The GST Reform India Needs but Didn’t Get with Arbind Modi
Insights on what it will take to reset India’s tax system, revive competitiveness, and lay the foundation for sustained growth
In this episode, economic journalist and author Puja Mehra speaks to Arbind Modi, retired IRS officer and Senior Economist at the IMF and one of the chief architects of India’s Goods and Services Tax (GST), about what India’s broken tax system means for its growth ambitions. The conversation explores how GST’s design flaws have hurt competitiveness, why exempting large sections of income undermines fairness, and how Centre–State revenue sharing has created new fiscal strains.
The discussion connects India’s tax choices to global shifts, from the Trump-era trade wars to the reordering of supply chains, making clear that without serious reform, India risks missing yet another growth opportunity.
Tune in for insights on what it will take to reset India’s tax system, revive competitiveness, and lay the foundation for sustained growth. This episode is both a masterclass in India’s tax system and a call for bold, evidence-driven policymaking.
(00:00) Introduction
(02:15) Why GST Hasn’t Delivered on Its Promise
(07:42) Fixing GST Design and Efficiency
(12:30) The Problem with GST Rates and Complexity
(16:58) Corporate Tax Cuts and Their Consequences
(21:47) Why Income Tax Exemptions Are a Mistake
(27:15) The Centre–State Revenue Sharing Dilemma
(32:44) The Case for Comprehensive Tax Reform
(38:52) How GST Reform Could Unlock Higher Growth
(46:10) Why Political Will Matters More Than Bureaucratic Hesitation
(51:21) Decluttering GST and Fixing Excise Duties
(55:23) Why Taxing Gold Jewellery Hurts the Poor
NOTE: This transcript is done by a machine. Human eyes have gone through the script but there might still be errors in some of the text, so please refer to the audio in case you need to clarify any part. If you want to get in touch regarding any feedback, you can drop us a message on [email protected].
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TRANSCRIPT
Puja Mehra: Mr. Modi, thank you so much for coming on the show to talk about GST. Thank you, Puja, for inviting me to this podcast. Mr. Modi, India's GST has been called flawed by several experts. But the GST Council has been dithering on reaching consensus for removal of its imperfections.
Now, after the Prime Minister stepped in and promised a GST overhaul by Diwali, one group of ministers from the GST Council has agreed to some of the things that were proposed by the Prime Minister. I wanted to start this conversation by requesting you to explain to us, what are the flaws in India's GST? And this reject that is being announced, if this will address all of those flaws and make India's GST a perfect GST?
Arbind Modi: Let me first outline what exactly are the flaws. We all designed a flawless GST. And that was a part of the 13th Finance Commission report, as you know. It was based on the task force on GST, which I personally chaired.
And everybody was a part of it. I mean, Ratan Roy, Ajay Shah, Kavita. Now, despite the recommendation for a flawless GST, the Centre and the state governments arrived at a consensus on a GST model, which was completely far, far away from flawless.
Now, what are the points of differences from what we conceptualised and what was finally implemented? Because what was implemented was basically an amalgam of compromises. Every state wanted to have something to be protected and therefore, everybody accepted that.
What are the key points of differences? First is the rate structure. The 13th Finance Commission was very clear in its recommendation that India should go for a uniform single rate.
And the rate proposed was 12%. Combined rate was to be 12%, of which 7% would go to the states and 5% would go to the centre. Now, that itself would have compensated the states for the loss in a big way, you know, because you are getting that extra one percentage point, number one.
Whereas what they adopted was a multiple rate structure. And multiple rates also went into probably six or seven rates. We don't normally count zero rate as a rate, because that's part of the structure for zero rating exports.
But if you count all other rates, then what you have today is 0.25% for rough diamonds, 3% for jewellery, gold bullion, etc., etc. Then you have a 5% rate for some special goods and services. Then you have 12%.
Then you have 18%, which is the standard rate. Then you have 28%. Then you have 28% plus SSEs, etc., which can go into, you know, very high rates. Second was, we envisaged very few exemptions. Basically, primary food products, that is more at the agricultural, at the farm gate, and education and health. Beyond that, at that stage, we didn't recommend anything else.
So, when you reduce the exemptions, you don't have cascading, etc. Because when there is an exemption under WAC, you don't get input tax credit. Now, when you don't get input tax credit, if some of those goods are used as inputs in other commodities, then there's a chance of high cascading.
So, we didn't recommend any significant exemption.
Puja Mehra: When you say cascading, you mean it gets taxed?
Arbind Modi: Tax on tax, tax on tax at each level, you know, and that distorts production also. So, the whole idea in our design of the GST was, production should not be distorted. Neither should consumption, of course, but the bigger emphasis was production should not be distorted in any form.
Choice of inputs, etc., should not be distorted. Now, the other third point, which was very fundamental to the efficiency of the GST was immediate input tax credit for capital goods. Now, that is something which is unfortunately very underplayed.
In India, we don't realise the implications. Now, what has happened is in practice, there are a lot of restrictions on the utilisation of input tax credit for capital goods today. One is, in practice, it is given only after the unit operationalises.
So, what happens is, Greenfield projects get input tax credit after the project commences production, which could be two, three years down the road. When that happens, effective input tax credit that they get, instead of getting the full 18%, they would probably end up getting 12%, 13% in real terms because of the inflation. So, that's an implicit tax or denial of input tax credit.
And effectively, that is also a tax on investment. So, that's the more serious part of it.
Puja Mehra: Does it affect the viability of projects?
Arbind Modi: Exactly. That will also affect the viability of projects. It's a tax.
