The Goods and Services Tax (GST) is being billed as the significant next step in indirect tax reform since VAT (Value-Added Tax) was successfully introduced all over India. However, in introducing GST, the government is missing one deadline after another, because of objections from some State governments.
GST is basically a comprehensive VAT on most (if not all) goods and services, where all taxpayers, except the final consumer, get credit on the taxes paid on inputs. Currently we have a dual VAT system — a Central VAT (replacing Central excise tax) and a State VAT (replacing State sales tax).
Since VAT has improved tax collection and compliance, presumably the same will happen when GST at both the Central and State levels subsumes the many remaining indirect taxes (such as entry tax, purchase tax, luxury tax, etc.) at varying rates, that have kept the indirect tax regime highly complicated and unstable. Then, why are some of the States objecting?
The principal issues are the fiscal autonomy of States and the compensation mechanism for possible revenue loss in future. If the same GST rate is applied to all States and the States cannot impose any other taxes, some States may feel they would lose the power to raise revenues, especially if they require the funds to come good on electoral promises of distributing freebies.
Compensation issues
The Centre is promising to compensate the States for any revenue loss for the first three years after GST is introduced. What happens after that? The calculation of a revenue-neutral GST rate (which will ensure the States suffer no revenue loss) is tricky. Different experts have come up with widely divergent estimates.
Moreover, a uniform rate may not compensate the revenue loss for all the States as some are more industrialised, some more agricultural and some resource-rich. Therefore, some States feel they should have the power to impose supplementary taxes, and at appropriate rates as necessary, even if a State-level GST is introduced.
But the Centre is not in favour of allowing States this freedom as that would undermine the objective of a single market with a uniform stable tax regime. The supporters of GST also argue that as the tax base would become wider (GST would apply to all goods and services, except for a small ‘negative' list of exclusions) and there would be less exemptions, even the same rate of tax (as the current sales tax) should yield higher tax revenue.
Further, as expenditure on services as a percentage of income typically goes up with a rise in income, the inclusion of services in the GST net will provide more automatic revenue gain, which the States will now share with the Centre.
The Constitution lays down a clear division of taxes that the Centre and the States can impose. The power to tax services lies only with the Centre. So, the introduction of two different GST regimes — one by the Centre and the other by the States — would require a constitutional amendment.
The UPA government at the Centre does not have the required two-thirds majority in both houses of Parliament.
So far, it has not been able to get the consent of all the States on the introduction of GST either. Hence, the deadline for introducing the Bill in Parliament is being repeatedly pushed back.
No single model
There is no single model of GST throughout the world. For example, the US does not have a GST — or even a VAT on goods — and the states have sales tax at rates varying from zero to 8.5 per cent. Canada has several models of GST applicable to different sets of provinces. Even the EU, which talks of a European Common Market, has VAT on different bases and at varying rates for different countries. China and Australia have a single centrally-imposed VAT and the revenue is shared between the Centre and the States/provinces according to an agreed formula.
No doubt, we are slowly moving towards a dual GST regime — one for the Centre and the other for the States — on the same tax base that applies to most goods and services. But, in view of the apprehensions of the States, one option is to set a floor rate instead of a single fixed rate for all the States. This is also necessary to prevent unhealthy tax competition among States trying to attract investment, with no real benefits to any State.
If at all a consensus emerges on a uniform rate, then possibly the States will want to retain the power to impose additional duties and cesses, if needed, in the initial years till revenues stabilise.
This may be subject to approval from the GST Council or the regulatory body that will have representatives from the Centre and the States.
Essential items such as food (specially unprocessed food) at zero rate and a higher rate for luxury goods (like high-end cars) is also likely.
For practical or social considerations, such transactions as those in real estate, education and health services may be kept out of the GST net. The maximum rate need not be specified as States with exorbitant tax rates will discourage investment and eventually lose revenue. This would act as an automatic restraint.
Giving the States some degree of fiscal autonomy is good also because it will force them to be fiscally responsible. Otherwise, some States may blame the Centre for their lack of efforts to raise tax revenue by arguing that their hands have been tied by the Centre as part of the GST deal and hence it is the Centre's responsibility to bail them out in case of any Budget shortfall.
Striking a balance
A GST model that strikes a balance between harmonisation and fiscal autonomy would be far better than the present complex system.
Any simplification and harmonisation in procedures that lead to a broader base, less exemptions, smaller number of rates (hence less classification problems and scope for corruption), will automatically result in greater compliance, less disputes, lower collection cost and higher tax collection.
A more comprehensive input credit system would avoid ‘cascading' (or tax-on-tax effect) — thereby reducing prices and improving the international cost competitiveness of Indian goods and services. We should keep in mind that if we start with a narrow base now, it will be difficult to change it later.
Changing tax rates also becomes troublesome in future as vested interests develop. Hence, it is better to go slow, build a consensus and put a good (though not necessarily ideal) system in place rather than push through a haphazard compromise hastily.
Investment depends on a host of factors, not just on whether we have a uniform tax regime. So, we need not worry that the delay in putting in place a GST will discourage investment or slow down growth.
(The author is a former Professor of Economics, IIM, Calcutta. >blfeedback@thehindu.co.in )