“Taxes are the Sinews of the State.” —Cicero
So far in India, right from suppliers of raw materials, manufacturers, wholesalers, retailers and ultimately consumers—all are made to pay indirect taxes to the Centre and States. For instance, the manufacturer pays tax to the Central Government, on the supplies made to wholesalers in different States. Manufactures add the tax component to price and charge accordingly from wholesalers. Wholesalers repeat the same procedures when they sell it to retailers and lastly retailers by paying taxes to the government sell goods to consumers.
The retail price includes taxes. Thus, it is leading to the compounding of taxes in the chain—that links manufactures and the ultimate consumers. The Goods and Services Tax (GST) Bill intends to put an end to this system, simplifying by making the ultimate consumer or purchaser to pay tax. The 13th Finance Commission, headed by Vijay Kelker (2010), was entrusted with the task of facilitating the transition from the prevailing system of indirect taxation to the GST. When all taxes are abolished and in their place the GST is implemented, it is feared that revenue both at the Central as well as State level may go down. Any such loss in revenue would not only adversely affect the States’ finances directly as well as indirectly, as their share in Central revenues would also go down; for such an eventuality the Finance Commission has made a provision of Rs 50,000 crores.1
As a result of the proposed new tax system, big States like Uttar Pradesh and Bihar with large populations where consumption is high (destination States) would derive huge tax revenue (GST). That is why these States are not opposing the GST Bill in its original form. As opposed to this, States where the production activity is based (origin States)—Maharashtra, Gujarat and Tamilnadu—fear that more tax revenue would accrue to States which buy their products. However, the Union Government allayed their fears by way of compensation by working out a formula: the quantum of compensation to be paid to the States in case the revenue generated by GST falls short of what they have so far been earning through the existing tax system. In December, 2015 the Central Government cleared an amendment by which States will get full compensation for five years. Regarding the one per cent additional levy by the origin States (manufacturing States), the government adopted a more circumspect route, exempting stock transfers within group companies from the additional tax on inter-State supplies, but keeping the overall tax in place.
On the whole the controversy on the GST Bill pinpointed the loopholes in the existing tax structure which leads to tax on tax in the chain of raw material supplies—manufacturer to final consumer. Multiple taxes imposed by different States and the Central Government not only increase product prices but also give enormous scope for tax evasion. Though India is endowed with a cheap labour force and the manufacturing capacity developed to produce a good variety of items for export purposes, multiple taxes at different stages prevent Indian companies from competing in the export market on account of the higher tax-induced prices.
In addition, to avoid Central taxes on inter-State trade transaction, several leading companies have to maintain 25 to 30 warehouses/cold storages. In advanced countries, this number is between eight-to-10. For acquisition of land, for the construction of warehouses and creating storage facilities, each Indian manufacturer spends huge amounts.
To move wares from one place to another destination there are many problems. Truck drivers, who are instrumental in the movement of goods across States on highways, have to cross 600-700 check-posts. By the end of 2014 the road transport sector supported the movement of 60 per cent of goods by paying 11 types of taxes to governments at different levels. It involves loss of time, money, and valuable fuel. Most importantly, the productivity and efficiency of drivers is on the declining side. In this context, it is argued, by reducing the number of warehouses the GST would help fast movement of goods thereby contributing to productivity in the economy.
Taxes merging with GST
• Services Tax
• Central Excise
• Additional Customs Duty (Counterveiling Customs Duty CVD)
• Special Additional Customs Duty (SAD)
• Central Surcharges, CESS
• State VAT
• Sales Tax
• Luxury Tax
• Lottery and Betting Taxes
• Taxes on Commercial Advertisement
What is GST?
Since all the above taxes are merged in the GST, for all practical purposes it is considered as a major indirect tax. The GST, in principle, is the same as the Value-Added Tax (VAT) already adopted by all Indian States but with a wider base. While the VAT—which replaced the Sales Tax—was imposed only on goods, the GST will be a VAT on goods and services. In the present tax regime, States tax sale of goods but not services. The Centre taxes manufacturing and services but not wholesale/retail trade. In the proposed dispensation, the GST would comprise equal Central GST (CGST) and State GST (SGST), with no deviations from the rates/exemption limits, so as to clear away potential ‘rate wars’ between States. The Report of the Rajya Sabha Select Committee allows States the freedom to impose the SGST within a ‘band of rates’ in order to meet revenue expediencie or as a policy tool. Recent reports also contemplate a three-tier rate structure instead of two. The Centre will administer Central GST (CGST) and the States the SGST. Compliance will be monitored indepen-dently at the two levels.
