The equity-complexity tradeoff in tax policy: lessons from the Goods and Services Tax in India

Developing countries often rely on consumption taxes, because these are broad, easy to administer, and harder to evade. However, the taxation system becomes inherently regressive. To counter this problem of regressive nature of consumption taxes, there is a temptation among policymakers to address equity concerns through a multiplicity of rates, making the consumption tax system complex. Here, complexity is considered the by-product, or companion to pursuing goals of equity. Complex tax systems, however, pose a different problem relating to equity. Assuming a minimum fixed cost of compliance imposed by a complex tax system, smaller firms and individuals face a much higher cost of compliance relative to larger firms and richer individuals. Oligarchic sectors dominated by a few large firms also find it easier to organize and lobby to get favorable rates compared to competitive sectors with small firms. Though complexity is considered a byproduct of several equity-enhancing measures, the Indian experience with its Goods and Services Tax reform serves as a cautionary tale and demonstrates the opposite, that there is a tradeoff between equity and complexity.