So, that has to be factored in, in your IRR calculation. And when that gets factored in, then obviously, some projects in the margin will fall out of consideration. To that extent, it will impact investment, overall investment also.
However, when it is brownfield investment, because they are already in operation, and it's only about expansion, they tend to get immediate input tax credit. Some delay could be there in their cases also, because if it's a very big expansion, then their output may not be able to, output tax may not be enough to absorb that big expansion. So, in that case, they are also affected.
So, that depends on what is the size of the project or the size of the expansion. Plus, there are also restrictions on input tax credit for capital goods, in the case of products which are subject to a 5% tax rate. Although technically, they say that no, we allow it to be accumulated.
Now, accumulation means it's kind of indefinite, unless somebody is producing along with a 5% taxed good, and 18% taxed good also. But that would be rare, you know. But by and large, input tax credit on capital goods is blocked in both cases, whether you are supplying services or you are supplying goods, which are charged to tax at 5%, you will have this problem.
The fourth is the gap in the base. A large number of exemptions have crept in over the years. In fact, there are a lot of jokes on the GST Council becoming a council for exemption rather than a council for protecting the tax base.
When we conceptualised the GST Council in the task force, and then it became a part of the 13th Finance Commission report, the idea was that it will act as a check and balance on the erosion of the tax base. But unfortunately, what is happening is, as you see, every time more and more products are being exempted, or products are being pushed from the standard rate to the reduced rate. There is some kind of relief which is always being talked about.
And each of those are creating serious distortions in the VAT regime. In fact, there's another thing. I mean, on the exemptions, I must say that if you are against a particular industry, then you should give them exemption, because it will automatically get paid.
I mean, unlike what people think, one, because exemptions, by nature, create an import bias, which again, is something which is not taken into account. So in order to address that import bias, what you do is you increase tariffs. And when you increase tariffs, then your tariffs appear to be very high compared to international standards.
Puja Mehra: Sir, I didn't understand. How does it create an import bias?
Arbind Modi: Okay. You see, what happens is, suppose you're producing a commodity A, which is exempt. Now exemption means no input tax credit.
So your inputs which you have used have borne some taxes. Let's say 70% are input and 30% is value addition in that commodity. So you would have suffered a 14.4% tax. Now, because there is no output tax, it is exempt. So you can't take credit. It automatically becomes a part of your cost.
Okay. Now, the same product, when it is imported, let's say Canada or UK, because the US doesn't have VAT, then that product, because it is an export, is zero rated. It does not carry any tax incidence.
All input tax on those products are also refunded. And that is WTO compatible, right? So they come without any tax burden.
And your local domestic producer faces the burden of that 14.4% in my example, it could be 10%, it could be 16%, it could be 10%, I mean, 5%. We don't know, depending upon what is the proportion of input that goes into its making. But regardless of that, there will be a difference between the tax borne by the exporter from the UK and the tax borne by the domestic producer.
That itself creates an import bias. So typically, as a consumer, if you have to buy a product from the UK, if you have a choice of buying from the UK, or from India, assuming that that good is exempt in India, then you tend to buy it from the UK because the prices are lower. This is one impact which is often missed out when you have these exemptions.
Puja Mehra: Basically erodes the global competitiveness of India.
Arbind Modi: Exactly, exactly, completely. So if you're saying I'm going to push, I'm going to tax at 18%. And I'm going to push products to 5%.
You're blocking input tax credit, etc. You're making your exports uncompetitive, exports from those sectors uncompetitive. These were the reasons why we were completely against exemptions.
And we wanted that ideally it should be restricted to minimum merit goods. Minimum would mean agriculture produced at a farm gate, and health and education also. We had reservations on both health and education also.
But to start with, we said, okay, let's concede that till such time we improve our systems. We don't improve our systems, we should allow for these exemptions. And over time, we can move to direct cash transfers.
So these are the major key differences. And because of these three key differences, the whole system is completely kind. We don't know whether we want to follow a VAT regime, or we want to follow a turnover tax regime, which most countries, almost more than 150 countries, have given up. So going forward, if you want your country to become a production hub, manufacturing hub, then you need to fix your GST. And one more point, the rate structure that we have today is one of the worst in the world. Let's not underplay that phenomenon. I remember doing in 2022, around 2022, 21 or 23, around that time, just a quick survey of the tax rates, GST and VAT rates globally. And if I remember correctly, there were about six or seven countries, which had more than four or five rates, I think.
Of them, there were two countries, India and Bangladesh, and some vague countries. I mean, when you are amongst the top 10 economies in the world, having such a distorted GST will certainly not help you to improve your manufacturing.
Puja Mehra: Ms. Modi, the politicians, because GST Council is primarily politicians, they've been saying all along that we have to keep in mind things such as, you know, Prime Minister Modi gave this famous statement where he said that I cannot have the same GST on Hawaii chappals and aeroplanes. So there is a political logic that they apply to something which is very technical and deeply rooted in economics and fiscal sensibilities. How would you persuade the GST Council and the finance ministers from all the states on the GST Council?
Because if there is a single rate GST, then, you know, the political economy implication of it is that the finance minister really has hardly anything left on their portfolio. Because nobody will come to them and lobby for an exemption. Nobody will come and lobby with them for a change in the GST rate.
Income tax in any case, the state finance ministers do not have. That is handled by the central government. So that and the logic of what you say to the voter that I can give you an exemption before Gujarat assembly election, some Gujarat products were given exemption a few years ago.
So that political logic, how will you sort of respond to that?
Arbind Modi: Okay, I'll break this question into two parts. One is that Prime Minister Modi's concern is legitimate. You know, basically meaning, I cannot treat the poor and vulnerable in the same way as the rich.
