Goods and services tax in India
Feasible options for the implementation of the GST in April 2016.
The introduction of the goods and services tax (GST) involving the unification and rationalisation of multiple production and consumption taxes at the Union and State levels, into a unified value added taxes on goods and services (GST) at Union and State levels, has been on the reform agenda for considerable period of time. The reform is considered to be extremely important to improve the ease of doing business and enhance productivity in the economy. The Union Finance Minister has termed it as a “game changer” and a “the reform of the century”.
However, the introduction of GST is like a bullock cart stuck in the mud. It has missed repeated deadlines. The latest one set by the Union Finance Minister is to introduce the tax in April 2016 and with the inability to pass the 122nd Constitution Amendment Bill, it would be difficult to see the introduction of GST by April 2016. The Bill, after being passed in the Lok Sabha was referred to the Select Committee of Rajya Sabha, but could not be passed in the Monsoon session of the Parliament.
Admittedly, the proposed GST in the Bill even after the incorporating the recommendations of the Select Committee, has significant shortcomings. Furthermore, the entire structure of the tax and its implementation details will have to be finalised by the GST council, and compromises from the ideal structure are unavoidable. In this context, the important questions are: One, To what extent the GST reform will be a game changer considering the infirmities implicit in amendment bill and the compromises likely to be reached between the Union and States and among the states themselves on the other? Two, What is the structure of the dual GST that is likely to emerge in terms of the thresholds and tax rates? Three, Can the reform be carried through for its final implementation by April 2016 or is it better to plan for its implementation after proper preparedness in a more accommodating time frame? Four, If indeed, the full-fledged GST takes longer time, is there a middle ground where the Union government can reform its own tax system which will be a significant move towards the adoption of GST and which will provide the necessary confidence for the switchover to full-fledged GST in the next year?
GST reform: A game changer?
GST is an important component in any modern tax system in most countries in the world with the major exception of the United States of America. In fact, few fiscal innovations in the 20th Century have had such a pervasive influence on the countries’ fiscal arsenal as the GST (Bird and Gendron, 2007). The promise of greater revenue productivity and neutrality in resource allocation has led to over 140 countries in the world to adopt one form of VAT or another and the discussion of reform is gaining ground even in the United States, the last bastion which has resisted its imposition thus far. Over the last 60 years since VAT was first introduced, there have been several lessons learnt, innovations made and different variants of the levy implemented depending upon not merely best practices but also political acceptability. Needless to add, except for 5 countries which repealed the tax after its imposition, all others found it worthwhile to continue with the tax.
The most important argument for GST is its neutrality. Relieving the taxes on inputs removes cascading from the tax and as tax credit has to be taken at every stage of transaction, there is an implicit incentive to comply with the tax due to an element of self-enforcement. For this reason, the tax is considered to be a money spinner (Keen, 2007). Properly structured, the GST is expected to improve the competitiveness of the reform by relieving all input taxes on exports. Efficiency gains are reasoned to accrue from the seamless trade the reform promises to achieve. All these are expected to result in productivity gains to the economy.
Expectations of the gains from GST in India have been far too optimistic. The gains arising from lower distortions due to broader base, lower and less differentiated rates, benefits of seamless trade across the country, greater export competitiveness due to comprehensive relief of domestic taxes on exports, and lower administrative and compliance costs are seen as the gains. The Finance Minister has stated that this is the single most important tax reform of the century and has stated that the growth rate of the economy will accelerate by 1.4 per cent on account of this. Writing on the issue the President of CII has asserted that the acceleration in the growth of the economy will be 1.5 per cent. The academic support for this comes from the NCAER study done for the 13th Finance Commission in which, the reform has estimated to accelerate the growth rate of the economy ranging from 0.9 to 1.7 percentage points and the gain in exports will be between 3.2 to 6.3 per cent.
The study assumed that the GST will be flawless and comprehensive and based its estimate of gains on the 2003-04 input-output table. Unfortunately, the GST that will emerge will be far from being flawless as it will be based on a number of compromises. Furthermore, productivity gains based on 2003-04 input – output table does not take account of subsequent developments enhancing efficiency including the application of new technology in economic activity and replacement of cascading type sales tax with a number of rates with a harmonised VAT on goods by the States in 2005.
In international practice, it is difficult to find examples of flawless GST. In most countries GST is essentially a Central tax. The subnational GST experience is available only in Canada, European Union and Brazil, which may be characterised as the “good, the bad and the ugly”. Canadian system is the best we have seen among the countries levying GST at subnational level and even there, the province of Alberta does not levy the tax at all and Quebec collects both provincial and federal GST and passes on the latter to the federal government. In European Union, despite the need to adhere to the Sixth Directive all the countries except Denmark have two tax rates or more and in most, the standard practice to have two rates. Furthermore, in these countries the standard rate varies from 15 to 25 per cent and the mean standard rate works out to 19.5 per cent. In Brazil, it is a combination of origin based and destination based system with multiple rates and the singular lesson from its experience is that it is not a model to follow.
