GST shows legacy issues make for difficult policy transitions
Major policy transitions are tricky even where the net gain is positive. In India, policy transitions can be even trickier. There are legacy issues to contend with at every turn. Then there can be announcements with no follow-up, such as when a minimum support price is declared without any tracking of the acreage response and the corresponding warehousing requirement. Farm unrest was sure to follow.
The transition to a nationwide goods and services tax (GST) on 1 July wisely provides an adjustment window until September during which glitches can hopefully be sorted out. The decisions taken by the GST Council on the issues falling within its very broad purview—the rate structure among them—have been as streamlined as they can be considering the number of parties whose consent had to be secured. All except one, having to do with the taxation of the financial sector, on which more further below. There are some obvious transition issues in terms of the robustness of the information technology platform for such a data-intensive taxation system. These have been signalled several times by many commentators, but the network seems confident it can hold up. There are access issues in remote areas. There is also worry about how the anti-profiteering provision will be implemented.
I never thought that the GST could actually carry collateral damage of any severity, but was alerted to it by a passing news item. The damage is not a consequence of the GST itself, nor of any decisions taken by the GST council, which has functioned thus far in an admirably cooperative spirit. It is a consequence of the non-transparent legacy of the taxation system being replaced by the GST.
The news item was about GST impact on the textile industry (an altogether different issue has agitated textile traders, concerning the 5% GST rate on textiles replacing the earlier exemption under value-added tax). The Surat textile industry association presented the following facts on the pre-GST taxation structure on imports of textiles: 10% basic import duty, 12.5% countervailing duty (CVD) and 4% special additional duty (SAD), adding up to 26.5% (this is the summation approximation, but will do for now). Their submission was that after introduction of the GST at 5%, imports will attract duty of only 15%—the basic duty of 10% plus the GST of 5% on textiles. GST at 5% is leviable on domestic production also, leaving the nominal import wall of 10% basic duty firmly in place.
The CVD was merely supposed to compensate for excise on domestic output, and the SAD was compensation for taxes on inputs going into domestic production. So with the GST replacing those levies (with full input credit), there should have been no problem, right? But in the textile case, as this submission brings to light, there was no excise on domestic production of textile fabric! The 12.5 % CVD turns out to have been a spurious addition to the basic duty, compensating for domestic excise that was not in fact leviable on textiles.
The 4% SAD by contrast seems to have understated the incidence of input taxation, which by one (unverified) estimate stood at 11.5%. Adding CVD and SAD, the compensating levy on imports stood at 16.5% pre-GST, when it really should have been 11.5% (remember, excise on output was zero). So domestic producers were getting 5% more protection than the nominal import duty of 10%. Now that GST has rationalized the import wall to the basic duty of 10%, the Surat textile industry rightly fears for its survival.
Should we be ramping up import duties (the basic levy) in order to hold the protection level constant in textile and other such cases? Textiles are among the most employment-intensive sectors in Indian manufacturing. Transiting out of an admittedly non-transparent regime will lay off large numbers of workers, with no immediate absorption possibilities in other sectors of manufacturing.
How did this mess happen? It is merely one of the many quirks of the policy legacy in India. The matching of CVD to excise should have been done transparently and accurately in the pre-GST era by the Central Board of Excise and Customs (CBEC). If the domestic industry wanted higher protection than the basic customs duty, it should have been done by ramping up the basic duty itself, not through the back door with a spurious CVD.
Frankly, this revelation caught me by surprise, although it is by no means the first time that I have learned about the taxation structure in India from industry associations. Indirect taxes in India have suffered from so many exemptions inserted into the small print, that any aerial overview of the rate structure never yielded the worm’s-eye view of the rates as they actually applied on the ground. Often those exemptions were at the behest of industry lobbies themselves, but the best way to learn about them was from calculations of tax incidence submitted by industry associations.
Two-and-a-half years have elapsed since the Constitution Amendment Bill to enable GST was presented to Parliament. One might have expected the CBEC to call a review meeting during this very long period to assess the implications of lack of alignment between the CVD-SAD level and the domestic levies they were meant to compensate for. The actual GST rate to be settled on textile fabric by the GST council would not have been of any relevance. Why do these arms of government not see problems looming on the horizon? For that matter, why did the textile association itself not sound its concern and get the matter sorted out earlier?
The textile story itself may well end happily. The alert has reached the proper quarters, and it seems possible that the basic import duty will be hiked up to 15%, which fortunately lies within the tariff bounds registered with the World Trade Organization. The textile industry is a major employer. And we most certainly do not need to add yet another sector to the list (steel, telecom, power) already contributing to the stressed assets of the banking system.
Which gets me to the one problem I do have with the configuration of taxation worked out by the GST Council, having to do with the taxation of the financial sector. Banks in India have a presence in all or most states. The GST now requires banks to register in each state, and compute their turnover taxable to GST separately in each state jurisdiction. Maybe not an impossible task, but it does impose huge incremental demands on the banking system in terms of internal accounting arrangements and manpower attention. There was no time for training bank officials for this, although I do see advertisements for GST training modules under the National Skill Development Mission. Banks will most likely outsource the task to the big four accounting multinationals. They never had it so good.
Banks have been under severe stress over the past few years quite independently of the overarching problem of declining asset quality, which continues to worsen as documented in the latest Financial Stability Report issued on 30 June. The additional stress has resulted from a sequence of policy transitions, each of which imposed a sharp unanticipated load on the duties of bank staff. Even commendable initiatives like the Pradhan Mantri Jan Dhan Yojana (PMJDY) for financial inclusion were done with no advance preparation.
PMJDY completely absorbed the front end of banks for essentially the first six months of calendar 2015. The voluminous application for a new account had to be filled in by bank staff themselves, who further had to cope with problems of names on Aadhaar and ration cards being altogether different for the same individual, and applicants not having a postal address to which the account passbook could be mailed. The further task of linking these accounts to direct benefit transfers of various kinds was borne principally by banks. Then there are the various insurance benefits attached to the new accounts, claims for which immediately started pouring in after the opening of an account, all of which are handled at the front end by bank staff.
Demonetisation completely took over all bank staff, not just those at the front end, for essentially the last two months of calendar 2016. Hapless bank staff bore the brunt of public wrath over non-functioning ATM outlets, in addition to the work of collecting and counting stacks of demonetised currency. Many faced abuse and even violence from irate customers. Routine functioning ground to a halt. One customer who had run out of cheque leaves with which to withdraw cash from the counter, the only option in those early days, was told issuance of new cheque books had been indefinitely halted.
Then there is the procedural burden of the farm loan waiver schemes announced by at least four state governments, with more to follow, of having to prepare lists of loans falling within the parameters of each scheme. A little-known feature of these schemes is that farmers themselves lose from incremental lending for farming being put on hold while the waiver is under process, which can take up to two years or even more.
Now with GST, there are the state jurisdictional boundaries along which bank turnover has to be carved. The cost of outsourcing this task to the accounting multinationals will have to be borne by—well, banks.
The final straw is the steep jump in provisioning requirements—introduced in late June—on loans referred to the National Company Law Tribunal for bankruptcy proceedings. This change is puzzling both in terms of the manner of its issuance (not through a public circular, the common channel for regulatory announcements) and in its impact, which will be counter-productive. Surely, this last imposition can be reversed.
Indira Rajaraman is an economist.
Comments are welcome at email@example.com