The age of GST dawns
As the most important indirect tax reform since 1947, it will create a single market and push competitiveness. It represents a historic political consensus, but there are potential implementation problems.
The introduction of a unified goods and services tax (GST)
across the nation is the most important indirect tax reform since
Independence. It has taken almost 16 years from the date of inception of
the idea, formation of a task force, to passage in Parliament. It
represents a Herculean, nationwide, multi-party consensus-building
exercise which is finally bearing fruit.
The upside of GST
It has huge implications. First, it addresses a serious impediment to our competitiveness. Without the GST, there are multiple points of taxation, and multiple jurisdictions. We also have an imperfect system of offsetting credits on taxes paid on inputs, leading to higher costs. Further there is cascading of taxes — that is, tax on tax. Interstate commerce has been hampered due to the dead-weight burden on Central sales tax and entry taxes, which have no offsets. All this will go once the GST is in place. It will enhance the ease of doing business, and make our producers more competitive against imports.
It has huge implications. First, it addresses a serious impediment to our competitiveness. Without the GST, there are multiple points of taxation, and multiple jurisdictions. We also have an imperfect system of offsetting credits on taxes paid on inputs, leading to higher costs. Further there is cascading of taxes — that is, tax on tax. Interstate commerce has been hampered due to the dead-weight burden on Central sales tax and entry taxes, which have no offsets. All this will go once the GST is in place. It will enhance the ease of doing business, and make our producers more competitive against imports.
Second, the adoption of the GST is an iconic example of what Prime
Minister Narendra Modi has called “cooperative federalism”. It
represents a national consensus, an outcome of a grand bargain struck
together by 29 States and seven Union Territories with the Central
government. The States agreed to give up their right to impose sales tax
on goods (VAT), and the Centre gave up its right to impose excise and
services tax. In exchange they will each get a share of the unified GST
collected nationally. The anticipated additional gains in efficiency,
competitiveness and overall tax collections are what drove this bargain.
Third, once the GST is in place, it means a unified, un-fragmented
national market for goods and services, accessible to the smallest
entrepreneur. Companies need not maintain stock depots to avoid paying
interstate taxes. This will free up some capital. All this will add to
demand, and also efficiency. The National Council for Applied Economic
Research and others have estimated that national GDP growth can go up by
one percentage point on a sustained basis.
Fourth, because the structure of claiming input tax credit is linked to
having proof of taxes paid at an earlier stage in the value chain, this
creates interlocking incentives for compliance between vendor and
customer. No more questions from a vendor: “Would you like that with
receipt or without receipt?” Because of this inherent incentive, the
total taxes paid, and hence collected, may go up significantly. This
provides buoyancy to the GST. In fact, a significant part of the black
economy will enter the tax-paid economy.
The potential downside
All of this constitutes the upside of adopting the GST. Its roll-out represents a rare and historic political consensus. But that should not blind us to its potential downside, or the devil lurking in the details of its implementation. Here are some issues to consider.
All of this constitutes the upside of adopting the GST. Its roll-out represents a rare and historic political consensus. But that should not blind us to its potential downside, or the devil lurking in the details of its implementation. Here are some issues to consider.
First is the question of the uniform GST rate. What should it be? An
early report of the Finance Ministry from 2003 mentioned a rate of 12
per cent. Over the years this rate drifted higher, and the focal number
being discussed now is 18 per cent. What determines this number?
The empowered committee of finance ministers uses a concept called
“Revenue Neutral Rate” or RNR. The RNR is that uniform rate which when
applied will leave all States with the same revenue as before. So no
State should lose out by signing up to the GST. But this approach is
faulty, since unless we try it for a year (or more) we won’t be able to
gauge the buoyancy of the GST. In trying to assuage the fears of States,
the calculation of the RNR has been loaded by every possible existing
tax (like entry tax, octroi, etc.). This has caused the RNR to steadily
escalate upward. At one point, the National Institute of Public Finance
and Policy mentioned 26 per cent. The higher the RNR (and hence GST
rate), the more is its inflationary impact. This is a sure way of
killing the golden egg-laying goose. A better approach is to keep the
GST rate low initially, and promise to fully reimburse losing States by
the end of the year. Everyone may be in for a pleasant surprise by GST
buoyancy. But this tax buoyancy will stop working beyond a certain
threshold (like say 18 or 20 per cent). The focus on the RNR is
self-defeating.