In India, with a number of players with varying perspectives and diverse economies involved in the negotiations to levy the GST, compromise is unavoidable. Therefore, pursuing flawless GST is a mirage, but nevertheless, it is important to get the basics of the reform right. As already mentioned, the GST Bill has some basic shortcomings. Surely, GST is an important reform for improving productivity of Indian economy and revenues, but the extent of gains will depend upon the structure and operational details of the levy that will eventually emerge. The Constitution amendment Bill, even after taking into account the recommendations of the select committee has some serious defects which will undermine the gains. It is neither comprehensive nor flawless. The exclusion of electricity, real estate, petroleum products and alcohol will render the tax base narrower add to cascading and adversely impact on the competitiveness of domestic businesses. Retaining one per cent tax on interest sale of goods and services contributes to inefficiency through cascading and balkanising the market. In fact, it would have been better for the Constitution amendment bill to leave out these infirmities and provide a broad framework for the levy leaving out the details for the GST Council to decide.
Even if the GST council decides to leave out the above sectors in their respective acts, these could have been included over time without having to go through the Constitution amendment route. Leaving out electricity and petroleum products from GST will deny input tax credit in transportation services. Not including real estate transaction in the tax base, besides creating an imperfect input tax credit mechanism in the construction sector, will deny the government important information from audit trail of these transactions that could help to contain the generation of black money in the sector. Even in the case of ‘sin taxes’ like alcohol and tobacco products, the input tax credit will be denied even when they are used in pharmaceutical and other products as inputs. Indeed, inclusion of these in GST does not mean that they will suffer lower tax rates. Human consumption of alcohol and tobacco products will have to be subjected to additional sumptuary excises.
As mentioned above, the Constitution Amendment Bill leaves the structure and operational details entirely to the GST Council. This implies that the entire gamut of issues relating to the structure and operation of the levy has to be negotiated and decided upon by the GST Council. These include the taxes to be subsumed, the list of goods and services to be exempted, thresholds for CGST and SGST, the structure of rates, place of supply rules, special arrangement for special category states, harmonised tax laws and date of including the tax on petroleum products alcohol and tobacco products, operational details of tax administration including GST Network and dates for discontinuing the tax on inter-state sale of goods and services.
In each of the matters, the interests of the Union and States differ and the interests of the producing states differ from those of the consuming states. Take for example, the determination of the threshold for CGST. The States would not like the Union government to reduce the threshold from the present level of Rs. 1.5 crore because, that would impact on the smaller producers and traders who have not been paying the tax so far and the being closer to them, the States would not like to burden them. On the other hand, retaining the threshold at the prevailing level would not help to broaden the base of the tax. Similarly, the imposition of service tax on small traders would have to be avoided from the viewpoint of the States as that will be an additional tax in the new arrangement, but the prevailing threshold is Rs. 10 lacs. The important issue to note is, the GST that will eventually emerge out of compromises will have a number of infirmities.
There has been considerable debate on the structure of rates of the proposed GST. The Constitution Amendment Bill has left the issue to be settled by the GST Council. The Council will have to consider the revenue neutral rate of tax estimated by an expert body. However, the report of the Select Committee has suggested that the rate should not exceed per cent. The note of dissent of the Congress party members of the Select Committee has also suggested that the rate should not exceed 18 per cent.
The NIPFP made a series of estimates based on the prowess data base of 2011-12 and by making assumptions about the possible revenue collections from the informal sector. The alternative estimates were based on the inclusion or otherwise of entry tax in GST and taking into account the revenues from central sales tax at 4 per cent and 2 per cent. Some relevant estimates are summarised in Table 1. The important point to note is that when the States levy the tax at one rate the Revenue Neutral Rate (RNR) is 10.3 per cent when the CST revenue is taken at 4 per cent but declines to 8.9 per cent when CST revenue is taken at 2 per cent. Since the single rate RNR for the Union government is 9.6 per cent, the combined GST rate works out to 19.9 per cent and 18.3 per cent in the two cases. When the SGST is levied at two rates with the lower rate fixed at 5 per cent ad RNR is estimated taking 4 per cent CST into account, the general rate works out to 13.9 per cent. The general rate works out to 11.4 per cent when CST revenue is assumed at 2 per cent. As regards CGST is concerned, when the essential consumption items are taxed at 5 per cent, the standard rate works out to 12.2 per cent. Thus, the combined incidence on essential items of consumption will be 10 per cent (5 per cent SGST and 5 percent CGST) and the standard rate will be 26.5 per cent when CST is taken at 4 per cent 24.6 per cent when it is taken at 2 per cent.
The above relates to the average of the States and there are significant inter-state variations in the RNR. The range in the single rate is from 6 per cent to 12 per cent for a single rate when CST is taken at 4 per cent and 5.8 to 10.2 per cent when CST at 2 per cent is taken. The variations in the standard rate when two rates are considered are from 6 per cent to 18 per cent in the first case and 5.8 per cent to 14.2 per cent in the second case (Table 1). The important question is, when the nominal rates of tax are broadly identical why should there be such a large difference in RNRs. The explanation lies in the differences in administrative efficiency, and perhaps, variations in the extent of unorganised economy. This shows that taking average rates need not necessarily result in large revenue losses even when we switch over to the destination based GST from the prevailing partially origin based levy.