As per the provision in the Constitution, the Centre can impose taxes on production and services. States can levy taxes on sale of goods but not services. Similarly, the Central Government has no power to tax sales. States cannot tax imports. To empower the Centre to tax sales and States to levy service and import duties, an amendment to the Constitution is necessitated. Accordingly, the GST Bill, the Constitution (122 Amendment) Bill, 2014, was passed in the Lok Sabha in May 2014. The same is expected to be taken up by the Rajya Sabha in the current Budget session (2016).
The main argument put forward in favour of the GST is that the GST, by encompassing an array of indirect taxes under one canopy, simplifies the tax administration, improves compliance and eliminates economic distortions in production, trade and consumption. In addition, by giving input credit for taxes paid on inputs at every stage of the supply chain and taxing only the final consumer, it avoids the ‘cascading’ of taxes, thereby cutting the production cost, and making exports more competitive.2
The producer gets input credit on taxes paid to raw material suppliers. He does not have to pay GST on exportable goods. However, he has to pay taxes on imports. The GST is expected promote exports from 3.2 to 6.3 per cent and imports from 2.4 per cent to 4.7 per cent. According to the Finance Ministry, these efficiencies generated by the GST are likely to add two per cent to the GDP. Consequently, revenues of the government would increase resulting in a cut in the current account deficit. In principle, the GST is designed to usher in a single national market. One of the major deviations from the GST is that sale of liquor, petroleum and tobacco products are excluded from purview of the GST. All over the world, nearly 160 countries moved to the GST-type structure.
The merger of many Central and States’ taxes, extension of input credit facility may result in the loss of a certain amount of revenue to both the Centre and States. To protect tax revenue hither-to accruing to the Centre and States, the issue of the GST rate arises. That rate is termed as the Revenue-Neutral Rate. The 13th Finance Commission’s Task Force on GST recommended 12 per cent—seven per cent State GST and five per cent Central GST. That was in 2010. In 2014, a panel of State Government representatives mooted Revenue-Neutral Rate (RNR) of 27 per cent (12.77 per cent CGST and 13.91 SGST). Revenue-Neutral Rate is the rate at which tax revenues for the Centre and States will remain the same as before the introduction of the GST.
Both rates might be unrealistic. A 12 per cent GST will definitely mean substantial revenue loss for States, as the general VAT for many States is 13-14 per cent. In June 2015, the Centre hiked the service tax from 12.36 to 14 per cent, perhaps with an intention to move to a GST regime. On the other hand, 27 per cent GST would impose an enormous tax burden on the wage-earning classes. Any populist government would not dare to purchase unpopularity.
The panel on the new tax regime, headed by Chief Economic adviser Arvind Subramaniam (December 2015), has suggested Revenue-Neutral Rate of GST around 15.0 per cent to 15.5 per cent which is much lower than the rates suggested by earlier committees. This is likely to be accepted by the governments (Centre and States). The capping of GST is not preposterous, it is in line with global standards, which is 16 per cent. In China the GST rate is 17 per cent, eight per cent in Japan and Australia 10 per cent. So 15-15.5 per cent is not unreasonable if India is to be globally competitive. Another aspect relating to the GST rate is that, as it is not mandatory, the clause relating to the GST rate need not be appended to Constitutional Amendment (2016).
According to the GST Bill (actually Constitution 122nd Amendment Bill), 2014, passed in the Lok Sabha, India will have not a single federal GST but a dual GST, levied and managed by different administrations. The GST, even in the diluted version proposed in the GST Bill, can still accomplish revenue compliance, provided the tax base is widened making it identical for both the Centre and States. In other words, the GST like all indirect taxes is a tax on consumption; when there is uniformity of GST rates on all types of goods and services, it tightens the tax net in addition to widening it. Many countries that have moved to the GST regime have kept lower rates for select goods that include essential commodities. In some cases essential commodities are exempt from the GST purview. But the logic of GST is such that the economy is benefited when exemptions are minimum or near zero. Any deviation from the original framework of GST may gravitate towards fewer exemptions and higher rates.3
A Critique of GST
The existing tax system has typically followed a model of rewarding States where production activity is based (origin States), as opposed to States where consumption is high (destination States). Accordingly, most States have incenti-vised the establishment of local industries in order to drive growth and augment tax collections.4 However, the present origin-base tax is anathema to the GST, which is by nature a destination-based consumption tax. While origin States may chalk out measures to redress the imbalance, the consumption and production patterns will not alter overnight, and industrialised States could be left in the lurch, at least in the immediate aftermath of the GST. Interestingly, there seems to be no globally available precedent which offers a solution to such an imbalance.5 With the move to introduce GST in India destination States, such as Uttar Pradesh, Bihar and Kerala, clearly stand to gain in terms of revenue, while origin States, such as Maharashtra, Gujarat and Tamil Nadu, stand to lose.