And that's legitimate. And that's legitimate for all politicians. And not only politicians, even economists, even common man, I mean, people like you and me also, it's legitimate that obviously, we don't want to treat the poor and vulnerable in the same way as we treat the rich or the middle class.
So that's one part of it. Then the second part of it is about crony capitalism. When you talk of rates being, yeah, that I want to give some concession because somebody has approached me or at the election time, I want to announce something.
That election part I will address and also the crony capitalism. Let's first come to the rich versus the poor, right? Typically, GST or a VAT or a GST kind of a tax should not be used for redistribution purposes or dealing with inequality.
In fact, modern thinking is very clear. We should have a whole public finance approach. So which means first you start with having a whole tax system approach.
And then if there is beyond that, if you need something, you have a whole public finance approach. Now, what do I mean by that? GST is meant for collecting revenues.
There will be regressivity. If you have a single rate, you can say that there will be some regressivity. Now, how do you address that?
The best way to address that is not by giving exemption, but by giving direct cash transfers. And countries are already doing it. Countries are already doing it.
Mr. Prime Minister Modi will be absolutely justified tomorrow if he said that if he can identify the Hawaii Chappal users and say these people, I will directly transfer 50 rupees every month to their bank account. And in fact, he has already spent a lot of capital on that in the sense that we have already created the infrastructure. We are effectively transferring.
And we have identified the poor also. The fact that you are able to provide food, in fact, grains in real, not even money. 80 crore people, which is almost 60% of your population, every month.
That means you have the capacity and a huge capacity. Something which is not created anywhere in the world. So, you use the same mechanism to transfer that.
And why do we say that? Why do we constantly say that? Now, let me give you an example.
Suppose, let's start with food, which is the most critical item. Now, food, if you see the household consumption survey data, expenditure data, you will find that at the bottom, the consumption may be, say, 5 kilo rice per month or 10 kilo rice a month. Now, as a proportion of income, that expenditure may be very high.
But the rich at the top are actually consuming 100 kilo rice because he has parties, he has lots of people. So, he is consuming 100 kilo rice. Now, when you exempt, you are actually giving, suppose your tax incidence is 2 rupees per kilo.
So, that 10 kilo fellow gets only 20 rupees, whereas this fellow gets 2000 rupees because he is consuming 100 kilos. The whole idea is, I mean, how does Mr. Modi prevent the rich from getting the benefit of that exemption of Hawaii Chappal? Because his intention is not to give it to Arvind Modi and Puja Mehra.
His intention is to give it to my driver or to my help at home. But unintendedly, the benefit is also taken by, availed by Puja and me. And maybe I am buying two Hawaii Chappals a year, those people are buying only one.
So, effectively more benefit is being given to me than to those poor. And we always say that, like in life, all sins are committed in the name of religion. In public policy, all sins are committed in the name of the poor.
So, here you design an exemption to help the poor, but it is the rich who are taking away the benefits. So, if you withdraw this exemption and you directly transfer cash to the poor, you will be much better off and you will be able to target better than through the tax exemption. And this is where the world is moving gradually, it's not something new.
And there are technologies which can do that. And India has already established the direct cash transfer mechanism. We are transferring cash every second day on some issue or the other.
It's not something which India cannot adopt. I mean, if it was difficult, then yes, you have to continue. I mean, you may have to continue for some more years.
But it's not difficult. This is something doable within six months, next six months. And that's where the problem is coming, because that fixation is there.
Therefore, I'm talking of a reduced rate. It starts with Hawaii Chappal. It starts with food.
And then gradually something, then you expand merit good. No, this is also a merit good. That is also a merit good.
I mean, let's say fridge. Is the fridge a merit good? I can say that it's a merit good.
Probably my maidservant, my driver needs it more than I need it.
Puja Mehra: Yeah, with climate change soon, you know, air cooling will become a necessity. There's going to have to be some way of dealing with these kinds of questions.
Arbind Modi: Yeah. So what happens? I mean, should you exempt the white goods also?
Or in the fridge, let's say, typically, because the help at home, she comes out, she leaves her home much early and works at several places. She needs to keep her food in the fridge. Whereas my wife probably doesn't need it because it's always on a real time basis, somebody is coming, cooking, eating and the next meal also somebody is helping her out and that's fine.
If I didn't have a fridge, nothing would happen. The heavens will not fall. But if she doesn't have one, yes, the heavens can fall for her.
There can be a crisis at home for her. So should you exempt it? That's why don't use GST as a tax for redistribution.
I mean, somebody, the advisors to the Prime Minister should, you know, discuss this with him and, you know, give this advice that this is where the world is moving. Yes, when we didn't have technology, that was a time when in the 60s, 70s, when this VAT was introduced, they did introduce these exemptions. But over time, the countries are moving away from it.
And that is exactly what we should be doing in GST 2. I mean, I can understand GST 1, whatever happened has happened. But GST 2, if this continues, it's going to be sad for India.
Puja Mehra: Lost opportunity.
Arbind Modi: Yes, it's a case of lost opportunity.
Puja Mehra: And what about lobbying? A lot of industries lobby for it.
Arbind Modi: That's exactly what, when the GST Council was conceptualised, the whole idea was to prevent that lobby. One of the purposes was that if you place decision making in the hands of a collective body, this whole lobbying can be eliminated, you know, because no single person can guarantee that he will be able to push it. Or he can assure you that this will be done.