Taxation and litigation
The second issue is that the GST is an indirect tax. By their very nature, indirect taxes are regressive because they affect the poor more than the rich. India’s ratio of indirect to direct tax collection is 65:35, which is exactly the opposite of the norm in most developed countries. India’s ratio of direct tax to GDP is one of the lowest in the world, and it badly needs to expand the direct tax net. Only 4 per cent of India pays income tax, but practically all Indians pay indirect taxes in one form or the other. Direct tax rates have been falling, and indirect tax rates rising. For instance, service tax (an indirect tax) used to be 5 per cent in the 1990s and is now more than 15 per cent. The Swachh Bharat cess, or frequent increase in excise duty on petrol and diesel are all recent examples of regressive indirect tax. Unless a rate cap is adopted, the GST rate could easily drift higher, further hurting India’s income inequality. To meet their fiscal needs, it is always tempting for governments to tweak indirect taxes higher, since the work of expanding the direct tax net is so much harder. This temptation must be curbed with a rate cap.
The second issue is that the GST is an indirect tax. By their very nature, indirect taxes are regressive because they affect the poor more than the rich. India’s ratio of indirect to direct tax collection is 65:35, which is exactly the opposite of the norm in most developed countries. India’s ratio of direct tax to GDP is one of the lowest in the world, and it badly needs to expand the direct tax net. Only 4 per cent of India pays income tax, but practically all Indians pay indirect taxes in one form or the other. Direct tax rates have been falling, and indirect tax rates rising. For instance, service tax (an indirect tax) used to be 5 per cent in the 1990s and is now more than 15 per cent. The Swachh Bharat cess, or frequent increase in excise duty on petrol and diesel are all recent examples of regressive indirect tax. Unless a rate cap is adopted, the GST rate could easily drift higher, further hurting India’s income inequality. To meet their fiscal needs, it is always tempting for governments to tweak indirect taxes higher, since the work of expanding the direct tax net is so much harder. This temptation must be curbed with a rate cap.
The third issue is of tax litigation. Approximately Rs.1.5 lakh crore is
stuck in litigation related to Central excise and service taxes. On the
other hand the State-level VAT is administered in a way that empowers
tax officials to dispose of cases quickly. Disputes involving Central
taxes go though an appeal and tribunal process, and can drag on for
years. But empowered staff under the Sales Tax Commissioner can dispose
of valid grievances of State-level VAT payers much faster. This
difference is called the “review” versus “revise” approach to tax
disputes. It is important that the GST approach leans towards the more
efficient State-level model.
State of the States
The fourth issue in implementing the GST is the governance within the GST Council. It is a de facto council of States, along with representatives from the Union Finance Ministry. It seems that one State will get one vote, irrespective of its size. This seems unfair. An economically larger State, contributing a bigger chunk of the GST pie, should have a greater say. Similarly, the special needs of smaller States should also be heeded. For instance, the Northeast States had to be assuaged already with a lower threshold for GST exemption, because if a higher (uniform) threshold were adopted nationally, then nearly all businesses of the Northeast would become tax-exempt.
The fourth issue in implementing the GST is the governance within the GST Council. It is a de facto council of States, along with representatives from the Union Finance Ministry. It seems that one State will get one vote, irrespective of its size. This seems unfair. An economically larger State, contributing a bigger chunk of the GST pie, should have a greater say. Similarly, the special needs of smaller States should also be heeded. For instance, the Northeast States had to be assuaged already with a lower threshold for GST exemption, because if a higher (uniform) threshold were adopted nationally, then nearly all businesses of the Northeast would become tax-exempt.
Finally, the issue of States’ autonomy. India will be a unique large
democracy that adopts a nationwide GST, with virtually no taxing powers
to the States. In the United States, the States have power to impose
sales and income taxes. Within the European Union (EU), each member
country retains fiscal autonomy, and also the freedom to breach the
fiscal deficit of 3 per cent of GDP. Indeed virtually all members of the
EU have breached that limit. In India, what if a State wants to
undertake a special spending programme to respond to a State-specific
situation, such as a disaster? In 1982, the Chief Minister of Tamil Nadu
upgraded a midday meal scheme which his opponents criticised as being
an empty promise and fiscally reckless. In response he raised taxes on
goods (not possible in a GST regime), and made the programme so
successful that it is praised to this day, not just in India but also
around the world. It achieved the double objective of better nutrition
for children and better school attendance. Similarly in the drought
crisis year of 1972, the Maharashtra government imposed a profession tax
on city dwellers (not possible under the GST) to fund an innovative
programme called the rural “Employment Guarantee Scheme (EGS)”, which
three decades later was acknowledged nationally as the inspiration
behind the National Rural Employment Guarantee Act. The GST regime
should remain sympathetic to this issue of States’ fiscal autonomy. We
have not even mentioned here what happens to the third tier, i.e. local
bodies.
The GST is obviously not a panacea for all ills of India’s economy. It
is nevertheless a revolutionary and long-pending reform. It promises
economic growth and jobs, better efficiency and ease of doing business,
and higher tax collection. We hope that its imperfections and potential
pitfalls will be sorted out as we roll it out.
No comments:
Post a Comment