Kolkata: States that have huge mineral and petroleum reserves, but are economically backward may face significant loss of tax revenues on implementation of goods and services tax (GST), according to economists and experts in public finance.
Introduction of GST would lead to the abolition of central sales tax (CST), which is collected by state governments on inter-state sales of goods. The CST rate was reduced from 4% to 2% at the time of introducing value added tax (VAT) in 2005.
Some states may have a revenue shortfall initially, though under GST they are to be given the right to tax services for the first time, said Asim Dasgupta, chairman of the empowered committee of state finance ministers which is working on the finer and final aspects of GST, which could create an unified market within the country for the first time.
Consumption of services is normally low in economically backward states, said R. Kavita Rao, a professor at National Institute of Public Finance and Policy, Delhi. “Their income from CST too may not be significant,” added Rao. “But if a state is rich in mineral reserves, the deficit could be significant.”
To compensate such states, the Central government would provide financial assistance like it did at the time of introducing VAT, said Dasgupta. States have been pressuring the Central government to compensate them for up to five years.
Tax benefits: Asim Dasgupta says that eventually GST should benefit all because the continuous chain of set-offs would lead to significant improvement in tax compliance, both for the Centre and the states. Indranil Bhoumik/Mint
Also, though GST rates would be uniform across the country, there would be provision under which a state could “through discussion with others” change the tax rate to tide over financial crisis, said Dasgupta.
“I think, states could be allowed to increase tax rates without disturbing the basic two-rate structure of GST,” said Rao. “However, states might not be allowed to reduce taxes... If a state decides to raise tax, it would be taking a revenue-risk. It should not affect any other states.”
GST, however, may not lead to a uniform two-rate structure across the country in the long run, said Rao. After the initial years through which the centre will compensate states for revenue deficits, states may not agree to a common structure “unless bound by the constitution or some alternative mechanism”. “In my view, there is no reason for states to agree to such a bind, but if they do, it’s the end of the debate,” she said. “What GST effectively does is include services in the VAT net.”
Dasgupta, however, said in an interview that GST is the most comprehensive step ever taken in India towards indirect tax reforms. Edited excerpts:
Why do we need GST to replace VAT?
The existing VAT was a major improvement over the sales tax regime that existed at the state-level before VAT was introduced. Similarly, the existing CENVAT (central VAT) regime at the national level was also an improvement over the central excise duty.
In the sales tax regime, there was the burden of tax cascading, or tax-on-tax. For instance, producers had to pay tax on inputs for which tax had already been paid… Also, there was the problem of multi-point sales tax in several states. When the producer sold a good to a wholesaler, tax was levied; when the wholesaler sold that good, on which he had already paid tax, to a retailer, tax was again levied and so on—a sequence of tax-on-tax or a tax cascade.
After VAT was introduced, a set-off was allowed for the tax paid on inputs; and for the distribution channel, set-off was allowed for any tax paid by the previous seller.
However, in the VAT regime, there were certain shortcomings. For instance, no set-off was allowed for CENVAT, which was levied when a good moves from the central tax zone to a state tax zone. Secondly, there were several other indirect taxes such as luxury tax, entertainment tax, which were not subsumed in VAT.
Also, taxes on services weren’t included in VAT, and so no comprehensive set-off was allowed for taxes paid on services.
If you take any good, it has embedded in it both material inputs and services, but there was no provision for set-off for the tax paid on services.
Also, numerous Central taxes such as Central excise duty, additional customs duty were not subsumed in VAT, and finally, CST wasn’t phased out —it was reduced from 4% to 2%, but remained there.
GST will establish a comprehensive chain of set-offs, both for goods and services, and reduce the burden of taxes. GST is proposed to subsume Central taxes such as excise duty, additional excise duty, service tax, additional customs duty, which is also known as countervailing duty and surcharges, and state-level duties such as VAT, sales tax, entertainment tax, luxury tax, state-level surcharges, taxes on betting and gambling and so on… Also CST will be phased out.
This is a significant step forward—all these could not be done at one go. States could not take the risk of subsuming so many taxes at one go. You may ask why states are taking the risk now? Because through a proposed amendment of the constitution, states are to be given the power to levy taxes on services, they are now taking the risk. That (tax from services) should compensate for the revenue loss on account of CST abolition.
What are the key concerns of the state governments?
From what we have observed, normally around 50% of a state’s income comes from services. But consumption of services is not always proportionate to income from services. Some of the states, I am not naming any, are not big consumers of services.
So, we have worked out which states would gain more than others, and on implementation of GST, the Central government should compensate state governments for any loss of revenue during the transitional period. The arrangement, I may say, would be revenue-fair for both the state and Central governments.
Eventually, you see, GST should benefit all because the continuous chain of set-offs, which is based on payment of taxes, would lead to significant improvement in tax compliance, both for the Centre and the states.
We are discussing with the government of India how this could be accommodated. We did the same thing when we implemented VAT, and the (Union) government eventually had to pay much less than was initially budgeted. How much the government might have to pay to compensate states is under discussion, and it would also depend on the rate structure that we eventually agree upon.
Also under GST, we are going for a two-rate structure: One called the standard rate, and the other, the lower rate. Some items are going to be exempt from GST, and some such as precious metals would attract a special rate. We would like the rate structure to be uniform. And from that arises the other concern—the autonomy of the states. So, while we keep the GST rates uniform across states, we have to work out a mechanism through which we can strike a balance between uniformity of rates and the autonomy of the states—we must keep in mind that India has a federal structure.
Say, if there is an exigency in a state…we will have a mechanism under which the state may be required to share its concern with other states and there would be transparent discussion on the problem. In some way, the state’s need would be accommodated and I think it wouldn’t disturb the uniformity of the tax structure in any significant manner.
How will GST benefit consumers?
Because of total set-off under GST, which wasn’t possible under the current tax regime, because of inclusion of so many taxes in GST, and because CST is going to be phased out, the overall burden of taxes on goods is bound to fall.
Other things remaining constant, this should benefit the consumer. This should also benefit the industry, trade and to some extent even agriculture. The government of India and state governments would work together to ensure that the benefits are passed on to consumers.
What is the experience of other countries that have implemented GST?
Most countries that have implemented VAT have eventually included services also under it, and have introduced GST. About 150 countries have GST. Among them, countries such as Canada, Australia, New Zealand, Brazil and few others have federal structures like India.
Brazil has not fully achieved it, but Brazil and Canada are comparable with India, but such are the characteristics and diversity of India that our model could be a unique one.