That will depend on the collective wisdom. Now, what has happened is, unfortunately, right from day one, in our pursuit for consensus, the Council has ended up approving a lot of these individual cases and things like that. The other problem is that, let us say, an exemption is necessary for a particular state, let's say.
It may not be necessary in every state. So when you do exemption under the GST, then it becomes an exemption for all states. That's another problem.
Whereas if you do a direct cash transfer, then an exemption which is necessary in Maharashtra, Maharashtra government can transfer the cash to the beneficiary, depending upon what it thinks appropriate. But Punjab is not bound by that. Punjab can follow another set.
West Bengal can do a third set. You know, you don't have to be bound by that. So that is the benefit of, you know, moving away from a GST-based exemption method to reach out to the poor, to the direct cash transfer benefit.
Puja Mehra: And for doing this, a lot of revenue will be required. When we were shifting to a GST, it was said that it will jumpstart economic growth and investments and jobs creation. Also, tax revenues will improve.
Given that it is a flawed GST at the moment, how has GST performed on these expectations? Will that make a case for what you're describing as GST-2? If it has not done well on those expectations, then that could be one reason why consensus towards GST-2 as how you are describing it, or as how it was originally conceived by this task force on GST, if that could go through.
Arbind Modi: Okay, the first point you made was a lot of revenues would be required to do this direct cash transfers. Now, when you eliminate exemptions, you will get revenue. Let's say you eliminate all exemptions, just as a hypothetical.
You should be able to mop up 2-2.5% of GDP in revenues, around that number. Now, under GST, your revenues would go up, say, by 2% of GDP. But when you do direct cash transfers, you will probably use only 1% or 0.8%. So the net gain to the treasury would be 1.2%. Even after addressing the needs of the poor and the vulnerable, that is the power of that change. It is not revenue neutral, it is revenue enhancing. That's a positive of that shift from exemption to a direct cash transfer. Now, coming to your question, how has GST performed?
And then if it has performed well, then yes, surely we should continue. And if it hasn't, then there is a case for change. Okay, let's take each of those first on revenue.
Let me start because one of the reasons was that we were hoping that revenues would be much higher than what the taxes which were subsumed in the GST were yielding at the time of that change in 2017. Now, before I came for this podcast, I was kind of looking at the revenue numbers. Broadly, the numbers that I quote are broad numbers, so nobody should take it as the absolute.
You see, the pre-GST revenues were about 6% of GDP, the collection. In other words, if those taxes had continued, we could expect to collect about 6% of GDP. Now, 2017 was a truncated year, but even if you adjust for that one quarter, which was in the old regime, you got about only 5.1, 5.2. So, clearly the first year, you did not achieve your targets. Then it rose a little, and it came down during the COVID period, and after that it has been going up. And this I'm talking of revenues without CESS. Please remember, I'm talking of without CESS for the moment.
We'll come to CESS separately. So, without CESS, all the years, the revenues have performed below the level of 6%. So, clearly there has been a loss of revenue.
And this loss, even today, the last year, if you take as the benchmark, 24-25, we have about 5.45 or something like that. It's close to 5.5. Now, CESS has been consistently about half percent of GDP. About half percent, 0.45, 0.4, so around that. Now, when you add up, assuming that you want to treat CESS also as part of GST, that this is a part of the GST initiative, let's say, even then, even as late as the last year, which is 24-25, we're still marginally below that 6%. We are only 5.9, whereas we should have been over 6% or at least 6%. So, that is the story on the revenue performance.
Puja Mehra: Why are we every month doing GST filing, records, registration, if we are not getting this efficacy? Taxpayers have gone through a lot.
Arbind Modi: That is a part of the process. But tax collection-wise, let's be very honest, we have not achieved what we set out to achieve. And that's the reason why even states are feeling the pinch.
Overall revenues have not gone up at the national level. And when it comes to statewide distribution across states, then that has been a greater hit. Obviously, because this was a consumption-based, producing states were expected to be affected in some way.
So, what we had done in 2009-13 Finance Commission was to recommend a split not equal between the centre and state. Like what they have done is say 18% is split up equally at 9 and 9. We did recognise in our report, if you see that in some states, the revenue shortfall will be for some, it will be structured.
So, the ones which are transitory, I mean, transitional losses, they will probably be expected to overcome them in 4-5 years. I mean, nobody expected COVID to come in between. But if COVID was not there, they should be expected to make up within 4-5 years.
Some others, where it is structural, then obviously something has to be done by the Finance Commission, or the central government sitting on its own, sitting together with them and finding a permanent solution. Because having a cess is not really a permanent solution. Or a compensation formula on a year-to-year basis indefinitely is not a solution.
So, what we had done was we had said that if we, instead of having a split between centre and state at 6 and 6, we said 7 for the states and 5 for the centre. So, that would have given a lot of cushion. So, maybe after that, one or two states would have remained, for which we could have found a solution to the problem.
But unfortunately, that didn't happen. And we opted for a cess kind of mechanism. And the Finance Commission had also set apart 50,000 crores.
Dr. Kelkar was very keen that we should set it apart because if we didn't set it apart, the government may not be able to find resources. So, the 13th Finance Commission was very clear that they had set apart 50,000. And very interestingly, when we went to give the report, Dr. Kelkar and myself, we went to give the report to Mr. Aluwalia as Deputy Chairman Planning Commission. We just went to see him and brief him on GST. Because Dr. Kelkar was retiring from the government and going back. So, at that time, the Deputy Chairman said that if they adopt what you have recommended, I'll be willing to increase that 50,000 to 100,000. The point is that everybody in the government was willing to step up for a flawless GST. While most of us were doing the thinking, we wanted it, but others were also in the government advocating that.
