By Dr Martin Patrick, Chief Economist
Describing the Goods and Services Tax (GST) as "a monumental tax reform", the Finance Minister of India, Arun Jaitley argues that the implementation of GST will help to add two per cent to the national GDP. He said it will benefit all segments of business, increase tax base and reduce harassment of tax payers. On the other hand, Goldman Sachs has put out estimates which show that the Modi Government’s model for the GST will not raise growth, will push up consumer prices inflation and may not result in increased tax revenue collections. What is the reality?
What is GST?
GST is nothing but a hybrid version of the Value Added Tax (VAT), modified to suit the complexities of a federal system. The central taxes do not cover value addition in goods beyond the manufacturing stage, and in services only listed services are covered. On the other hand, in the case of state taxes, only sale of goods is covered. GST rectifies this defect by covering all goods and services. It is essentially a tax only on value addition at each stage, permitting a supplier at each stage to set-off, through a tax credit mechanism. The final consumer will bear only the GST charged by the last dealer in the supply chain, with set-off benefits at all the previous stages. GST is the latest in the category of indirect tax reform.
India is working towards the introduction of a comprehensive GST covering both the Centre and the States. It combines about 16 types of taxes such as Central excise and service tax, States’ VAT, entertainment and luxury tax, and various surcharges into a single tax. The unified GST was announced in the budget speech of 2006-07 to the effect that GST would be introduced with effect from April 1, 2010. It has been further extended to April 1, 2012. Now the government is eyeing GST roll out from April 2016.Still there is no certainty that it will be implemented from this date.
Rationale & Key features
Two-fold rationale has been put forward for this proposed reform: First is to expand the tax base available for taxation for each level of government and the second is to reduce cascading effect prevalent within the economy.
There are certain key features of the proposed plan of the Goods and Services Tax for the Indian economy, approved by the Government of India and Empowered Committee of State Finance Ministers. Firstly, there are two components in GST : one levied by the Centre (‘Central GST’), and the other levied by the States (‘State GST’), rates for which would be prescribed appropriately, reflecting revenue considerations and acceptability. This is called dual GST.
Secondly, the administration of the Central GST to the Centre and for State GST to the States would be given. The government has made certain amendments in the proposed Bill .The first one is that it seeks to establish a GST Council tasked with optimising tax collection for goods and services by the State and Centre. The Council will consist of the Union Finance Minister (as Chairman), the Union Minister of State in charge of revenue or Finance, and the Minister in charge of Finance or Taxation or any other, nominated by each State government. The setting up of Councils would imply a reduction in unhealthy competition among the centre and the states over tax revenue that was prevalent earlier and an increase in harmonious functioning between them.
Thirdly, the Central GST and the State GST would be applicable to all transactions of goods and services made for a consideration except the exempted goods and services, goods which are outside the purview of GST. Fourthly, it has decided to adopt a two-rate structure - a lower rate for necessary items and goods of basic importance and a standard rate for goods in general. There will also be a special rate for precious metals and a list of exempted items. Fifthly, the GST will be levied on import of goods and services into the country.
Sixthly, when the supply of goods and services is between States, as an inter-state transaction, a levy called Integrated Goods and Services Tax (IGST) would be levied by the centre. IGST revenues will be shared between the Centre and State as per the recommendations of the GST Council. The Centre will levy an additional one per cent tax on the supply of goods in the course of inter-State trade, which will go to the States for two years or till when the GST Council decides. Parliament can decide on compensating States for up to a five-year period if States incur losses due to implementation of GST.
Eighthly, alcoholic liquor for human consumption is exempted from GST. Also, it will be up to the GST Council to decide when GST would be levied on various categories of fuel, including crude oil and petrol. The proposed design for GST however keeps crude petroleum, natural gas, some petroleum products, and electricity outside the purview of GST (The Empowered Committee of State Finance Ministers, 2009).
Further, GST would be capable of being levied on sale of newspapers and advertisements therein. This would give the governments the access to substantial incremental revenues since this industry has historically been tax free in its entirety.
