Much can and has been said on the merits of the goods and services tax (GST). It will bring about a phase change on the tax firmament by redistributing the burden of taxation equitably between manufacturing and services. It will lower the tax rate by broadening the tax base and minimizing exemptions. It will reduce distortions by completely switching to the destination principle. It will foster a common market across the country and reduce compliance costs. It can provide a fiscal base for local bodies to enable them to fulfil their obligations. It will facilitate investment decisions being made on purely economic concerns, independent of tax considerations. It will promote exports.
A recent study on the impact of GST on foreign trade indicates that the rate of growth of exports will be significantly higher than that for imports. GST will also promote employment. Perhaps, most importantly, it will spur growth. As I have mentioned elsewhere, it has been estimated that the GST implementation increased Canada’s gross domestic product by 1.4%.
Illustration: Jayachandran / Mint
In India, we can expect a similar kind of positive impact. This means gains of about $15 billion annually. Discounting these flows at a modest 3% per annum, the present value of the GST works out to about half a trillion dollars. This is indeed a staggering sum and suggests the need for energetic action to usher the GST regime at an early date. I will attempt to address important questions relating to effective implementation of the GST regime.
Most concerns expressed about the implementation of GST can broadly be divided into three categories—design issues, operational issues, and infrastructure issues.
What should be the design of GST? The broad framework of GST is now clear. GST will be a dual tax with both Central and state GST component levied on the same base. Thus, all goods and services barring a few exceptions will be brought into the GST base. Importantly, there will be no distinction between goods and services for the purpose of the tax with a common legislation applicable to both.
However, a number of issues remain to be resolved.
The rate structure and value: The primary concern of all state governments is protection as well as enhancement of existing revenue streams. There are three parameters, which need to be balanced here—one is the range of taxes presently being levied which will be subsumed into the GST. This will determine the tax base of GST. The other two parameters are the number of rates and the numerical value of these rates which will be applied to this base.
All indirect taxes on the supply of goods and services would need to be subsumed into GST. For the purpose of computing the revenue-neutral rate, the task force assumed that apart from value added tax, stamp duty, vehicle tax, taxes on goods and passengers, taxes and duties on electricity, entertainment tax, entry tax, luxury tax, taxes on lotteries, betting and gambling, purchase tax as well as all state cesses and surcharges will be subsumed into the state GST. Central sales tax will stand abolished. From the government of India’s side, Central excise, additional excise duties, service tax, additional customs duty, and all cesses and surcharges (other than educational cess) will be subsumed into the Central GST.
There appears to be agreement that the best option would be a bare minimum number of rates, at best two, preferably one. This single rate will ensure low compliance costs, obviate classification disputes, and ensure uniformity of approach among all players. But to be attractive, a single rate cannot be too high. At the same time, the rate must be high enough to address the concerns of states regarding revenue neutrality.
Rules of supply for goods and services: While Central sales tax will be abolished in the GST regime, the treatment of inter-state sales will need to be carefully thought through. It would be necessary to guard against tax arbitrage where local sales—which will be taxed—could be shown as inter-state sales—which will not.
Putting in place the rules of supply for the inter-state provision of services will be demanding. Services produced and consumed within the same state would not pose a problem as far as the appropriation of taxation proceeds is concerned.
However, some services may be supplied from one state, consumed in another and paid for in a third state. A set of rules to determine the taxation jurisdiction and appropriation would need to be worked out. There is adequate international precedent for this but here again, trade and industry associations could take proactive steps to suggest possible options.
The framework for exemptions, thresholds and composition: The existing sales turnover thresholds for VAT taxation vary widely across states. To allow for uniform treatment of inter-state transactions nationally, it may be necessary that these variations be bridged so that tax cascading is eliminated. However, the concerns of smaller states need to be kept in mind. For this reason, perhaps such convergence could be targeted over a certain period of time rather than immediately.
Common approach: For GST to be successful, all states and the Centre should implement it in a similar fashion. Only this will bring about the national common market, which is one of its goals. This will be possible when there will be a common law, a common assessment procedure and perhaps even a common return.