Puja Mehra: I suppose that is the difference between a government in which there were many voices that were trained economists, whereas right now, we don't see presence in policymaking of any economic inputs. There is a Prime Minister's Economic Advisory Council, but they do not really input into policymaking much. Do you think what happened by the GST seems conceptually misguided?
Or is it that the political considerations were far more compelling?
Arbind Modi: No, I wouldn't like to be judgemental about my colleagues in the government now. Obviously, what happens is, different people have different expertise. But on this issue, particularly, GST is a complex subject.
It is a subject to which not many of us, even in the tax department, were exposed. I mean, those of us who lived abroad or who worked, we got to understand a little. But I would highlight that India had the benefit of two great experts on GST, which we should have utilised more.
One is Satyapodar. He is undoubtedly one of the best in the world. And he was there all the time.
So, I'm surprised why he was not utilised. In fact, he is one go-to person for us. If we conceptually have any problem, talk to Satya.
If you have a problem with the GST, you should talk to Satya. Unfortunately, he got so disgusted towards the end that he went away to an ashram.
Puja Mehra: I didn't realise that. Now that you mentioned, yeah, I no longer hear about him. But I didn't realise that he has become a hermit, is it?
Arbind Modi: Yes. I mean, hermit means he's gone to the ashram. He's gone to the ashram.
He's not. Three days back, I spoke to him. In fact, he sent me saying that I read your article and all that and I agree with you and all that.
I think we could have used him more. So, we had access to the best. I'm not exaggerating about Satya.
This is globally accepted. On GST, in fact, people in the fund tell me that Satya is there. You should ask Satya.
I said, unfortunately, nobody wants to. So, that was one. Then even Dr. Shrom was there. Unfortunately, the government didn't, nobody used him for GST. And secondly, yes, politics is also very important. As I said, there are a lot of perceptions. So, you have to constantly train the members of the GST council.
You have to constantly train. I mean, you see, after all, they are politicians. Don't expect them to know everything nitty-gritty about it.
It is the bureaucracy, GST bureaucracy, which has to do the research and brief the politicians.
Puja Mehra: Mr. Modi, I think that that is a failure. As you're speaking, I'm reminded of the first GST council meeting that took place after the Constitution Amendment Bill was passed for introducing GST. It was in Delhi. And Mr. Jaitley, as the chair of the GST council, did a press conference in which he took all of our answers. As a reporter, I was in that press conference. And then when he stepped out, as was his habit, you would also recall, after the formal press conference, he had an informal chat with some of us. And I had just done an interview a few days before that with Mr. Chidambaram as former finance minister, who had given his position on GST. And he had said that he thought that the best GST would be three rates and a dispute mechanism and several other issues he had. So, you know, he told me that, Puja, I saw your interview that you did with my predecessor. But you know, he's recommending three. We have gone ahead and done five rates.
And somehow, he assumed that five rates was better than three rates. So, I don't know if it was only for the consumption of journalists or if there was actually a failure on the part of the bureaucracy to convey to him how this was problematic.
Arbind Modi: You see, the point is, exemption was the conventional method. In fact, all EU countries have exemptions. Now, they were the first few countries which adopted VAT.
And that was the model that was advocated. And now they are finding it very difficult. Now, the modern VAT is actually, you should look at New Zealand.
Today, in the literature, you will see there is a discussion of the traditional or the conventional VAT and the modern VAT. When you talk of modern VAT, you talk of New Zealand VAT. In New Zealand, we typically measure the efficiency of a VAT regime by what we call C efficiency, consumption efficiency.
The consumption efficiency of New Zealand is always over 9, which means 0.9. And if it achieves 1, then they are taxing everything 100%. Which means that if your rate is 10%, let's say, which was the case in New Zealand, when they started off, and now they have moved to 15, more recently to three years back. So, 10% with that efficiency, they were collecting more than 9% of their GDP, almost 9%.
Yeah, almost 8% to 9% of the GDP VAT revenues. And our efficiency is only 0.44 or 0.45 around that. So, you can see, if you increase, you can, with that same 10% rate, you can have your efficiency, I mean, if you design your base correctly, from 5.5 or 6, whatever you are collecting, you could jump up to 8, 8.5, 9, 8 clearly. So, rates do not necessarily give you revenue. You see, this whole perception. And again, I agree with the political concern, they ought to be concerned about it.
If they are not concerned, then the bureaucracy, none of us will be concerned. And after all, they are the ones who are voting them to power. So, they ought to be concerned.
The question is, how do you target them? How do you reach out the benefit? There is no dispute that the poor and the vulnerable need to be protected.
On that, I don't think anybody in this, at least any one of us can dispute that. The question is, how do you do it? Is this the right mechanism?
Or are there better methods of doing so? Nobody's questioning the motive. We are questioning the mechanism.
Puja Mehra: Ms. Modi, so you said something very interesting. You said tax rate is not necessarily revenue, but the exemptions you also explained are not necessarily promoting equity or progressivity of a tax system. But tax exemptions, you know, we all the time hear demands for tax exemptions, probably uninformed opinions.
And politicians are also always very keen to be seen as giving tax exemptions. So, for instance, a few years ago, we saw corporate tax relief being provided. And I don't know how effective it has been because we have all heard the finance minister herself say very often that I have given corporate tax relief and yet I'm not seeing private investments coming in response to that relief that I gave.
I know that by talking about corporate taxes, I'm now moving from indirect taxes to direct taxes. So, what is the story over there? Do tax exemptions or relief cuts, rate cuts also not work in direct taxes?
Arbind Modi: Good point. See, the same story again. Do exemptions help in general?