Before concluding discussion on the rate structure, it is important to emphasise an important factor. So long as it is decided to levy the tax at two rates both in CGST and SGST, it will be difficult to see the standard rate relating to RNR at less than 25 per cent. It is here that the Union government will have to take leadership to assure a combined rate of less than 20 per cent. This could mean that if the compliance of the tax does not increase, the Union government may have to earmark substantial funds for compensating the states for revenue loss. In contrast, if the reform is properly calibrated and the tax is placed on an efficient information technology platform, the compensation amount may not be large and both the Union and the States may gain substantially. In fact, it is possible that if the technology platform of GST is harmonised with that of Income tax, there can be a significant increase in income tax. We may actually see the tax – GDP ratios rising significantly as was seen in the direct taxes during the period 2003-04 to 2007-08 when the tax information network was put in place in a phased manner.
The GST reform agenda has been on the table for quite some time. The proposal for the reform was first announced by the Union Finance Minister in his 2005-06 budget speech. In the 2007-08 budget speech, the Finance Minister stated that the reform will be implemented from April 2010. The 115th Constitutional (Amendment) Bill, 2011, for the introduction of GST was introduced in the Lok Sabha in March 2011 was referred to a Parliamentary Standing Committee (PSC) which submitted its report in August 2013. The Bill however lapsed with the dissolution of the 15th Lok Sabha. The Union Finance Minister in the 2015-16 budget speech has announced that the GST will be implemented from April 2016.
The time frame and the art of feasible
However, there are questions about the feasibility of introducing the tax by April 2016. First, 122nd Constitution Amendment Bill, after revisions in the light of the recommendations by the select Committee of Rajya Sabha has to be passed by both Lok Sabha and Rajya Sabha by two-third majority. With the present Logjam continuing in the Parliament, passing the Bill is doubtful, particularly in the Rajya Sabha where the government does not even have a majority. Once this is passed in the Parliament, this has to be endorsed by one half of the states before the amendment comes into effect. Thereafter, both the Parliament and each of the State legislatures will have to pass the respective acts and rules relating to the implementation of GST.
Apart from the Constitutional and legislative tasks, there is considerable work that has to precede the introduction of GST. The GST Council is required to finalise decisions on the exemption list, thresholds for SGST and CGST, mechanism to deal with inter-state transactions, application of place of supply rules relating to the apportionment of revenue from inter-state transactions in services, special provisions for the special category states, harmonised forms and procedures across states, administrative arrangements, treatment of dealers with small turnovers, dispute resolution mechanisms, technology platform, capacity building of tax administration, information and publicity and education of taxpayers on GST and creation of an effective taxpayer service. It is doubtful whether all these can be accomplished within the next eight months. It must also be noted that half-baked reform is more harmful and therefore, it is advisable to tread the ground carefully.
Politically, while continuing the efforts to implement the reform, it may be worthwhile for the government to take a via media of merging the Union Excise Duty with the Service tax to introduce the GST at the manufacturing stage. This can be achieved by working out a common threshold for excise duty and service tax, rationalise the excise duty by converting all the rates into ad valorem, converge and unify the rates into two – one for items of common consumption and a standard rate which will be applied on services as well and provide input tax credit for goods against services and vice versa. This will transform the prevailing Central domestic indirect taxes into a GST at the manufacturing stage. Of course, on sumptuary items like cigarettes, in addition to the GST, the government can levy a separate excise duty. This, in fact, was the recommendation of the Expert Group in taxation of services in 2001 and can be carried out by the Union government without going through the Constitutional amendment (India, 2001). Implementation of this reform will also demonstrate the seriousness of the government in bringing about reform and also help in the eventual introduction of full-fledged GST. This reform can be accomplished in April 2016 and the Finance minister can claim that under the circumstances and constraints placed on him, he has tried to bring about the reform in Central indirect taxes.
The reform of domestic trade taxes to evolve a destination based GST is important from the viewpoint of improving business climate, improving tax compliance and long term revenue productivity and improving the productivity of the economy. However, it is important to keep in view four important issues. First, given that India suffers from the tyranny of status quo and given the numbers of actors involved, it would be too much to expect to transform the existing indirect taxes into a ‘flawless’ GST. It would be useful to approach the reform as a process rather than as an event. In other words, it is necessary to introduce reforms and improve it upon rather than trying the get the ideal system in place. Second, as arriving at consensus on the basic parameters of the reform reform entails a number of compromises, while considering that it is an important reform, it is important keep pour expectations on the gains from reform at a realistic level. Burdening the reform with overly optimistic expectations to consider it to be a “game changer” and the “reform of the century”, could lead to disappointments later. Third, it would be inappropriate to rush through to introduce the reform in April 2016, without adequate preparations. A lot of work needs to be done to get the basics of the reform correct. Fourth, inability to accomplish the reform by April 2016, should not deter the Union government from unifying its own indirect taxes to evolve a GST at the manufacturing stage.
Photo: Phillip Ingham
Dr M Govinda Rao is an economist and a member of the 14th Finance Commission. He is an advisor at the Takshashila Institution.