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GST Bill: A Successful Exercise of Consensus-Building in Democracy

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Image courtesy of The Indian Express

Bhavani Castro is a Fellow of Indian Studies, Getulio Vargas Foundation in São Paulo

The first half of 2016 was marked by several setbacks for democratic institutions and liberal values all over the world. From the Turkish government’s repressive response after the failed military coup to the rise of radical parties in Europe, a controversial impeachment process in Brazil and the rise of Donald Trump in the United States, it seems that democracy has recently been under significant pressure. Intense animosity and partisan divisions are challenging the way democracy works and its core values, undermining decision-making processes in parliaments, blocking key reforms, and leading to authoritarian administrative measures. However, in the midst of many worrying examples of flaws in democratic regimes in different parts of the world, it is possible to identify one case of significant success when it comes to democracy’s capacity to overcome division and build consensus: the passage of a groundbreaking tax reform by the Indian Parliament.

Goods and Services Tax Bill (GST) was passed in August in the Upper House of the Indian Parliament, the Rajya Sabha, and approved by President Pranab Mukherjee on 8 September. The GST, now turned into law, creates a single tax system in India, and represents a significant breakthrough that in practice will transform the Indian states into a common market. This notable success generated little reaction in the international media, especially in emerging and developing countries; however, it holds important lessons on how game-changing reforms can be implemented in a democracy.

The world should look at the ratification of the GST law as a substantial example for effective democracy for a variety of reasons. First, it shows the capacity of a messy, multiparty parliamentary system. Since the 1990s, the Indian government needs to recur to coalitions to rule at the national level, as the increasing number of national and state parties make it impossible for a single party to rule alone. This means often making deals and negotiating not only with the opposition, but also with strong regional parties that seek policies that benefit only – or mostly – their local constituencies. Similar phenomena are visible in other large democracies like Brazil, where large coalitions make governing extremely difficult.

An increase in polarization usually means fewer laws pass in Parliament. For emerging countries like India, where there is a necessity of progressive reforms to manage the economic transformation and push for social improvements, political fragmentation and a lack of consensus building can have devastating effects. To avoid setbacks, the strategy adopted by the Indian government was to engage and include strong regional parties in the discussion, rather than coercing and embracing a combative tone. At the same time, the biggest opponent, the Congress Party, was slowly isolated and eventually, faced by the risk of having its image damaged, had to accept the bill and enter the negotiation. Consequently, opposition parties contributed to changes in the bill, while the ruling coalition yielded to demands and offered concessions in the final written version. The process was not simply an exchange of favours as it is usually observed in multiparty democracies, but instead a conciliatory process of political commitment by all parties involved.

Moreover, the GST, when implemented, will go against an ongoing international trend of isolating peoples and markets – the new tax system has even been called a “reverse Brexit”. While the European Union is going through one of its biggest crises – with rise in partisanship and the exit of an important economic member – India is showing the world that democracies can do better. The new tax system will replace dozens of different tariffs that made selling a product to another Indian state as hard as selling products abroad. That means connecting 1.2 billion people in a European-style market and an expected increase of 1-2 per cent to the country’s GDP growth rate.

Finally, it is important to consider the dimension of this tax reform. The GST was designed along the lines of the value-added tax (VAT) model from OECD countries, and it is considered a key reform for restructuring economies. For India, it is one of the biggest institutional reforms since its independence in 1947. Most countries still struggle to enact legislation that will lead to this type of revolutionary work, as it can negatively affect some industry sectors and interest groups. Brazil, another populous democracy, has been trying for years to design a tax reform to substitute its inefficient system; however, it never even managed to produce an initial project for a new tax scheme. India’s lessons on the GST law-making process could be extremely valuable for countries like Brazil, which could follow India’s steps: first creating a highly skilled committee to design a uniform tax system, and then submitting the initial proposal to the legislative for a comprehensive discussion and adjustments between all political parties.

India still faces many problems threatening its democracy, including an ongoing civil upsurge in Kashmir, suppressed by the government, and a severe water-sharing dispute that increases tensions between southern states. However, in the case of the GST process, the government proved that it is possible to use democracy as a tool to reach potentially painful but necessary reforms in a pluralistic country. It took more than a decade to pass the GST Bill, but democracy is a slow process and does not provide fast solutions to urgent problems. India’s political system can be inefficient, polarized, disorganized and sometimes exhausting, but hopefully this experience will be a positive example for other democratic countries still struggling with much-needed institutional reforms.