Let me put it this way. Why only about GST? Even under corporate income tax, exemptions do not work.
And this is not one country, this is every country here. I mean, country after country after country. I work in several countries.
The problem is the same. Exemptions, exemptions, exemptions. And standard recommendation of all multilateral agencies is please do away with these exemptions.
They are inefficient. They don't serve your cause. They don't bring in investment.
I mean, there's no second opinion anymore. I mean, it's a well-accepted point that exemptions don't help. Now, I must give credit to this government that they successfully eliminated all exemptions in 2017, corporate exemptions, for which, unfortunately, neither they take credit nor anybody's writing about it.
But I think the press should be more generous. They should write that this is something that was a very difficult decision, and yet they took it. So, they need to be complimented for that.
But after that, of course, small, small exemptions have crept in. I mean, a lower rate for startups, etc. That is something which we should have avoided.
Despite that, you said investments have not picked up. The finance minister is likely worried that investments have not picked up. We are doing a study on that.
We are still in that process. And maybe by the middle of September or end of September, you will see us releasing those findings at some point. I'll just give you the gist that while the tax rates have come down, we also, and we studied for 60 years, while the tax rates have come down, the depreciation rates and investment allowance, etc., they have also steadily come down. So, as a result of that, the marginal effective tax rate, which is important for taking an investment decision, has increased over time because of inflation. It hasn't decreased. And hopefully, we will have the opportunity to present it to the FM and show that this is what has happened, that therefore it is not picking up.
And that is further compounded by blocking input tax credit under GST. If you have to ask me what is the tax story on investment, then this is the tax story on investment.
Puja Mehra: And all along the focus has been on the cost of credit. But it is probably the tax story that is responsible for the...
Arbind Modi: You see, tax is not the only element which determines investment. There are many other criteria. There are several studies on this.
But all other things being equal, tax becomes an important element. At the end of the day, what happens is if you put a tax on investment, then the IRR is affected, right? And if that is affected, then to that extent, the projects at the margin will get out of the financial feasibility space.
And you have only projects with high returns. Now, when you have projects with only high returns, then it means resource-based projects, which takes you to crony capitalism. Again, you're dependent on the government, etc.
to allocate resources. You know, you will have telecom projects, which will give you high returns, you will have all resource-based projects. Now, that is why because that part is going up, you see that small and medium industries getting affected, because they work in a non-rent space.
So they tend to be... And their answer is, avoid, evade taxes, don't report your sales, don't report full profits to make up for all of that. So if we clean up that, you will see more medium industries coming up.
And you will see better compliance also.
Puja Mehra: And massive compliance.
Arbind Modi: Yeah, because they already work in a competitive environment. So this is the story on the CIT. But exemptions are bad.
I won't recommend that we should go back to the pre-2017 era, where we had a lot of exemptions. So compliments to this government for having done that hard work. And now they should not go back.
We should clean up. We should actually, if you are really looking at investment incentives, we should introduce full expensing. That will completely eliminate the implicit tax on investment.
A full expense here would mean 100% depreciation on all capital goods. Simple. In the year in which you install, you get 100%.
So your recovery, because of inflation, you don't have any under-recovery, you get it instantly. So that's the only way to address that issue.
Puja Mehra: And earlier this year, since we are talking about direct taxes, earlier this year, significant income tax relief was also provided. The Finance Minister said that tax officials were not very keen that this relief should be given. They were in fact quite reluctant and it took her some convincing, especially because the Prime Minister, she said, had said that he wanted honest taxpayers to be rewarded.
And that's how this relief finally went through. Was this a good decision?
Arbind Modi: Intellectually, I don't agree with that decision. Because our thresholds were already very high compared to the rest of the world. We were operating at about 500,000 rupees, I mean 5 lakh, which itself was about two times your per capita income.
Most other countries would have about half of per capita income or even less than that. Now, what has happened is by increasing it to 12 lakhs, you've increased almost in this country. If people with almost four times their per capita income don't want to pay income tax, then there is a serious problem.
And more so, because if you're looking at revenue raising and you want to resort to GST, which is regressive, and at the same time, you don't want to do this, then there is a problem. In fact, we should have lower rates under GST, collect revenues, and then the inequality part is to be dealt with in the income tax. So, you have a reasonable threshold, but not of the kind that has been proposed.
And there's another implication, which I think could have been avoided with a little more deeper thinking on the subject. That is, that there was a time when we started off with what, 25% of the centre's revenue being devolved to the states. Gradually, we inched to 32%, up to the 13th Finance Commission, and then 42% under the 14th.
And then the 15th also reiterated that. And we're continuing on what will happen on the 16th, we still have to wait and see. Now, with 42 means you almost have an equal share.
Almost. Right?
Puja Mehra: Actually, sir, the effective share, if I remember correctly, is somewhere close to 30%, because the centre also has CESS, which they don't share.
Arbind Modi: That's a separate issue. But at the margin, you are still sharing 42%. Every additional tax which you collect, you share 42% with the states.
So, if you lose PIT, this is not CES, if you lose PIT, states lose 42%. Now, states lose a regular source of income. And to compensate for that, the finance minister has allowed them extra half percent borrowing, which means I lose revenue, and I pile up more debt.
I mean, so that is a little awkward for most states. So, I wish that had not been, and if they can reverse it going forward, that would be ideal. And you see at 12, again, the way they have structured it, that if you cross 12, it's about 1275, or I mean, they've given some relief, but essentially meaning that you start off from 5.
