Unifying India: Towards a Common Market

“India that is Bharat shall be a union of states,” proclaims the very first Article of the Indian Constitution. Our founding fathers envisaged India to be not just a political, but also an economic union. The freedom to move freely throughout India, to reside and settle in any part of India and to carry out any profession, trade, occupation or business are guaranteed as fundamental rights under the Constitution.

These have acted as the foundation for a unified labour market, allowing people to gravitate from relatively poorer, labour surplus areas to more prosperous parts of the country that provide greater job opportunities. The freedom to “reside and settle” facilitates the free movement of capital, as people can freely invest in houses and commercial establishments in any part of the country. With free movement of trade, capital and labour all guaranteed as fundamental rights, our constitutional structure effectively paved the way for the creation of a subcontinent-sized free trade zone.

 The fundamental right of trade and business is buttressed by Part XIII of the Constitution, whose guiding principle is that “trade, commerce and intercourse throughout the territory of India shall be free.” Part XIII further strengthens the architecture of free trade by first, prohibiting both the Parliament and the state legislatures from enacting laws that discriminate between states in matters relating to trade and commerce and secondly, authorising the Parliament to create an authority to facilitate the promotion of free trade and commerce across India.

The importance of the trade and commerce provisions can be gauged from the Constituent Assembly debates during the drafting of the Constitution. When these were debated, Dr. Babasaheb Ambedkar argued “there would be no use and no purpose served in forming an all-India union if trade and commerce throughout India was not free.” A framework where wheat harvested in Punjab, cars manufactured in Tamil Nadu and Banarasi saris woven in eastern Uttar Pradesh are available unhindered across the length and breadth of the country was central to the vision of a strong and unified Republic.

 The right to freedom of trade and commerce is, of course, not absolute. The Constitution allows the Parliament and state legislatures to impose reasonable restrictions on trade and commerce in public interest, with the additional caveat that no restriction can be imposed by a state legislature without the prior sanction of the President. Given the nature of Indian federalism and the need for states to raise their own revenues, state legislatures are also permitted to impose taxes as long as they do not discriminate between goods produced within the state and outside of it.

 Recognising the importance of freedom of trade and commerce to the constitutional framework, Indian courts have made stellar efforts to limit the scope of these exceptions. In Atiabari Tea Co. v. State of Assam (AIR 1961 SC 232), the seminal judgment on this issue delivered by a constitution bench of the Supreme Court, Justice Gajendragadkar, speaking for a majority opined that:

“the free movement and exchange of goods throughout the territory of India is essential for the economy of the nation…and enshrines a principle of paramount importance that the economic unity of the country will provide the main sustaining force for the stability and progress of the political and cultural unity of the country.”

The court adopted a test whereby restrictions which “operate directly or immediately on trade or its movement” would be violative of the freedom of trade and commerce. In Automobile Transport Ltd. v. State of Rajasthan (AIR 1962 SC 1406), the Supreme Court further elaborated on this test and held that states could only impose regulatory measures and compensatory taxes for the use of trading facilities that did not hamper trade or commerce. These foundational principles have guided subsequent decisions of the courts on this issue. By setting these precedents, Indian courts have followed courts in countries such as Australia and the United States; other common law based federal polities that have also acted as a bulwark against legislative encroachment on the freedom of trade and commerce.

 Despite the checks imposed by the judiciary, the exceptions have gradually chipped away at the general rule positing free trade and commerce. The exigencies of generating revenue at the state level and the nature of India’s federal arrangement has led to a variety of taxes and regulations being imposed at the state level, in addition to central taxes and regulations. Indirect taxes, in particular, are a key source of revenue for both the centre and the states, but these have also become the single biggest impediment to free trade.

 India’s indirect taxation system, which is a patchwork of multiple central and state taxes, affects the freedom of trade and commerce in three major ways.

First, multilayered taxes have a cascading effect on the costs of goods and services by imposing “taxes on taxes.” For example, excise duty may be payable on a product that is manufactured. The same product, when it crosses the producing state’s borders may be subject to the central sales tax and may also be further liable to sales tax in the state where it is consumed. The value added tax regime introduced in 2005 has not been able to fully resolve this problem.

Secondly, the complexity created by multiple taxes and exemptions under the current framework leads to massive compliance and litigation costs for firms.

Finally, the indirect tax regime adds to logistical bottlenecks in the form of customs inefficiencies and state border check-post clearances. While the impact of cascading taxes and compliance costs are well understood and documented, the effects of logistical bottlenecks are often underappreciated. According to the World Bank’s latest India Development Update, manufacturing firms incur relatively higher costs in logistics compared to areas such as power and labour, with trucks spending a quarter of their journey at check posts and negotiating other regulatory stoppages. Simply cutting the delays would add an estimated 3-4 percent of net sales for key manufacturing sectors.

 The single most important reform would be an overhaul of the indirect tax system by having a nationwide Goods and Services Tax (GST). A properly implemented GST regime would do away with multiple compliance requirements, eliminate cascading taxes and reduce logistical bottlenecks, adding an estimated 0.9 to 1.7 percent to the nation’s gross domestic product.

The proposed constitutional amendment to facilitate GST is therefore not only constitutionally sound as it removes barriers to freedom of trade, but also economically logical. The centre should certainly honour our federal arrangement by adequately compensating states for any revenue forgone as a result of GST. At the same time, the states should be mindful that supporting the amendment is a constitutional duty in the national interest.

 While the GST remains the single most important reform, there are several other bottlenecks that need to be removed to create a truly single market. Encouragingly, the government is considering setting up a constitutional authority to work towards eliminating internal barriers to trade, an idea that was endorsed by both the Sarkaria Commission and the National Commission to Review the Working of the Constitution.

 The multiple layers of regulations, taxes and red tape created over the past 67 years are like self-inflicted wounds, distorting the constitutional principle of a unified market and preventing the country from reaping its obvious economic benefits. They have led Onno Ruhl, the World Bank’s India director to remark, “India actually has an opportunity to conclude a free-trade agreement with itself.” That is a sentiment with which the architects of our Constitution would have readily concurred.

Featured Image,Photo Credit: simplydecoded