Current state of India’s tax system

This post on Current state of India’s tax system has been created based on article “Our tax system retards growth. It’s time for an overhaul” published in The Indian Express on 27th January 2025.

UPSC Syllabus topic: GS Paper 3- Indian Economy

Context:The article critiques the current state of India’s tax system, particularly its Goods and Services Tax (GST) regime, and calls for an overhaul to prioritize economic growth rather than revenue maximization. Using the symbolism of the Roman god Janus, the author reflects on past policy decisions and their consequences, urging introspection and forward-thinking reforms for the coming years.

What issues arose from the 55th GST Council meeting?

1. Policy Backsliding: Chronic tinkering with GST rates continues, alongside retrospective amendments to nullify Supreme Court judgments.
2. Example of Retrospective Taxation: The council nullified a Supreme Court ruling that allowed input tax credits for warehouses and infrastructure projects, sending a message that even court victories can be overruled.
3. Impact on Investment: Such amendments undermine India’s reputation as an investment destination, signaling disrespect for the rule of law.

How does retrospective taxation affect India’s economy?

1. Historical Example: The Vodafone case resulted in an international arbitration award of ₹8,000 crore against India.
2. Present Issue: Retrospective amendments discourage foreign investment, increase policy uncertainty, and harm India’s image as a rule-of-law-driven country.
3. Proposed Resolution: No more retrospective amendments should be a key policy change.

What is the core flaw in GST Council’s functioning?

1. Revenue-Centric Approach: The Council prioritizes revenue maximization over growth, often publicizing exaggerated claims of tax evasion.
2. Lack of Simplification: Complex notifications, arbitrary demands, and inadequate appellate systems remain unaddressed.
3. Input Tax Credit Denials: Denying credits on lease rentals and joint development rights hampers the real estate sector and the broader economy.

What are the proposed reforms to simplify GST?

1. Streamlining Rates: Introduce a single GST rate of 12% for hotels/restaurants and a maximum rate of 18% for essential sectors like cement.
2. Economic Impact Studies: Analyze whether lower tax rates could boost demand and, ultimately, tax collections.
3. Sector-Specific Adjustments: Exempting certain real estate activities from GST could make affordable housing more viable.

How do high tax rates and complex systems harm the economy?

1. Historical Parallels: India’s pre-1991 tax system, focused on high rates and exemptions, stifled economic growth.
2. Current Trends: Signs of reverting to old practices are evident, benefiting professionals like lawyers and accountants but burdening businesses.
3. Adverse Outcomes:
   1. Increased imports from China (from $70 billion in 2018-19 to $100 billion in 2023-24).
   2. Manufacturing’s GDP share falling below 15%.
   3. Continued rupee depreciation.

What is the proposed way forward for the tax system?

1. Growth Maximization Framework: Shift focus from revenue collection to economic growth.
2. Reforms 2.0: Introduce a long-term fiscal policy for 2025-2030 to enable 9-10% annual GDP growth.
3. Philosophical Shift: Recognize that taxes should be the byproduct of growth, not the primary goal.