Sharing of information: Recent experience relating to revenue collections from the Central sales tax has raised issues relating to tax arbitrage. Some states have expressed concerns and referred to tax evasion in developed countries which have a VAT in place. They have sought reassurance that revenue leakage would be effectively checked in the GST system. Apart from putting in place a comprehensive information technology network, sharing tax-related information and coordination among all the states will be crucial for this.
IT infrastructure: A simple system for inter-state verification of dealers and transactions is essential to ensure tax compliance and check avoidance. Given the volume of such transactions, this system necessarily has to be IT-based. We need to put in place a system which will uniformly incentivize all states to participate in and contribute to the verification system. Or alternatively, one central agency could be charged with maintaining this system. Both the alternatives available are challenging, but this needs to be done.
Checkposts: Most states have put in place a system of checkposts on road borders. Apart from other verifications which may take place, these checkposts verify and document inter-state sales of goods carried by the vehicles which cross these borders. These details are then cross-verified with the VAT returns of the importing dealers. The need for such an arrangement to continue in the GST regime has been emphasized. However, the fact remains that such checkposts by the very nature of their operations, generate enormous delays in road traffic, sometimes up to three hours per checkpost. Delivery times for goods may be extended significantly because of these delays.
It may be difficult to eliminate checkposts given the valid concerns of state governments which may extend beyond collection of taxes and movement of goods. But what appears to be egregious is that the same vehicle has to pass through two checkposts while crossing one border—the exporting states checkpost and the importing states checkpost. Officials of both states could sit together and conduct their verifications in one checkpost. But essentially there would be only one check per border for a goods vehicle. Such an arrangement will significantly reduce travel time.
A ‘flawless’ GST
Ideally GST would subsume all the major state-level taxes, use a single rate, allow for only essential exemptions and eliminate all barriers to trade. This flawless GST will feature the following characteristics:
For GST to be effective, there should be identical GST laws across states as well as at the Centre. I propose that not only the law but also the methodology relating to levy, assessment, collection and appropriation of GST should be similar across states and the Centre. Such a unified approach will simplify procedures, eliminate bottlenecks and drastically reduce transaction costs for dealers, enabling them to leverage cost and time gains from the new taxation system.
For industry to reduce its transaction and compliance costs, it is necessary that apart from a common law, the implementation of the law be also similar across states. All stages of the taxation chain from the levy of the tax to its assessment collection and appropriation should be similar. This would involve similar rules across states dealing not only with assessments, audit, refunds but also more basic issues such as registration, filing of returns, treatment of transportation of goods, etc. A common dispute resolution mechanism as well as a mechanism for giving advance rulings would further facilitate trade and industry.
Benefits to state governments
A few state governments have recently indicated their opposition to the implementation of GST at the present juncture. While their objections need to be carefully examined, it must also be recognized that while implementation of GST is aimed at being revenue-neutral to the states, it will be budget-positive for the government. This is because governments are large purchasers in the market for their own consumption and their cost of procurement will come down significantly with the implementation of GST. Apart from these static benefits, dynamic benefits will be generated in the medium-term through more economically efficient production, improved competition and, more importantly, greater employment.
Role of the Finance Commission
It is possible that some states may want assurances that existing revenues will be protected when they implement GST. The commission is willing to consider providing for compensation in order to advance the implementation of a “flawless” GST.
I have shared with you my views on what should be some of the goals of the GST. I am acutely aware that there has been as yet no agreement on which of these goals will be adopted and how then will we reach the selected goals.
During his recent interaction with state finance ministers, the finance minister has encouraged state governments to implement GST from 1 April, 2010 noting that this was a critical part of the government’s economic reforms programme. This is a strong signal. The agenda is vast. All stakeholders need to and must contribute to the present debate. Once GST is introduced, outreach efforts by all agencies will be equally important.
Vijay Kelkar is chairman of the 13th Finance Commission. These are edited excerpts from an address given on 29 June to the Associated Chambers of Commerce and Industry of India. Comment at email@example.com