As per the GST Bill, all issues concerning rates, exemptions and the like are to be decided by the GST Council (of which the Centre and States are members) by consensus, which may prove elusive given the federal and revenue dynamics at play. Equally questionable is the voting pattern within the GST Council, with the Centre’s vote carrying a one-third weightage of the total votes cast, and the States’ votes a collective two-thirds weightage. In effect, each State, irrespective of size, representation and contribution to the GDP, will command an equal vote, a structure which works against the very basic spirit of representative democracy enshrined in the Constitution. Also, this type of voting system opens up the Council to greater manoeuvring by the Centre on issues that it seeks to pass or veto.
According to the panel on the new tax regime, suggestions to impose a revenue-neutral rate of GST around 15 to 15.5 per cent would put the economy on a higher growth trajectory by encouraging production. But it should be noted that with the implementation of GST, although the export sector is exempted from the GST, most of the exemptions being granted to the small scale sector would be automatically withdrawn and worst hit by the implementation of GST would be particularly small enterprises, small traders etc.6 The GST is vital for the simplification of the tax system and will eliminate corruption to a large extent. There is dispute among States over the threshold level above which the goods and services tax (GST) should be applicable. It is ironical that the States are disputing whether the threshold should be Rs 25 lakhs or Rs 10 lakhs. The States supporting the Rs 25 lakh level say Rs 10 lakhs would put the small and medium industries and traders at the mercy of the Inspector Raj. There is merit in this. But those wanting the threshold at Rs 10 lakhs feel that it will add to their tax kitty. Perhaps the latter need to be convinced they will get enough revenue if the tax collection is efficient and transparent.7
The GST is to replace all other taxes, like sales tax, excise duty and VAT. This would enable the seller to bring down prices and pass on the benefit to the consumer. There is no reason why retailers and manufacturers would not want to pass on the benefits as it would increase their volumes. This, in turn, means more revenue for the government and eventually higher GDP growth. Estimates show that for the Indian economy, implementation of GST is expected to add between one-and-a-half to two per cent to the GDP growth, which is why it is important for retailers and manufacturers to pass on the benefits to the consumers. It is for the governments to see that this happens. Services, however, would be two to three per cent more expensive, according these estimates.8 The fine print will reveal which services would be exempt, etc. It is interesting that the panel of new tax regime (December 2015) has recommended 40 per cent tax on the so-called sin goods, like tobacco, aerated drinks and luxury goods. In the case of those services that enjoyed taxes between two to six per cent, the panel suggested a 12 per cent tax rate.9
Unlike the existing system, which has greater scope for manual intervention, the GST aims to achieve a singular digitised compliance set-up. The proposed GST will also be far more dependent on IT. The proposed IT infrastructure will have to be suitably equipped, as any snags would effectively render the levy dysfunctional.
Till three decades ago, many economies followed the policy of higher corporate taxes and lower indirect taxes with many exemptions. However, faced with declining tax revenues and integration of world capital markets, many emerging countries in the world turned to indirect taxes. Fearing a further hike in corporate taxes might lead to capital flight, they started slashing corporate taxes. Besides, indirect taxes like VAT (now GST) have a wider base than direct tax and are more difficult to evade.
The lower income groups spend a greater proportion of their income on items of essential consumption compared to the richer classes. Indirect taxes, which are regressive in nature, adversely affect their consumption basket, when all indirect taxes are merged in the GST. The BJP-led NDA Government seems to have diluted the ‘welfare’ ideal of the Indian mixed economy. The 2015-16 Budget fixed a roll-out date for the GST (April 2016). The Budget abolished the wealth tax. Though the corporate tax was kept 30 per cent, there was a promise to reduce it to 25 per cent in a phased manner by 2019-20. In the Budget there is an estimated Rs 20,000 crore exemptions and incentives per year to the corporate world, that is, a total of Rs 80,000 crore tax exemptions granted over a period of four years. There is a proposal to reduce direct taxes levied on the higher income groups to the tune of Rs 8315 crores. There’s a steep increase in indirect taxes that would cause a heavy burden on the lower and middle income groups to the extent of Rs 23,383 crores.10 According to a study (2013) by the Centre for Budget and Governance Accountability, India’s direct taxes contribute only 37.7 per cent of the total tax revenue, whereas in other emerging markets, such as South Africa, direct taxes fetch 55.85 per cent and in Indonesia, 55.85 per cent. When the GST is adopted in the Indian federation, the taxation regime will become more regressive.
Only time will tell whether the GST will have a positive impact on the GDP. But one thing the GST will not have: a positive impact on the States’ fiscal, and therefore fiscal-federalism.