Era of a Good, Sensible Tax dawns

In This World nothing is certain but death and taxes -Benjamin Franklin

Since 1990s, with the globalisation of economies, all the leading countries started rationalising their tax structure both direct and indirect tax components. The Government of India started making efforts since 2010 with Kelkar Committee taking up this task. The impact of the radical changes is the emerging of a new (indirect) tax system i.e., Goods and Services Tax (GST) which is expected to radically alter the economic history in the post-Planning Commission era.

For the last six decades, the Indian tax system has become a maze with multiple taxes with different rates in various states making the economic system more rigid, stalling promotion of manufacturing and trade both internal and external. The casualty of the present regime is fluctuations in growth rates, low employment creation and deviations in standards of living among various sections as well as regions. A kind of ‘Centre’-‘Periphery’ Socio-Economic System emerged after 1970s.

With the adoption of GST from July 1, 2017, the destination states (where there is more consumption) are going to be benefited in the long term; at the same time tax neutrality will protect revenue of the originating states (states which produce goods and services for internal needs and exports). In other words, GST is radical tax reform expected to bring in qualitative changes in both production methods, and consumption benefiting both consumers and producers the off-shoot of the changeover is increase in job potential.

According to various studies conducted between 1995-2005, the intra-state trade is resulting in 8-10 per cent additional expenditure, leading to this ultimate burden falling on individual consumers. For transit of goods which meet various needs of individuals, a truck in USA, on an average covers 800 km distance; while in India, it is in between 280 km and 325 km. This is because of tax variance, and toll tax and octroi system. Now with the adoption of GST, almost all octroi check posts will be closed. Consequently, trade will be conducted at a faster rate without any hustles resulting in increase in overall productivity in the economy.

The prevailing impression outside India among investors is that India’s tax system is highly complex, giving scope for corrupt practices. For achieving overall higher standards, India has to reduce excess work force dependence on rural sector. For this, India has to achieve higher levels of industrialisation, particularly in manufacturing sector – major, medium and small scale sectors; and also pave way for efficient services sector. For this, apart from monetary instruments, an efficient indirect tax regime is an essential condition. It is hoped that GST would fill in this vacuum.

Currently, the proportion of tax revenue in India’s GDP is around 18-20 per cent only, while this percentage is as high as 30-32 per cent in highly industralised countries. Many activities hitherto not covered in manufacturing, trade and services sector are going to be covered by GST. It is anticipated that the adoption of GST will substantially enhance tax revenue of Centre and State governments, which is expected to speed up productive and relevant welfare activities. And also the quality of provision of public goods and merit goods essential for public will improve.

The ideal of co-operative federalism can easily be realised with a proper GST regime, as it reduces frictions among States and also between Centre and States in sharing public revenue (tax revenue) in a more optimum manner. Except alcohol products, GST will cover all goods and organised services. On petroleum, diesel, crude oil, turbine fuel and natural gas, the GST Council (comprising Centre and State representatives) is going to decide the application of GST, from future date acceptable to all parties.

The GST Council is the final authority to change and modify GST rates on various goods and services. The current rates slabs are 5, 12, 18 and 28 per cent. GST is applicable to all manufacturing goods and service providers whose annual turnover exceeds Rs 20 lakh. In the case of States enjoying Special Category Status, the limit is Rs 10 lakh.

What is GST?

For all practical purposes, GST is considered as a major indirect tax. The GST, in principle, is same as the value-added tax (VAT 2005 April) 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 earlier tax regime, state tax sale of goods but not services. The Centre taxes manufacturing and services but not wholesale/ retail trade.

Now in the new dispensation, the GST would comprise equal Central GST (CGST) and State GST (SGST) and also IGST (Integrated GST, for Intra-State Trade activities), with no deviations from rates/ exemption limits, so as to clear away potential ‘rate wars’ among states. States have freedom to impose SGST within a ‘Band of Rates’ in order to meet revenue expediency or as a policy tool.

As per the provision in the Constitution, the Center 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 Center to tax sales, and States to levy service and import duties, an amendment of the Constitution was necessitated.

With the amendment to constitution, Central Taxes – CENVAT, Services Tax, Central Excise, Additional Customs Duty (Countervailing customs duty CVD), Special Additional Customs Duty (SAD), Central surcharges (CESS) – and States Taxes – State VAT, Sales, Tax, Luxury Tax, Lottery and Betting Taxes, Taxes on commercial advertisements and Octroi – got merged and a new unified indirect tax on goods and services (GST) emerged.

The main argument put forward in favour of the GST is that the GST, by encompassing an array of all the above indirect taxes under one canopy, simplifies the tax administration, improves compliance and eliminates distortions in production, trade and consumption. Besides, by giving input credit for taxes paid on inputs at every stage of the supply chain and taxing only the final consumer, GST avoids ‘Cascading’ of taxes, thereby cutting the production cost, and making exports more competitive.

In several countries, GST was successfully adopted and these economies could reap cost-benefits of GST regime for the last 50 years. It is France which experimented in GST type indirect tax system in 1954. Later, Mexico shifted to GST regime in 1980, Turkey in 1985, Russia 1991. Singapore adopted GST with several modifications successfully. As per GST system in UK essential consumption goods and services come under least taxed category.

The existing tax regime 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). With the shifting to GST regime, in India Destination States such as Uttar Pradesh, Bihar, Madhya Pradesh and Kerala, clearly stand to gain in terms of consumption and therefore tax revenues; while Origin States such as Maharashtra, Gujarat and Tamilnadu stand to loose. However, attempts are made to maintain ‘Revenue-Neutrality’.

Unlike the existing tax system, which has greater scope for manual intervention, the GST aims to achieve a singular digitalized compliance setup. The proposed GST will also be far more dependent on IT. Therefore, IT infrastructure will have to be suitably equipped, as any snag would cause the levy dysfunctional. In the words of Cicero, “Taxes are sinews of the State.” (Prof Rao is an Honorary Professor in Economics at Jawaharlal Nehru Institute of Advanced Studies (JNIAS), Hyderabad. Dr Ramulu is an Assistant Professor, Department of Economics, Osmania University, Hyderabad).

By Prof AVVSK Rao & Dr M Ramulu