Bhavani Castro is a Fellow of Indian Studies, Getulio Vargas Foundation in São Paulo

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Potential Areas for Reforms

With most parliamentary sessions in 2015 being washed out due to noncooperation by the opposition, there is a lot left to done by the Modi government. Depending on the success of Modi’s talks with the opposition, here’s a few things that can be achieved in 2016.

The February session promises to be action packed with a few interesting bills lined up:

GST: The goods and services tax, once approved, will simplify India’s tax regime by integrating the central excise tax, service tax, and state value-added tax. India currently has as many as 14 state level taxes, each of which differ from state to state in levels and implementation. The simplification and unification of these taxes is, according to some estimates, poised to add 2% to India’s GDP. The GST, which has been adopted in several other countries with good results, is expected to boost export volumes, create employment opportunities, encourage competition between states, and increase the tax collection for the government.

Pushing the GST through the parliament has not been easy though. Despite a clear majority in the lower house, the BJP has not been able to pass the bill in three consecutive parliamentary sessions, due to opposition from the Congress party. The latest winter session was again washed out without any major reform going through. Since then, however, PM Modi has had several political talks with the opposition leaders with GST as the specific agenda and the Finance Minister Arun Jaitley commented on January 3, 2016 that he was reasonable confident of passing the GST in the February session. Mr. Modi will have to spend a great deal of capital to pass the GST in the upcoming session, and even then, the bill that gets passed might be a slightly diluted form of the ideal bill.

Bankruptcy Reforms: The average time taken for insolvency proceedings in India is a staggering 4.3 years, whereas the comparable figure in the US is 1.5 years and 1 year in the UK. Having a clearly defined bankruptcy law is essential for providing a favourable investment climate in any country. Exit norms are as important as easy of entry. The new bankruptcy law is expected to not only reform domestic bankruptcy law but also set the framework for developing an effective system for addressing cross-border insolvencies in India. The Insolvency and Bankruptcy Code Bill, which was introduced in the 2015 winter parliamentary session, is currently stalled in a joint committee between the two Indian houses of parliament. However, because bankruptcy reform is a priority area for the Modi government, we expect to see movement on this important matter in the next parliamentary session.

Banking Reforms: The Indian banking sector is dominated by the public sector banks, which are starved for capital and have huge Non-Performing Assets. The pace of stressed asset creation has also been high, which had prompted Moody’s to keep a ‘negative’ outlook for Indian banking sector. However, the Modi led government has been talking of reforming the banking sector with the Finance Minister introducing a 7 point programme to revitalize the public sector banks. The revitalization plan includes creation of a Bank Board Bureau, improving governance standards, and additional capital infusions. Though privatization of the banking industry is the need of the hour, which is unlikely to happen any time soon, this is the first step in the right direction. 2016 should see some significant improvements in the banking industry. Moody’s has already changed its outlook to ‘stable’, following the reduced pace of stressed assets addition.

Legal reforms: Opening up the legal sector in India, i.e., allowing foreign firms to practice and set up offices in India will be crucial to improving the ease of doing business. Inflow of FDI is hampered by concerns over legal cover and arbitration. Companies investing in India want the assurance that they can rely on sound legal advice, judges, and courts.  In 2015, the government began discussions surrounding a gradual opening of the legal services sector to foreign attorneys. The Prime Minister strongly supports legal reform in India and though India is adopting a cautious approach, it has taken the first steps by informing the World Trade Organisation in August 2015 that it would open its legal sector to foreign lawyers and law firms, but would do so only after consultations with all stakeholders, including the Bar Council of India (BCI). As the first step, the benefits of an open legal sector would only be provided to those countries that offer similar treatment to Indian lawyers and firms.

The proposal being considered by the CoS recommends that international arbitration and mediation services and only advisory or non-litigious services in home country law of the foreign lawyer, third country law and international law may be allowed. It proposes that foreign lawyers could be permitted to practise in India in conjunction with Indian lawyers, as a joint venture, with a cap on foreign participation.

Increased Ceiling for FDI: The Modi government has increased the ceiling for FDI in India in many sectors since 2014. It has also cleared many sectors to be considered under the automatic route and has allowed up to 100% FDI, without prior approval of the RBI. The long-standing 10 percent limit on single institutional investors still exists and continues to inhibit growth. Furthermore, even in sectors where the investment limit has been increased to 49 percent, barriers still exist. For example, in the insurance sector, even though the government raised the FDI cap to 49 percent, no foreign company has been able to increase its investment due to India’s restrictive interpretation of management control.

There are some exciting times ahead. If the Modi government can push through some of these long pending reforms, India can look forward to the next wave of growth.

Anupam Manur is a Policy Analyst at the Takshashila Institution and blogs @anupammanur

 

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