Lessons from a tale of two reforms | Sarma & Sunder

by Atul Sarma Shyam Sunder*

The Modi government at last climbed down to repeal the three farm laws on November 29, 2021 that provoked more than a year-long farmers’ protest starting from August 9, 2020. The protest allegedly took a toll of 600 human lives and public and famers’ loss of ₹ 5000 crore as estimated by a study conducted by two economists associated with the Panjabi University at Patiala. The study also found that contrary to the claim that big farmers are the protesters at Delhi’s borders, most of those who died during the protest were cultivators cultivating 2.26 acres or 0.91 hectare on an average based on a study of 460 dead farmers. What it all means was an abortive but costly attempt to bring about reforms in agriculture.

It is not that agriculture does not require any reforms. It does need but requires to be designed and implemented in a democratic process. It could also be said that the aims of the laws as stated: to modernise India’s agricultural infrastructure, boost supply chains, facilitate proper marketing and care of perishables and provide better market access to farmers and build a new and efficient farm to market-to home eco-system were quite in order. Yet the government failed to carry these through.

We propose to discuss two cases of reform attempted in democratic India. One relates to Goods and Services Tax (GST) and the other to farm laws- both largely fall within the state jurisdiction. The first is the exemplary case of centre-state cooperation. More important, it lays down the golden path for carrying out reforms in the areas which fall within the jurisdiction of states that function in a participatory federation.

First, we discuss state tax reforms. Indirect taxes generally, large in number, became clumsy with cascading effects leading to distortions in investment and adverse effect on growth as also a hindrance to free flow of goods across the country. Numerous exemptions and concessions, corruption in tax admiration made them unproductive and violated all cannon of taxes: equality, certainty, economy and convenience, elasticity, productivity, simplicity and diversity.

Following deliberations and recommendations of several committees, the Value Added tax (VAT) system was considered to address the deleterious impact of commodity taxes. The Central government first introduced VAT in the form of Modified Value Added Tax (MODVAT) in 1986 and later renamed it as Central Value Added Tax (CENVAT) in 2002, also covering services. On October 18, 2002 in a meeting convened by the then Prime Minister, the Chief Ministers of all states committed to introducing Value Added Tax (VAT) that would address the detrimental effects of the existing system of taxes from the sales side. VAT is a tax on consumption charged at every stage of value chain eliminating double taxation in terms of first on input and again on output produced with the already taxed inputs under sales tax framework. VAT is a multi-point sales tax system in which the tax is levied as a proportion of value-added (sales minus purchases), that is at each transaction in the production distribution system. In the process it eliminates double taxation and thus cascading effects as also multiplicity of taxes while augmenting revenue mobilisation. Despite some initial transitional problems, most of the states rolled out VAT from April 1, 2005.

The rate of growth of revenue from VAT nearly doubled the average annual growth in the pre-VAT five-year period. However, several shortcomings remained. First, cascading effects are not fully eliminated in the VAT framework. More specifically, VAT on sale is levied on the excise gets included in the cost of a good thus resulting in VAT being levied on the excise component of the tax too. Again, Central sales tax for not being a set-off, gets embedded in the cost of a good. Second, several taxes such as Entry Tax, luxury tax, entertainment tax, excises on alcohol for consumption, betting tax etc. fell outside the VAT system. It means input tax credits are not available in these taxes thereby these taxes get embedded in the sale price of a good. Third, service tax not being integrated in the VAT structure, no set off is allowed on VAT levied by the state government. All this distorts resource allocation as well as price structure.

Goods and Service Tax (GST) addresses all these shortcomings. The tax base covers all goods and services without much exemptions. Most indirect taxes were merged into GST and the entire tax base was shared both by the Centre and the States. Since input tax credit are provided against all taxes, cascading was eliminated. CST being origin-based tax was abolished. GST widened the tax base and improved tax compliance. As a result, revenue mobilisation significantly improved.

The implementation of GST was as much a game changing reform as daunting. It required participation of all state governments several of which were ruled by parties different from the ruling party at the centre. It also required subsuming of seven central taxes plus surcharges and cesses and seven state taxes and surcharges and cesses in GST. Given states’ limited taxation power, it led to abridgement of their fiscal autonomy. It further required amendment of the Constitution which had to be ratified by the Legislatures of not less than one-half of the States, “to authorize the levy, collection and appropriation of the Goods and Service Tax (GST) by both the Centre and the States.” Despite such formidable challenges, GST could be implemented from July 1, 2017.

However, it took long seventeen years since the idea of GST was first mooted in 2000. Even after the proposal to introduce a national level Goods and Services Tax (GST) by April 1, 2010 found place in the Budget Speech for the financial year 2006-07, the process of consultation with stakeholders, its designing, and legislative approval through parliamentary scrutiny and so on took ten years.

More specifically, an Empowered Committee of state and UT Finance ministers was constituted in 2007 to prepare a Design and Road Map for implementation of GST. The Constitution was amended. Goods and Services Act 2017 were implemented under five acts, Viz .Integrated Goods and Services Tax Act, 2017; Central Goods and Services Act 2017, State Goods and Services Act 2017; Union Territory Goods and Services Act 2017 and The Goods and Services Tax (Compensation to states). A GST Council, a remarkable Centre-State consultative mechanism was put in place with Union Finance Minister as chairman and minster in charge of finance or taxation of all states as members to recommend to the union and state governments on all important GST related matters. In short, the implementation of GST, even if its faulty design was an exemplary case of cooperative federalism at one level and at the other, a model for carrying out complex reforms involving multiple stakeholders, though timeframe needs shortening.

In contrast, three farm laws on a subject within the state domain affecting the lives and livelihoods of more than half of India’s population and thus involving farmers as major stakeholders were first introduced through Ordinances and thereafter passed in the parliament in a few minutes without any parliamentary debates and scrutiny and evading any consultation with state governments nor with farmers’ association. No wonder, they met with the fate as they did even if the farm sector was truly crying for reforms.

What does the above tales of reform drive is that reforms and their implementation require to be carried out through a democratic process in terms of consultations, discussions with all stakeholders and their active participation instead of steamrolling through political management. In fact, indirect tax reforms through GST implementation demonstrated how to manage complex policy reforms. In short, Modi government could have adopted a broad-based consultation process and taken its time to put the farm bills through a proper consultative and parliamentary process to avoid farmers’ unrest and protests. This is particularly important as country is celebrating “Azadi Ka Amrit Mahotsav” and to achieve higher and sustainable economic growth, a lot more reforms would need to be implemented.

(Authors: (Atul Sarma (sarmaatul[at]yahoo.com) is Distinguished Professor at CSD, New Delhi and Shyam Sunder (shyams.eco[at]gmail.com) is working with an Indian Corporate. Views are personal.)