Pros and Cons
Evaluating GST at this juncture is a difficult affair. A uniform rate of tax throughout the country is a welcome step from point of view of “doing business” in India. No doubt it removes the cascading effect of tax burden except those items like petrol exempted from the GST.
Bringing all the goods into the GST regime, without any other changes in the economy, would imply that GST has to be levied at higher rates for revenues to be protected. Introducing GST at higher rates would make the reform more difficult to implement.
Positive impact on growth is often cited as major argument in favour of GST. In fact there are two opinions regarding this. While one group suggests that it leads to growth, others object it. National Council of Applied Economic Research (NCAER) estimated in 2009 that India’s growth would be increased by 0.9 to 1.7 percentage point based on an outdated 2003-04 input –output table. The situation has changed a lot now as it has excluded many items like petroleum, alcohol, electricity and real estate. Goldman Sachs estimates that the GST would add only about zero to half a percentage point to the growth if the current proposals are accepted. The major defect is that it affects the federal autonomy of the States in the country. Leading economists like Prabhat Patnaik highlights this aspect. The political right to fix its own tax rates by the States will be lost after the implementation of GST.
The introduction of additional one per cent inter-state tax is against the spirit of moving to a harmonized GST. All these will ultimately lead to increase in prices. According to Goldman Sacs report, the GST would lead to a percentage point increase in consumer price inflation if it is fixed at 20 per cent. The possibility is that it would be above 20 per cent. If so, what would be the impact on retail inflation?
There are two unsettled issues in respect of the introduction of GST in India. First is the determination of right tax rate and the second is the threshold limit. Finding out a right GST rate is the major hurdle as there have been a number of attempts at estimating the size of the tax base and the corresponding revenue neutral rate (RNR). The estimated revenue neutral rate (RNR) is within the realm of reasonable and feasible, especially when compared to the present rates of tax which are considered as the benchmark. “Very high rates” of tax will not encourage compliance. The Kelkar Committee Report had proposed a figure of 20 per cent, and this has become one benchmark for what constitutes limits of an acceptable rate. The report of the Task Force on GST of the Thirteenth Finance Commission recommended 12 per cent (7 % SGST and 5 % CGST) in 2010. This is unrealistic because the average tax rate of various states is 13 to 14 per cent and hence it will lead to revenue losses to the states. The latest in the series is the recommendation made by a panel of state government representatives which suggested RNR of 27 per cent (12.77 % CGST and 13.91 SGST). Most of these exercises throw up incredibly low or high revenue neutral rates causing apprehension about the validity of these estimates and consequent revenue risk. Now a new committee is working to determine the right RNR. Whatever be the chosen rates, would all the states and the central government get “adequate” revenue? Here adequate has meant equivalent to that from replacing the existing taxes levied by the states. Now the confrontation is centered on 18 and 25 per cent.
The threshold limit is cited as another hurdle. It is almost agreed that traders with a turnover of less than Rs 10 lakh a year need not have to register for or pay the GST. However, Punjab demanded Rs 25 lakh as threshold limit while Haryana suggested for Rs 20 lakh limit. Rest of other states including Maharashtra and Karnataka were seeking lower threshold limit of Rs 10 lakh.
Given the multiple objectives of reducing cascading, keeping a check on prices and protecting revenues, how far GST will be effective and successful? There is no consensus regarding this aspect. When we analyse the positive correlation between growth and GST, there is no cross country evidence to substantiate this. Moreover, there is every chance that the inflation will be mounted up as in the case Nigeria and Malaysia where the introduction of GST witnessed price rises. In India, services sector account for nearly 60 per cent of GDP and it is expected that GST will be above the existing 14 per cent tax in the service sector leading to steeper increase in prices of services so that consumer spending will be affected adversely. Asian countries which implemented GST all had witnessed retail inflation in the year of implementation. No doubt, GST will simplify existing indirect tax system and will help to remove inefficiencies created by the existing current heterogeneous taxation system. Is it necessary at the expense of federal autonomy in the midst of a gloomy picture about contributing it to growth?
* The Author is Chief Economist at CPPR. Views are personal