Traditionally, indirect taxes such as customs, excise and service tax have been the largest contributor to the Union government’s tax kitty. This is about to change. In the current year, direct taxes are, for the first time, poised to overtake indirect taxes. Finance minister P. Chidambaram has described direct taxes as taxes of the future, but it’s indirect taxes where the painstaking reforms are being carried out.
Reforms in indirect taxes are far more complicated than any that might be attempted under direct taxes. This is because the taxation powers, under the Constitution, are shared between the Centre and the state governments. In fact, the power to levy indirect taxes on some commodities has been exclusively reserved for states. Alcohol, for instance, is taxed by states, and plays a critical role in keeping many states financially afloat. Moreover, tax at the retail outlets is levied at varying rates by the states, which makes for a country with fragmented markets and distortions.
The solution to the fragmentation and distortion is going to be the goods and services tax, or GST, which is scheduled to be introduced in April 2010. GST, according to finance ministry officials, is the single most important tax reform India will undertake.
Given the enormity of the implication of GST, it requires a consensus among all political parties and states. The groundwork will be overseen by state finance ministers (FMs). A body called theEmpowered Committee of State Finance Ministers was created and registered as a society to ensure continuance to the GST process. As a result, despite regime changes at the state level, the transition to GST has, so far, been according to the timetable. About 120 countries currently follow the GST model.
In 2007, committees of bureaucrats from different states and the Centre worked on evolving a road map for GST under the overall guidance of the then special adviser to the FM, Parthasarathy Shome. In December 2007, state FMs discussed the road map suggested by the committees of bureaucrats and reached a consensus that India would move to a dual GST: a Central tax and a separate one for states. The big change is that states would charge a uniform GST rate, as opposed to the existing practise of multiple rates.
How would the GST work? Based on the road map, GST would work in the following way. Suppose a shoe firm makes a pair of shoes, the Union government charges an excise duty on them as they leave the factory. At the retail level, the state where the outlet is located, charges value-added tax (different states charge different rates of VAT) without giving credit on the excise duty levied earlier (the state tax is levied on top of a Central tax). In the GST system, both Central and state taxes will be collected at the point of sale. Both components (the Central and state GST) will be charged on the manufacturing cost. The result: lower incidence of tax and, possibly, reduced prices.
The possibility of lower taxes comes about as GST is expected to solve a significant problem in domestic manufacturing: cascading taxes. Taxes are levied more than once for the same good and companies are not able to offset them as the market is fragmented.
A big change in administering GST is that tax incidence is at the point of sale as against the current system of point of origin.
What we do not know now is what will be the tax rate in the GST system; it will be finalized as the deadline approaches. That has not prevented speculation about the possible GST rate. S. Madhavan, executive director of PricewaterhouseCoopers Pvt. Ltd, feels the rate is likely to be around the 20% mark.
GST has other benefits. It is expected to play a key role in bringing about more transparency into the system. Successive FMs have disapproved using taxes as a magnet to draw investment into favoured sectors or states. The advent of GST will mark the last stretch— implementing VAT in states was a key step—when the economy will move to a more transparent method of directing investment.
Instead of fiscal concessions, concessions to select industries on grounds such as environmental protection could be provided in a transparent manner through cash refunds on taxes paid, say finance ministry officials. There must be exceptions everywhere. Even in the GST regime, states will be allowed to charge tax rates most suitable to them on alcohol, tobacco and petroleum products.