Prime Minister Narendra Modi came to power in 2014, promising to focus on development and cement India's position as an economic power.
As the country's parliament meets, hopes are high that lawmakers will finally pass a reform that may prove to be one of the most meaningful achievements of his leadership.
The implementation of a national Goods and Services Tax (GST) would not only bolster investor confidence in Asia's third-largest economy, it would also strengthen Modi's image as a reform-minded leader amid criticism that he hasn't done enough during his two-year reign. The tax reform has been pending for a decade.
India's current system consists of 15 types of taxes, including central excise and states' value added tax (VAT). The model's sheer complexity has scared off many businesses and investors--the World Bank noted that tax compliance actually became more difficult this year, compared to 2015--underlining the need for a single, unified structure.
"The impetus to move towards GST stems from the inadequacies of the present system and the need for a taxation system which is economically efficient, neutral in its implication, simple to administer, encourages voluntary compliance and, most importantly, integrates India to a single common market," Morgan Stanley economists explained in a report.
Overcoming political tensions
Following the bill's passage in the lower house last year, approval is now needed in the upper house. Should that go through, state assemblies will then be asked to vote independently and at least 50 percent approval is required before GST can be fully implemented by Modi's target date of April 1, 2017, Goldman Sachs explained in a recent note.
In order to ensure successful passage in parliament before the current session ends on August 12, Modi's administration has been reaching out to opposition parties to build consensus.
"The ruling government does not enjoy a majority in the upper house and has reached out to key opposition parties and state governments for support. Some are on board, subject to concessions. Near-term positive sentiment could falter if the bill is stalled yet again, delaying its implementation beyond 2017," commented DBS economist Radhika Rao.
State governments have long opposed GST adoption as it would mean their share in the pool of tax revenues would shrink to 53 percent, from around 68 percent, while the central government's share would rise to 47 percent, versus 32 percent currently, Rao added.
There's still a healthy chance that Modi's team could emerge victorious.
"With recent changes and retirement schedules, the number of members opposing the bill has come down to 80 (versus 91 in February). This implies that if all the members of the upper house are present and voting and 82 members oppose it, technically, the GST could be passed with all the remaining members supporting the bill," Morgan Stanley noted.
Benefits
Economic growth and public finances are expected to spike following the GST's implementation.
"The overall impact of better allocation of resources, improving efficiency of domestic production and exports is likely to improve overall growth. As per estimates from the National Council of Applied Economic Research (NCAER), growth could increase by 0.9 to 1.7 percent," Morgan Stanley said.
As for price pressures, investors needn't worry about a return to double-digit consumer price inflation (CPI).
"A bottom-up analysis of CPI components suggests that the implementation of GST would not be inflationary if the standard rate were to be 18 percent," said Goldman Sachs. "In addition, high-tax items such as petroleum, alcohol and tobacco are also not included in the GST."
So far, the government has yet to confirm whether GST would consist of a single rate, or a tiered system.