So, as a result, there is what we call it in the tax literature, notch effect, which means people will all bunch below the 12. Because as they cross the 12, it's a huge deal. Although you say that we stagger it is 1275, it doesn't work out that way.
Even at 1275, 1210, 1220, the incremental liability is almost 100%. So, it isn't really 100%. I think it's 50% or 100%.
I think it's 100%. So, that is another sticking point on the design issue. Hopefully, let's hope that they reverse that, because correcting this 12 lakhs is going to be very difficult.
Puja Mehra: Politically, I think it might be very difficult to revisit it now. But we've spoken about GST, corporate tax and income tax. On the whole, what tax reforms do you think are needed for 8% GDP growth?
And at this point in time, it is also very important because of what is happening in the US and what President Donald Trump is doing, where trade internationally is changing, probably global supply chains will be refashioned. And this is an opportunity that has opened up for India once again. We have missed several opportunities in the past.
But this is an opportunity that has opened up all over again for us to better integrate our economy into global supply chains. Now, if you're saying that the way the GST is currently operating, it puts Indian manufacturing at a disadvantage vis-a-vis global competition, then GST as well as other taxation in corporate tax, etc. What reforms do we need so that we don't miss the bus this time, at least on the tax part, we are able to take advantage of this refashioning of global supply chains that may happen?
As it is, we are at a disadvantage on the tariff front, the US is sticking to a 50% tariff on Indian exports.
Arbind Modi: See, it's very difficult for me to say what measures you should take, a comprehensive set of measures for 8% growth. But I know if you do your tax reform correctly, in the right manner, both across taxes, surely, it will improve the efficiency of the economy. And to that extent, you will have record higher growth.
Now, I'll give you some ballpark numbers from the literature. Let's say I gave you that number on GST. I'm just starting again with GST. On GST, if you improve the C efficiency from 0.4, or 44%, as we call it, by one percentage point for every one percentage point increase, it is estimated that GDP would go up by 0.19%. And there's also well documented in the literature, that if you had a single rate with a very broad base, you could increase your C efficiency by anything between 5 to 10 percentage points. So we are looking at something rising from 44 to 55 or something like that at the top. OECD countries on an average achieve about 0.6. So you have the potential of going there. New Zealand, if you compare, I said 0.9, I mean, 0.9 or 90, over 90% consistently. Now, suppose you went from 0.44% to 55%, based on empirical estimates, your GDP can go up by two percentage points. I mean, I'm just giving you a ballpark.
Of course, many other factors will impact. But I'm just giving you how far you can go. If you are at 6.5% or 7%, then clearly that 1% can be achieved if you improve your tax system, as far as estimates in the literature is concerned. So it's not impossible to do it. It's possible. The only thing is we need to know what we want, what needs to be done.
One of the advantages of the GST Council was, or is, I would, when we conceptualised it, it was completely depoliticised, because everybody was part of it. That's how we looked at it. That a body which will have all political parties effectively, because some political party or the other will be ruling some state or the other.
So effectively, everybody is represented there. And it would be a collective decision. So in a sense, nobody can blame the other party, because you have all collectively done it.
And nobody can run away with the credit, because you've all endorsed the right decision and the wrong decisions. But unfortunately, what has happened is you've seen that it has worked more in terms of doing the wrong things, rather than the right things. So somewhere, I think what is important is that the intellectual input that goes into the briefing of the ministers must be sharpened and improved.
Because only then can they make a better decision. I mean, there's no point in blaming the ministers sitting there, because they are not technical people, right? If somebody goes and tells the Prime Minister that, sir, your point is well taken, the poor must be protected, but this is another way of doing it.
I'm sure he will sit down and say, yes, let's think about it.
Puja Mehra: That is what I hear. I hear from bureaucrats that it's not like he's closed to inputs. It's just that people often don't speak their mind.
Arbind Modi: Yeah, so that's it. And the other problem within the bureaucracy is we always try to second-guess the political master. Oh, sir, it won't be politically acceptable.
But why are you second-guessing? Let the minister decide whether it is acceptable to him or not. And they will surprise you.
I worked in tax policy from 1987 onwards, when I first got posted there. In 30 years, I have never seen a good proposal being shot down. Whoever, across finance ministers, across finance ministers, not just one or two, across finance ministers, if you've gone with a good package, sometimes they may say that, okay, this is a good proposal, we'll time it, maybe six months down the road.
That, of course, you have to accommodate them. But by and large, after all, whatever has happened, they took the decision, right? Whatever good things happened in the tax system, it was they who took the decision.
It was not the bureaucrat who took the decision. So there is room for that. Even with GST, if the right advice is placed before them, or the right options are placed before them, I'm sure they will make the right decision.
I'm very optimistic about that.
Puja Mehra: I wish they would invite you to do a presentation before the GST Council.
Arbind Modi: Well, I'll be happy to do that. But that will not happen. Unfortunately, it's become very closed.
Even on this, the present discussion that is going on, I wish they publish a white paper and let the GOM have open discussion. Like a standing committee, let us let people go and present. I mean, then they will know what is here.
Maybe then somebody, I'll be happy to go and do it. But otherwise, it's not possible. How do you reach out to them?
I mean, there's no way you can reach out.
Puja Mehra: No, it can only be on invitation.
Arbind Modi: If there is a public hearing, then somebody can write, we can write to them and say that we would like to come and make a presentation. But today there is no such occasion. That's another problem.
Well, there's a lot to be done on the exercise also. It's getting neglected. And I'm surprised that we are talking of sin goods in GST. Sin goods taxation is part of exercise. Why are we cluttering up the GST with sin good and high rates? You want to do that, go ahead and do it in exercise. You can double your excise in petroleum, I don't care.
