In a first, state will be taxing services
The Government pushed through four legislations relating to the Goods and Services Tax (GST) in the Lok Sabha, overruling the objections of the Rajya Sabha, in their determined effort to bring in the GST regime by July 1, 2017. Now, the state legislatures have to pass similar legislations and put the infrastructure in position to enable the rollout of the new tax regime.
It has been a long and tortuous journey, and the organic entity that has emerged is very different from one that was conceptualised in 2003-04. At that time, the VAT structure had just been agreed to among all the States and the new structure resulted in revenue buoyancy and in ease of levy, benefiting both those who were taxed as well as the revenue collection agencies. Most importantly, state finances were in good shape, on the back of improved devolution, state debt restructuring and a formula to reduce power sector liabilities. States were interested in the new GST measure as a development initiative that would help growth and revenue receipts.
Even though the UPA regime remained committed to the concept of GST, economic constraints caused by global meltdown, budget stress, and imprudent fiscal expansion at the level of the center constrained progress between 2004 and 2014. The states, with a mandate for regional parties interested in distribution of freebies rather than on a growth and development agenda, slowed down discussions and consensus further.
It is important to understand this backdrop against which the NDA Government restarted discussions in 2014, to better understand the regime that has finally come about. The new Government, a trifle unsure of governance and of its ability to persuade the States, was yet determined to fulfil the promise of the new GST regime, firmly believing that it would herald a new era of development and growth initiatives. The states also took the opportunity to push back on a number of earlier suggestions like a single rate of GST. A lot of compromises that have happened can be traced back to this political development.
Many of these compromises have invited criticism. The final picture has a Central GST (CGST) and a state GST (SGST). There are close to six different rates rather than one or two rates envisaged earlier. States have been given the power, under a recently enacted constitutional amendment, to levy taxes on services, but the allocation of taxation limits as well as jurisdictions will remain a thorny issue for some time to come. With six different rates, the battle for classification of goods and services will benefit lawyers, accountants and consultants, rather than businesses, for a long time to come.
The largest criticism has been that the time given for industry and businesses to respond and react to these changes that have evolved during discussions has been inadequate. Businesses are worried about compliance, about assessment hurdles, getting input credit. This is first time that States will be taxing services, and there is the anxiety that this may lead to arbitrary classifications and levies and differential levies across states, that would take a long time to sort out. The mechanisms for resolutions of disputes are unlikely to result in quick solutions. Small businesses are worried about the costs of compliances.
At the back of these problems is very clearly a lack of appreciation of how the State and Central tax collection agencies are structured, and a reluctance by the Central government to understand that the State structures represent a strong institutional group, and states would not agree to give up the power of these groups, for personal as well as state ends. It is surprising that in all these years, no committee was set up to examine what needed to happen to the state and Central tax collection agencies, and to prepare a road map for their eventual harmonisation. I would feel that going forward, this reluctance of the States to share their tax administration powers would be the greatest drawback for the new regime.
There is yet another conceptual issue. There is no other country that has implemented GST in an economy that is 60 per cent services, and less than 20 per cent manufactured goods — and the last bit, agriculture, which is untaxed. Service tax levy and transfer of credit is likely to emerge as the biggest challenge, a challenge which states are as yet not trained enough to handle.
There has been a sincere attempt to resolve these issues. The promise of compensation for revenue foregone, for five years, will give states time to improve their institutions and take advantage of the resulting buoyancies. There is a healthy sharing of responsibilities between Centre and states, with the Centre being more than fair in sharing assessment responsibilities. There is help for building the IT architecture for all states, without which the long-term sustainability of the input tax credit arrangements would be in jeopardy. It has to be admitted that, in the discussions, the Centre has done all it can to accommodate State views. The differences that persist are more state specific than all India.
There is sincerity in the expectation that, in the medium to long term, GST will lead to growth and ease of doing business, and importantly, that more and more businesses and services will be tax compliant, resulting in an improvement in the tax GDP ratio.
Currently, the effective indirect tax rates on goods and services are 22.5 percent and 15 per cent respectively. Through GST, lower tax rates will cover a broader range of goods and services, with tax only on value addition and set-offs against taxes on inputs. According to Prime Minister Narendra Modi, more than 55 per cent of the items in the consumer price inflation index (i.e. food and essential items) are outside GST . However, ideally, no goods or service should be tax-exempt, as this affects the input tax chain and drives away the economy from its optimum.
If the GST rate is kept at the 18 per cent mark, service producers will suffer from an increased tax burden while manufacturers will face a lighter rate. Because a uniform GST threshold across States is desirable, there is great debate around the threshold as well, which is particularly important for government revenue as well the economic situation of small entrepreneurs and traders. The managerial capacity and the costs involved for collectors are to be considered. A high threshold allows reduction in the necessary administrative means and focus available resources on the most important taxpayers. In particular, the selected thresholds must be high enough to ensure that the taxpayers preserve the capacity to meet their obligations.
A relatively high threshold generally does not cause excessive revenue losses because the small businesses actually bear the tax on their inputs and equipment as a final cost. Revenue losses can be significant only if the intermediate consumption of enterprises are exempt from VAT.
What is sure is that by reducing the cost of inputs, GST will help in reducing the cost of locally manufactured goods and services. In addition, it can be expected that the removal of interstate tax barriers, through uniformity in tax rates and procedures across the country, will also be helpful in reducing the compliance cost and the distortions in economic decisions. Indeed, as each person in the value chain who gets input tax credit has an incentive to ensure that the previous person has paid taxes, the GST mechanism can lead to better tax compliance and a broadening of the tax base.
Through the GST, the resulting reduction in transaction costs of doing business will eventually lead to an improved competitiveness in trade and industry, thus benefiting the government’s ‘Make in India’ initiative. Moreover, because of its higher rate on services, GST is likely to compress supply chains by making them more efficient through either lower transport time or optimal location of warehouses.
For Central and state governments, such a tax system will be easier to administer in the long run, both in terms of costs and controls on leakage. Indeed, as compared to the current situation, GST is expected to decrease the cost of collection of tax revenues for the Government, and will therefore, lead to higher revenue efficiency. Such additional budget will be available to the Centre which could be used for welfare services.