New Delhi: The Narendra Modi government will at midnight today launch the much-discussed biggest tax reform of independent India — Goods and Services Tax (GST) in the presence of President Pranab Mukherjee and other members of the cabinet with much fanfare in true Narendra Modi style. A special session of Parliament with all chief ministers in attendance will begin when the gong goes off at midnight. Will the much-hyped and touted GST be the game-changer the government claims that it will be?
This column is the third of a three-part series that helps you to decode the GST, what are its implications for businesses and you as a consumer/householder.
Will GST boost economic growth?
Over a period of time, yes. GST brings more efficiencies to the economy. The ‘One nation one tax’ and the abolition of entry tax/octroi will mean a seamless movement of goods across state borders. Since the tax is levied at the consumption point, there will be no need to check trucks for goods that could be evading tax in the originating state. Octroi posts often delayed movement of trucks inordinately.
GST should improve compliance.
The chain of tax credits and online processes will mean it will be difficult to conceal all transactions. At some point, a transaction that is sought to be concealed will get captured and subjected to tax. Besides, if a business in the transaction chain knows that it can offset the tax paid at one stage at the next stage, the temptation to evade tax is reduced. This also broadens the tax base. The combination of improved compliance and a larger tax base should improve revenues.
It could also give a push to formalisation of the economy. Small firms that do not need to register for GST because they are below the threshold may decide to in order to get the benefit of input tax credit. They may also be pushed to register under GST by their clients.
Small firms may not have the bandwidth to conform to the compliance requirements under GST – heavy use of information technology and computers, quarterly returns and the like. That may actually make many of them go under. It is quite possible that small firms may decide that the pains involved in being part of the GST chain outweigh the gains and may decide to stay out. How much of a boost to formalisation GST gives is unclear.
A study by the National Council of Applied Economic Research (NCAER) had estimated that GST will add between 0.9 percent and 1.7 percent to the GDP. But that was based on an input-output ratio of 2003-04 and assumed a flawless GST with no exemptions and a single rate.
A more recent study by researchers at the United States Federal Reserve says GST could result in real GDP gains of 4.2 percent, provided the aggregate weighted GST was 16 percent. The International Monetary Fund and World Bank have also said this would give a boost to the economy.
Whether these gains come will come with the current model of GST remains to be seen, however. What will happen to growth in the current year is also not clear. The transition to a new tax regime will involve some disruption and this will be more keenly felt by small businesses which have only just started recovering from demonetisation; in fact many are still to recover. Growth figures for the current year released on May 31, 2018 will provide an answer.
This sounds good, so why is it being called imperfect?
An ideal GST has only one or two rates, apart from a zero rate and there are no exemptions. That is the model most countries follow. India has five rates and an additional cess over and above the peak rate for sin goods and certain luxury goods. And then there are sub-classifications of items.
Plain waffles and chocolate coated waffles are taxed differently. So is footwear below Rs 500 and above Rs 500 as well as readymade garments below Rs 1000 and above Rs 1,000.
Tax experts like Vijay Kelkar, M. Govind Rao and Satya Poddar have said such a multiple slab structure will take away from the efficiency gains GST normally brings. Not only does this keep tax administration as messy as it was earlier, it also leaves the room wide open for classification disputes.
So why was this model adopted?
Two factors drove the decision on multiple rates – economic and political.
On the economic side, there was need to ensure that the exercise is revenue neutral, that is, current levels of revenue collections from indirect tax continue and there is no significant decline. Having a single high rate on all commodities may not have helped – price increases may have killed demand and led to lower actual tax collections.
A single low rate, however, would have led to a significant decline in revenues. This conundrum could have been overcome with some clever fitment of rates. And that is where the politics comes in.
Taxing all goods at one or two rates would have seen a large number of commonly consumed items being taxed at higher rates than at present, pushing up prices. This would have pushed up inflation (most countries that implemented GST have seen a spike in inflation in the first year or two). No Indian politician likes to be associated with anything that leads to higher prices and inflation, even if it is temporary.
Most members of the GST Council – comprising the central and state finance ministers – are career politicians; even the non-politicians will need to succumb to populist pressures. With elections due in 2019, the Narendra Modi government would have wanted to keep a lid on prices. Therefore, the rates on most items have been kept as close as possible to the earlier tax rates so people don’t get a sense of the price increasing too much.
Rates, however, can be reviewed and if the GST Council realises its folly and revenues of states are not affected negatively, the number of tax slabs can be rationalised to one or two. But this will take at least a year. For now, India is stuck with an imperfect GST.
The government claims GST will adversely hit the black economy. How?
Well, simply by bringing more transactions under the tax radar. GST will have a paper trail for every transaction which makes it difficult to evade taxes. But one has to see if the Indian ingenuity in evading taxes surpasses the determination of the tax bureaucracy to capture every transaction.
Which states gain and which lose?
Since GST is levied on consumption and the revenues goes to the state where the final sale happens, states which are net consumers (which import goods and services from other states more than they export) stand to gain. The producing states from where goods and services originate stand to lose. They will be particularly hit hard by the withdrawal of the 2 percent central sales tax (CST) on inter-state movement of goods which they collected and kept. That is why some of them like Tamil Nadu, Gujarat and Maharashtra were a bit wary of GST.
What needs to be remembered is that producing states are more prosperous because of more economic activity and could see large amount of consumption as well. So they could well gain from GST as much as the non-producing states which may well have lesser purchasing power. Besides, the producing states will now also get to tax services, which they could not earlier.
What happens if some states lose out?
There is a compensation mechanism in place. A state will get compensated if its revenue from GST falls below a certain threshold. If a state’s GST revenues grows at less than 14 percent a year over the 2015-16 revenue from the sum of all taxes subsumed under GST, the shortfall will be compensated. The compensation will be funded from the cess that is to be charged on sin goods and certain luxury goods. The compensation will be available for five years from the date of implementation of GST.
What about local bodies?
With the abolition of all local taxes – entry tax, octroi, entertainment tax etc – the finances of rural and urban local bodies will suffer. The Brihanmumbai Municipal Corporation, for example, collects close to Rs 7000 crore every year from octroi. But local bodies can make up for the loss by ensuring better compliance on property tax and levying user charges. This will mean political will to rationalise property tax and go after defaulters as well as ending or significantly reducing freebies. Clearly GST will bring in behavioural changes in areas not covered by it at all.