GST and Tax Competition

In the last post on GST, Adithya Reddy highlighted
some speeches by members of the Constituent Assembly. Two of those are
germane to our present discussion. One is by Mr. Mahavir Tyagi: “Because there
is no ceiling limit on this sales tax, they can go on raising the tax …My point
is that if we do not fix a limit, the provincial Governments would go on taxing”.
The other is by Mr. Ramaswamy Mudaliar, who said: “as
far as possible, it (sales tax) should be uniform… in all the provinces. You
will be killing the goose if you go on increasing the sales tax”.
These statements are puzzling. If certain
taxes are left to the states, one would expect taxes to be driven down, due to
constant competition among the different states to attract investment. One explanation
would be the closed nature of the economy at the time – states did not have to strongly
compete with lower taxes to attract private firms.
Under the proposed GST regime, the indirect
tax rate(s) will be set by one central authority, the GST Council comprising of
the finance ministers of the Union and the States. The GST Council does have
any internal competitive pressures to anchor the tax rate. As this
piece by Prashant Perumal argues, this centralisation is (theoretically) likely
to lead to higher tax rates.
tax competition is ‘good’ or not, is a subject of debate amongst economists and
policymakers. Tax competition leads to a race towards the bottom, with
governments forced to cut taxes for wealthy investors (especially corporate
taxes) whilst compromising on subsidies and redistribution (Vivek Dehejia’s piece
presents a brief overview of this debate). This has led to calls for
cooperation among governments to limit the harmful effects of such competition.
For instance, member states of the EU (a monetary union with each member state
having independent fiscal policy) have agreed to a ‘Code of Conduct’ for business
taxation. The agreement acknowledges both the positive and negative effects of
tax competition, and aims to restrict the latter through cooperation and collaboration.
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