In the end, the government succeeded in breaking the biggest deadlocks in negotiations for a Goods and Services Tax—India’s biggest reform since the 1990s. And that, without much noise because for every problem, the finance ministry had readied a backup, middle-of-the-road solution. A July rollout is now on track. To be sure, there’s a lot of work to be wrapped up.
Businesses are struggling to get their tax maths right. A complex, backend infrastructure, part-physical, part-virtual, needs to be tested. But there could be no better start to 2017 for Prime Minister Narendra Modi, who can now look to shrug off some of the dire consequences of demonetisation. The status of a GST-compliant economy alone will improve India’s ease-of-doing-business rankings by a few points.
With the GST, Asia’s third-largest economy will move into a different gear. Lorries piling at interstate checkpoints, a common reason behind highway jams, will vanish. Speedier and seamless movement of goods—a sign of mature economies—itself raises the GDP by a percentage point. It’s not just trucks that will move faster. Supply chains fragmented across states will become tax-pliant cohesive systems because making goods in one state and selling them in another will no longer mean paying a welter of taxes at every stage, and often, paying twice for the same stuff.
Here’s why the GST is a big deal. Suppose an e-commerce website sells a high-value television set to a consumer in Vizag. Suppose further that it is manufactured in a factory in Uttar Pradesh, a state that charges an extra exit tax on all goods whose value exceeds Rs 5,000. As the telly moves at least five states from UP to down south, the seller pays an exit and entry tax at every border. Such a system discourages firms from having large stocks because ploughing back the unsold goods mean additional expenses. This way, India, politically one country, acts like 29 different markets. The GST will integrate the country into a uniform market, much like the case with the European Union.
The GST is nothing but a pact between all states to levy uniform rates of taxes and not charge for the same good twice. And dodging taxes will become difficult because there’s nowhere to hide. With both ends of the supply chain mapped into a national software, there’s little chance a taxpayer can go missing in between.
Equally important, there is actually a disincentive for not complying. A good reason why compliance will improve is that a firm had to earlier pay taxes for the entire value chain rather than just its own portion of value added. So a buyer of bicycle parts pays, for instance, only for the spokes supplied. The buyer of the finished bicycle pays for the whole product. In this way, the GST is a destination-based tax—charged where goods are sold—with a tax credit for the previous custodian of the product.
The GST will replace a complex patchwork of state- and local-level taxes with a uniform tax structure for all kinds of marketplace transactions. The immediate gains will be felt by consumption-related sectors such as auto, consumer durables and FMCG.
What does the GST mean for consumers? Most economies, as a rule, see a rise in prices immediately after implementing the GST. “It will temporarily dip growth because of increase in taxes on services, which account for 60 per cent of India’s GDP. And headline retail inflation by 20-70 basis point,” according to analyst Sonal Varma, an economist with financial advisory firm Nomura. A basis point is one-hundredth of a percentage point.
A report by the GST committee estimates a standard GST rate of 18 per cent, a low rate of 12 per cent and a high rate of 40 per cent would have no net impact on headline CPI inflation if producers adjust prices after accounting for input tax credits under the GST. But inflation could rise, since firms are unlikely to fully pass on the benefits of tax credits to consumers. That will kick in the policing function of the GST. Services typically will be expensive anyway, such as restaurant meals, salon services and travel. After about a year, the impacts should even out.
Economists have long made a strong case for a national sales tax. The first discussion paper of the Empowered Committee of State Finance Ministers makes clear why. It gives details of how prior to the introduction of the VAT, there was a burden of multiple taxation in the pre-existing central excise duty and the state sales tax systems. Before any item was produced, inputs that go into its making were first taxed. Then, after the commodity is out of the factory, it gets taxed again—this time it’s an output tax. This caused an atrocious system of multiple taxation or “tax on tax”, also referred to as a cascading-effect phenomenon. Businesses just hated this archaic taxation system.
Moreover, under the sales tax structure, there was also a system of multipoint sales taxation along the distribution chain. To this, “input tax load, burden of sales tax paid on purchase at each level was also added, thus aggravating the cascading effect further”.
Warm tone to talks
Negotiations between the Centre and states were hobbling ahead, until they nearly came unstuck on the crucial twin issue of “dual control” and “cross-empowerment”. “We remain committed to GST,” said Amit Mitra, West Bengal finance minister, wrapping up the last round of talks. “The GST, in principle, is something we strongly support. But we cannot have a GST that is not sustainable and that will not work in practice.”
In the last meeting of the GST Council—a body represented by the Union and state finance ministers—states and the Centre continued to quibble over who gets administrative control over assessees, or millions of business firms to be taxed in the new system.
According to its plan, the Centre would have control over businesses, whose annual worth is upwards of Rs 1.5 crore. It also wanted joint centre-state jurisdiction over those below that cutoff. States insisted they must have exclusive control over smaller business or those below that cutoff.
The Centre had been insisting on joint control over a proportion of smaller taxpayers, for it feared the GST might leave it with a reduced taxpayer base and therefore smaller revenues. This crucial aspect falls under the Integrated GST Bill, which is one of the legislations that need to be passed to make the GST a reality. In all, four separate laws need to be passed. Parliament will have to pass the Central GST legislation and states need to pass their versions of the same law, apart from one Integrated GST bill. Another law that must go through allows for monetary compensation to states to make up for their initial revenue losses after the GST rolls out.
A middle path seems to have broken the logjam. “We have been able to arrive at a decision on this,” Union finance minister Arun Jaitley said after concluding the latest round of talks. “The entire taxation base will be shared between the assessment machinery of the Centre and states.”
Of all business firms with a GST turnover of Rs 1.5 cr or less, 90 per cent would be assessed (for the purposes of scrutiny and audit) by the states. The remaining would be under the Centre. Those above a turnover of Rs 1.5 crore would be assessed in the ratio of 50-50 between the Centre and states. In other words, states would control half of those above Rs 1.5 crore and 90 per cent of those below the cutoff.
The demand of coastal states, which wanted their tax jurisdiction over sea territory up to 12 nautical miles to continue, was acceded to, paving the way for the deal to be clinched. In a country with acrimonious centre-state rivalries, the GST stands out as a rare moment of political consensus. The finance ministry, sources said, has agreed to give higher compensation if any state can give proof of revenue dip due to demonetisation. By no means perfect, the GST, however, may present enormous teething problems. But as top revenue bureaucrat Hasmukh Adhia says, no country has a flawless GST and it’s better to push for “endogenous change” than to wait for the perfect GST.
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Leaps & Snarl-Ups
The Gain
- Seamless interstate trade Uniform GST will eliminate a welter of taxes. No waiting at borders means trucks can travel six more hours a day. That’s a productivity boost at less cost
- Investments Firms will get credit for input taxes across goods and services. Means lower capital goods prices.
- Less black A self-monitoring GST system will continually nudge the informal economy towards a more formal one
The Pain
- Inflation Consumers pay higher prices in the immediate aftermath because of new, higher service taxes
- GDP Temporarily, growth could see a dip because consumers may cut down discretionary spending
- Teething troubles The GST ecosystem will initially run into a trial and error mode. Firms may not pass benefits of tax credits to consumers immediately. The first year may see interstate disputes.
