A sustainable paradigm for growth.

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How high rates of indirect taxes hamper consumption in India

In short, the death of Washington consensus -- especially that of export driven growth model - is yet to be formally announced one has surely to think of life after that. As usual, the government of India is yet to recognise this tectonic shift in global economics. In the early 90's it was a standard slogan -- export or perish.

Now it may not be as yet to announce export and perish, yet it seems that globally export driven economies are having a revisit of the fundamental assumptions governing their economy and notably on the export driven economic model. Consequently, internal demand and domestic consumption are fast emerging as the engine of growth and development.

All these mean that this changing paradigm calls for a re-look at domestic markets by exporters in particular and business in general. Crucially, to aid domestic consumption, the government too has to play its part.

One factor that inhibits domestic consumption is the high incidence of indirect taxes -- we end up paying 16% to central government and another 12.5% as VAT to state governments aggregating to approximately 30% or one fourth of retail prices. This is one of the highest in the world. Obviously indirect tax reforms are crucial to boost domestic consumption.

Pointing out to such high incidence of indirect taxes on the final retail prices the report of the National Manufacturing Competitiveness Council states in its report on the National strategy for manufacturing "Domestic indirect taxes are often singled out as a major reason why Indian manufacturing is non competitive. For instance, many studies argue that total taxes on manufactured goods are 25 to 30% of the retail price in India, compared to 15% in China. Indirect taxes contribute 50% to the difference in retail prices between India and other low-cost countries. Lower duties would also boost the domestic market and permit synergy (exploitation of economies of scale, attracting FDI) between domestic and export markets. Therefore, there is a case for reduction of domestic indirect taxes both from the point of boosting domestic demand as well as improving export competitiveness."

This is the only way to lower inflation in India, boost consumption and in turn ensure a consumption driven manufacturing boom in India.

PS: Given the fact that export-driven growth model is fraught with extreme risks caused due to a multiplicity of factors, a revisit to Swadeshi economics -- of encouraging savings within a country, converting such fiscal savings into physical savings by providing appropriate investment climate, ensuring appropriate returns for such investments within a particular country through stable laws and lower taxes and ensuring that the domestic consumers are benefited -- is inevitable.

The author is a Chennai-based Chartered Accountant. Comments are welcome at mrv1000.