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This article was first published 9 years ago  » Business » The imperfections of India's GST regime

The imperfections of India's GST regime

By A K Bhattacharya
April 29, 2015 13:21 IST
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Instead of improving tax compliance, there could be a strong incentive for tax payers to avoid the higher tax burden to be imposed by the new system, notes A K Bhattacharya.

Make no mistake about it. What India is likely to get, if its politicians agree to the idea finally, will be a sui generisversion of an Indian goods and services tax (GST) regime.

It will be truly an indigenous model and a product of India's fractious politics, containing all the imperfections of a system that the GST's original proponents would shudder at.

The reasons for the GST experts' disenchantment are obvious. Far from creating a barrier-free pan-Indian market for smooth transaction of goods and services across the country, the proposed system may well create new tax hurdles.

Instead of improving tax compliance, there could be a strong incentive for tax payers to avoid the higher tax burden to be imposed by the new system.

The tax base too may not widen because of the many items that would be excluded from the GST chain. And, most important, instead of enhancing the value of the country's economic activity, the proposed GST system may well be a dampener for achieving higher growth in gross domestic product or GDP.

The success of a GST system is largely dependent on the width of its coverage. All items in the tax chain must ideally be included in the GST system to achieve the best results.

That also helps eliminate the incidence of paying tax on taxes, reduces the cascading effect of a tax system and enables producers of goods and services to enjoy the set-off benefits on the taxes they may have paid at various intermediate stages.

However, the proposed GST regime now under consideration of the Indian Parliament is likely to exclude potable alcohol, tobacco and petroleum products.

Taken together, they account for a large chunk of the indirect taxes base in the country. Unfortunately, this exclusion is largely triggered by some of the states' myopic desire to preserve their revenue streams.

This is often aided and abetted by the federalist streak among many of the Indian states to assert their right and freedom to fix duties on certain products as they please.

Worse, such an approach is often inspired by irrational thinking and narrow political calculations based on party affiliations.

Experts also point out that the exclusion of items from the GST chain results in a higher rate of final taxes to be paid under the new system - or the revenue neutral rate.

The legislative Bill seeking to to introduce GST does not indicate the revenue neutral rate and delegates that responsibility to the GST Council, which will be a body composed of the finance ministers of the Centre and states.

If, recent studies by some expert bodies are an indication, the revenue neutral rate with the proposed exclusion of items could well be around 27 per cent - almost half of which will be the state GST rate and the other half would be the central GST rate.

This is considered too high a revenue neutral rate to ensure an easy buy-in for states and address concerns of a sharp increase in the tax burden.

Barring a few Scandinavian countries, the revenue neutral rate for GST is well below the 20 per cent mark in most countries.

True, a GST regime with a 27 per cent revenue neutral rate might help improve the country's low tax to GDP ratio, but surely a more prudent and effective way of improving that ratio would be to increase the coverage and the base of direct taxes.

A far more risky idea in the proposed GST regime is the imposition of a one per cent tax on all cross-border sales of goods and services by states, in addition to the GST rate.

There is now a demand from two producing states of Gujarat and Maharashtra that the additional tax on inter-state sale of goods and services be raised to two per cent to help them protect their revenues.

GST is a tax levied by a state where the goods and services are consumed and hence states that produce them are afraid that they might lose revenue.

If the additional duty is allowed, under political pressure, the spirit of the GST regime would be seriously undermined.

Imports would get a fillip as they would not be subjected to the additional tax, whose multiplier effect, every time the goods enter a new state, would be substantial, dealing a blow to the government's 'Make in India' programme.

Add to this the fact that the real estate sector will not be covered under the proposed GST. Thus, all construction activities and the expenditure incurred on them would be outside the GST chain, robbing their suppliers of the benefits of setting off their intermediate tax burden against their final tax liability.

Not surprisingly, instead of adding to the country's GDP, the new GST regime with all these imperfections may perpetuate the barriers that split the large Indian market into 29 states and seven union territories.

In addition, they may undermine whatever additional growth the proponents of the new taxation system may have envisaged as a net gain for the economy.

Congress president Sonia Gandhi had led her party's walk-out from the Lok Sabha, lodging her protest against the new GST regime.

It is not clear what changes she or her party wanted in the GST regime, an idea that was first mooted and even introduced in Parliament by her party when in power.

The problem is that the country is in such a political situation, with states flexing their muscles in the name of federalism, that a new idea like the GST regime does not appear feasible in its original form.

Whichever be the government at the Centre, it has to accept the fact that the Indian polity is not yet ready for wholesale changes in economic policies that will require major shifts either in the way states collect their taxes or in the way companies do business.

What should Finance Minister Arun Jaitley do? Should he scrap the current proposal for what is clearly an imperfect GST and wait for more consultation and consensus to help formulate a perfect GST?

That would not be a pragmatic move. The nation has waited for a GST regime for far too long.

It would be wiser to make a beginning even with an imperfect GST, with all its flaws, as long as the government is committed to addressing the concerns that arise over time.

It should also ensure that the new structure should be such that necessary changes to address those concerns can be brought about without going through a long-winded process.

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A K Bhattacharya
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