The first giant step towards the implementation of a single goods and services tax for the country as a whole has finally been taken. Showing rare bonhomie, the Rajya Sabha voted to pass a constitutional amendment bill that will allow the Centre and the states to draft appropriate GST legislation. The next step is for the majority of states to ratify the bill. This will mark the end of the first stage of a reform process which was first mooted over a decade ago when the then finance minister, P. Chidambaram, mentioned the idea of a GST in his 2006 budget speech. He had mentioned April 2010 as the deadline for its implementation. Unfortunately, politics came in the way of its adoption with Opposition parties of the day fighting tooth and nail to oppose what has typically been labelled the biggest overhaul of the Indian tax structure. This is not a hyperbolic statement because the GST truly represents a watershed in the structure of Indian public finance.
The single tax structure will replace an array of taxes such as central excise tax, value-added tax, octroi and various other state taxes – as many as 17 according to one report. The GST is, of course, an indirect tax and will be levied only at the final point of sale. The incidence of taxation on the retailer will be lower than that under a non-GST system since the retailer can offset the tax that was due on the value of the product at previous stages of production. In other words, the cascading effect of ‘taxes on taxes’ will be avoided under the single tax. This can in principle reduce the final cost to the consumer, though much will depend on the tax rate that is finally imposed after discussions with various stakeholders. There is no doubt that the structure of indirect taxes has been rationalized, with the number of tax rates being lowered over time. Nevertheless, there are still a number of different rates of excise taxes. Each budget brings about some change in the rate structure, particularly in the list of goods which are exempt from taxes. It is not always clear why these changes are made. Some changes are clearly ad hoc, and one cannot escape the feeling that in at least some of these cases, lobbyists have achieved their goal. The single rate of tax, with a clearly laid out rationale for why some goods are put in the exemption list, will hopefully eliminate the power of lobbyists, as well as any elements of ad hocism.
The GST regime is very likely to provide a boost to the capital goods industry. Full input tax credits are currently not available for capital goods. This will change once the GST is introduced. This will obviously reduce the cost of capital goods and so promote greater investment. The GST regime will also require an extensive IT infrastructure to account for the chain of transactions taking place from suppliers of raw materials to the final users – this will be required in order to provide the appropriate input tax credits. An important side benefit of the IT infrastructure is that it will now become much harder for suppliers at various stages to hide their transactions or evade taxes. So, there will be some (involuntary) increase in tax compliance.
The uniform single tax for the entire country will also eliminate tax competition between states. ‘Competition’ is often equated with greater efficiency. However, not all forms of competition are beneficial. The tendency of different states to attract larger flows of investment typically induce state governments to offer all kinds of incentives, including lower taxes. Tax competition can result in what economists call a “race to the bottom” with tax rates being driven very low. While this may have resulted in a larger aggregate level of investment for the country as a whole, this has come at the cost of significantly lower state tax revenues. Once the GST rules out tax rates as a mode of competition, states may well be forced to compete by offering better infrastructure, such as assured power supply, improved connectivity and so on. Of course, improved infrastructure generates significant positive externalities.
An apt comparison that has been made recently is that the GST will convert the entire Indian state into a giant common market, much like the European common market. An obvious benefit of the single market is that it will facilitate inter-state movement of goods. There will no longer be any delays at state borders, haggling over whether appropriate state taxes have been paid, whether paperwork is in order. (It never is since state officials need to make a fast buck). One estimate puts the cost saving as a result of this seamless movement across state borders at 20-30 per cent, though these back of the envelope calculations need to be taken with a dose of salt.
What will be the appropriate tax rate in the GST regime? A finance ministry committee, chaired by the chief economic adviser, recommended a range between 17-19 per cent. However, there is no guarantee that the final rate will actually fall in this range because a host of factors will have a role in determining the chosen rate.The usual trade-off will come into play – a high rate will be inflationary while a low rate will reduce aggregate tax collection. Tax collection will be helped by the fact that a much larger array of services will be brought into the tax net. Some states may still demand a relatively high rate under the apprehension that their share of tax revenue be adversely affected. Some of their fears will have been removed by the Central government assurance that all states will be compensated for any revenue losses for 5 years.
Arun Jaitley has announced that the GST regime will be put in place by April next year. This is a very tight deadline since many intermediate steps will have to be completed before the GST actually becomes reality. First, a majority of state legislatures have to ratify the bill. Since all parties except the All India Anna Dravida Munnetra Kazhagam voted in favour of the Constitution amendment bill in the Rajya Sabha, this should normally not cause any headaches to the finance minister. However, strange things can happen in Indian politics, and so it is better to keep one’s fingers crossed. Next, the GST council, which consists of the Union finance minister and representatives from all the 29 states, has to approve the eventual rate.
The mechanism through which the rate is chosen will have a major influence on how quickly the council can reach a decision.
The council will arrive at a decision quickly enough if a simple majority is enough to take a decision. At the other extreme, a single state such as Tamil Nadu can hold the entire process at ransom if a consensus is required. Finally, Parliament will have to approve the chosen rate as well as the list of goods and services that are exempt from the tax. A risk-averse person should not bet on the April 2017 deadline being achieved.
The author is professor of economics, Ashoka University