Why India’s New GST Reform Is a Game Changer for Development

August 04, 2016

When the Upper House of India’s parliament recently passed the landmark Goods and Service Tax (GST) legislation, India finally, after more than six decades of independence, became a truly common market. Once the 122nd Constitutional Amendment, to give the GST Bill its proper name, is ratified by two-thirds of the state legislatures, India will move to an integrated tax on both goods and services, or a comprehensive VAT system that is common across much of the world. Some experts believe that a well-designed GST can boost GDP growth by 2-2.5 percent, over and above the 7.5 percent that India has recorded in the last fiscal year. That could be a game changer for India’s development in the coming years.

The main benefit of the GST is that it would eliminate a bewildering array of excise duties, surcharges, earmarked levies and exemptions that makes India’s indirect tax system one of the most complicated in the world. And to make matters worse, each of the 29 states has its own taxation powers on goods (but curiously, not on services). This has discouraged both the domestic and foreign investment in manufacturing that India desperately needs. Movement of goods is also restricted due to arcane entry taxes that imposed costs on movement of merchandise and created a fertile ground for corruption. The line of trucks backed up for miles along the interstate highways is the enduring image of a broken system that badly needed wholesale reform. Nobody will be happier than long-distance truckers after the GST comes into force in April 2017.

The promise of the GST is, therefore, enormous. Businesses will be able to worry less about filing tax forms and focus more on increasing investment and creating jobs. With 10 million young people entering the workforce every year, the GST cannot come a day too soon. The GST also symbolizes the new era in India’s Centre-State relations, the notion of ‘cooperative federalism’. As I have discussed here, greater fiscal devolution to states following the 14th Finance Commission’s recommendations has created an enabling environment where the Center and States can come together to do what is in the national interest, as the GST process demonstrated so clearly.

But in the haze of euphoria, it is also important to keep in mind that India cannot rely on the GST only in order to generate the resources it needs for its huge developmental challenges. Also, as my CGD colleague Nora Lustig’s work shows, indirect taxes can be bad for equity and there is no substitute for creating an effective system of taxing income and wealth. With only 1 percent of India’s 1.23 billion population paying income tax, there is a considerable scope for improvement there. For all its historical importance, the GST is only a means to the ultimate goal - to create an India free of poverty, with education, health and opportunity for all.

More than a decade in the making, the final leg of the journey would not have been possible without the tireless efforts of CGD’s very own Arvind Subramanian, the current Chief Economic Advisor to the Government of India. Congratulations to him and his team who proved that good economics is also good politics!


CGD blog posts reflect the views of the authors, drawing on prior research and experience in their areas of expertise. CGD is a nonpartisan, independent organization and does not take institutional positions.