But take it out of GST. GST is not meant for that. And even compensation, you do a separate tax and give the compensation. After all, what do you need for compensation?
Revenues. If you do it as part of exercise also, you will get your revenues. You make compensation cess a part of exercise.
Why are the states not willing to levy compensation cess on alcohol? Why only on one or two products? Let's ask that question.
The whole idea is that we should impose a tax on the tax base, right? Now part of the base is with you. Part of the base is within the centre.
Petroleum is with the centre. Most states, almost all states are under taxing alcohol. So why are they not doing their own bit rather than depending only on the centre?
I mean, this is not to defend the centre, but that base is with them. That base is not within the centre. That base is not being shared.
Similarly, the petroleum excise. Petroleum excise is below the level it ought to be based on the cost of negative externalities. So I think much more needs to be done there.
Declutter the GST, move that part to your excise and just have a single rate. And if you moderate the rate from single rate from 18% to 12, 11, 13 or 14, that will really give a boost to the consumption, to production rather than having this multiple structure. For example, gold.
This is another point which should be flagged. GST on gold, I mean, jewellery is highly under taxed. World over, the principle is very simple.
Bullion is treated as an investment. Jewellery is treated as a consumption. The consumption is taxed at the standard rate of VAT or GST. If it is 12%, 12%, if it is 20%, 20%, 17%, 17%. And bullion is exempted because it is an investment, we don't want to tax industry or savings as you call it, whatever. But what are we doing? We are even exempting the consumption.
Puja Mehra: But sir, I know the politician's logic and this runs across party lines. What they say is that in India, even the poor consume gold jewellery because it is given to women at the time of marriage and it is the only asset that women own, especially in the vulnerable or the low income bracket. And therefore, to suddenly put such a high rate GST tax will be politically absolutely suicidal.
You may recall that in the 2024 Lok Sabha election campaign, there was this whole conversation that was going on about what happens to women's jewellery. It was said that the Congress Party's manifesto is saying that they will go for women's jewellery, which was not there in the manifesto, but that is what was said. And on the other hand, the Congress Party's campaign or such as Priyanka Gandhi, were saying in villages, they were saying to women that inflation has gone up a lot.
The price of, if you have a wedding in the family, buying jewellery has become impossible. Of course, globally, gold prices are going up, but that tells you what she was saying, tells you what it would be, what it would do to the political narrative if a GST was to be put on gold jewellery.
Arbind Modi: Okay. Okay. Let me respond to that.
First part, that's the only asset that the woman owns, right? That's exactly what we are exempting. We are saying, don't make jewellery.
It's a bad idea. You're losing money on jewellery.
Puja Mehra: So that did not happen. Women get jewellery at the time of weddings.
Arbind Modi: That is the message all over the world. Women are always very possessive about their jewellery. This is not just because the cultural sensitivity is not unique to India.
It is all over. I mean, if you go to any part of the world, women think the same way that we should have jewellery. There is a big jewellery market.
When you tax, you are only discouraging them. And if you levy 25-30%, yes, I can understand. But if your general rate is going to come down to 10-12%, and even today you are levying that amount of tax, but you're levying it as custom duty.
And you're levying 3% on that. So domestic trade is completely at a low rate of 3%. And you are encouraging the woman and they are not actually ending up saving because when they buy that, let us say it is 1 lakh, when they go to sell that, they get only 90,000.
So you have to educate them. It is the responsibility of the government to educate them that look, you own gold. We are not saying that you should not own gold.
We're only making a point that keep it in bullion, you will get your increased value whenever you want to encash it. And that will be zero tax. Not even custom, I'm not even suggesting you want to levy some small custom duty, you can levy, but it's not required.
But if you consume, which means you don't care about your value, it's the alloy part also. People don't see that. Your jeweller tells you that I have 5% alloy I have, but when you go to resell it, you find that it is 15% or 20%.
And at the village level, it's much more. Actually, it's an unfair treatment. By not educating, you are actually killing the poor.
You're even taking away part of their savings. They are holding that as part of their savings. And at times they wear it also.
But when they actually go to encash it, they get less than what they had invested. You forget the making charge. Even with the gold component, they are surprised that it contains less gold than what they were told earlier.
And there is no check. Everybody doesn't buy from goldsmiths. They are all buying from informal goldsmiths.
There is no guarantee, there is no buyback, nothing. And you are losing revenue. And what is the extent of revenue?
Only on the domestic trade, you are losing about 1 lakh crore. You can use that to reduce your general rate. And that same poor will have greater savings to buy gold again, if she wants to.
Today, she's paying 18% on that, nothing on gold. Gold she buys once in two years or something. Whereas all other times throughout her life, she's paying tax at 18%.
Puja Mehra: Makes sense. No, no, no, sir. I was just saying because I think it is a very emotional issue. And I would be surprised if politicians were to bite the bullet on this.
Arbind Modi: No, that is why the GST council is the best place. Because everybody is in it. It is not that X party will run away with it or will take a year.
So, you can say that if they disagree, you say that they didn't vote for it. They also voted for the levy. But you will do a great service to the poor if you actually reform this taxation and educate the poor that hold bullion, don't buy jewellery.
Buy some minimal whatever you want to. And these days, you know it. People have moved to artificial jewellery.
So, when that is coming up, why do you want people to hold gold jewellery? Let them hold bullion. They'll be better off.
They'll be better off.
Puja Mehra: Thank you, sir. It's been a long conversation that has lasted for more than an hour.
Arbind Modi: Yeah. Thank you.
Puja Mehra: Thanks.
