means tax reform which causes least distortion, easy to comply and collect and leads to revenue buoyancy. Hopefully, the ideal and full version of GST meets these criteria. But the latter, i.e. the equity notion, requires that taxes also be “fair”.

There are two notions of fairness—horizontal and vertical equity. The former means that two persons earning the same income should pay a similar tax amount. The latter means that a higher income earner should pay more taxes than a lower income earner, both in absolute terms and as a percentage of income. Indirect taxes such as GST are inherently unfair because they only depend on the value of the transaction, not on the buyer’s income. Direct taxes like income tax, capital gains tax and wealth tax are fairer and can be progressive. In a fair and just society, we need persons with higher income to contribute more to the national exchequer than those less fortunate. Taxes should be seen as each person’s membership fee to be able to live in a civilised and democratic society. Justice Oliver Wendell Holmes famously said in 1927, “I like to pay taxes. With them, I buy civilisation”.