GST will not change India
It would be foolish to deny the benefits of the landmark legislation for the business community and in terms of administrative streamlining, but more foolish still is the notion that it is going to radically change India’s growth story
Dhruba Basu Delhi
Even as issues like the situation in Kashmir, the plight of Dalits and the vigilantism of gau rakshaks are belatedly raging in the public consciousness and in Parliament, the passage of the much-debated, much-awaited Goods and Services Tax Bill in both Houses has divided and inflamed opinions in a way that leaves no room for doubts about the significance of the legislation. The tortuous path of the Bill and the political victory that it signals for the ruling party at the present juncture automatically confer a symbolic significance upon it.
This has been partly achieved through much hyperbole. The Prime Minister on August 8 smoothly cashed in on global sentiment by linking the Bill to ‘freedom from tax terrorism’ (emphasis added) and peppered his speech in the Lok Sabha with creative full forms like ‘(G)reat (S)tep towards (T)ransformation’ and ‘(G)reat (S)tep towards (T)ransparency’. Meanwhile, nearly every major media outlet and think tank has welcomed it as India’s biggest tax reform. At the other end of the spectrum are the less numerous but no less vehement naysayers, who are denouncing it as a body blow to federalism, a death knell for the manufacturing states, and another empty promise that will in all likelihood have no positive effects on growth or inflation.
It would not be a new experience for the excitement at noisy policy decisions to give way to disillusioned sobriety. In the spirit of pre-empting tragedy from repeating itself as farce, there are several questions that must be asked … Most importantly, is it really the ‘biggest tax reform’ undertaken since India’s independence?
Back in 1991, a dominant Congress flung open the gates of what until then was a rigidly protected economy and declared it the beginning of an era of growth and prosperity while the BJP raised hell in opposition. Today, the tables have turned: the Congress, at its lowest ebb ever, seems to be nothing more than an obstructionist force while the BJP enjoys the largest majority since 1984 and now has an equally transformative reform to its name. But, as in the case of the previous ‘transformation’, a dazzling surface may not be the best indication of what lurks in the depths; the New Economic Policy engineered by PV Narasimha Rao, Manmohan Singh, Montek Singh Ahluwalia and P Chidambaram has neither made India a manufacturing and exports giant, nor reduced poverty.
It would not, therefore, be a new experience for the excitement at noisy policy decisions to give way to disillusioned sobriety. In the spirit of pre-empting tragedy from repeating itself as farce, there are several questions that must be asked before the Prime Minister’s words can be taken at face value. Most importantly, is it really the ‘biggest tax reform’ undertaken since India’s independence?
Distortions to be Ironed Out
Much has already been written explaining what the GST is and why it is needed. The fundamental idea is simple enough: remove the distortions within the existing Value-Added Tax regime. These distortions take many forms. Taxes like customs duty (a Central levy on products imported from abroad) and entertainment tax (levied by States) do not come under the VAT umbrella. At the Central level, ‘goods’ and ‘services’ are treated as separate entities. The former are subject to different rates on the basis of whether they are MRP or non-MRP goods; the latter, a Union monopoly (states have not until now been allowed into the Service Tax arena), are characterised by various exemptions, especially for a number of the services provided by the government, but also for services provided, for instance, by advocates to small businesses and by the IIMs to students under specific programmes.
Not only do these distinctions contribute to the complexity of the tax regime, they are often invalid. The line between 'goods' and 'services' is by no means a clear one, particularly in the age of information technology, when, to illustrate, a software update could be a discrete product (a good) or a part of a maintenance package (a service).
Meanwhile, at the State level, rates are based on the schedule a good belongs to (a taxonomy within which luxury goods are subject to lower rates than necessities, which is strange, to say the least, for a country that includes the word 'socialist' in the Preamble to its Constitution). Taxes on items that are on the Concurrent List are levied by both Centre (CENVAT) and State (SVAT), and are therefore levied twice on the same good. There are different rates for inputs (4%) and outputs (12.5%) as well, which is problematic because one industry's input is generally another's output; for the tax on a product to drop by 8.5% between successive stages in the supply chain encourages fudging and evasions by those who see themselves as unfairly or irrationally paying the higher amount.
Decisions will be considered binding on the strength of a three-fourths majority subject to a quorum of half the members of the Council. The voting pattern is weighted in favour of the States: two-third weightage goes to them and only one-third to the Centre. This is because the GST … disproportionately affects the States
It is this irrational aspect that the GST seeks to do away with, by proposing to bring all taxes on goods and services under two main heads, the Central GST and the State GST, and an additional Integrated GST on inter-state sales (equivalent to the sum of the other two and divided between Centre and State as per the rates set for the CGST and SGST). This effectively removes the discrete powers of the Union and States to impose duties on inter- and intra-state sales respectively, as well as many other existing deviations from the stated aim of instituting a single national market undergirded by a uniform system of taxation. These include excise duty, surcharge and cess, which have been the preserve of the Centre, and entry tax, octroi and entertainment, luxury and gambling taxes, which are set by and accrue to the States.
Subsuming this vast array of taxes that lie outside the VAT under one framework will address most of the problems that have plagued what the BBC has referred to as ‘India’s messy plethora of indirect taxes’. The mess gives rise to a labyrinth of different rates that the administration must deal with for the final tax calculation, turning it into an expensive and ungainly affair. With hidden nooks and crannies and the business-unfriendly phenomenon of ‘cascading’ taxes, repeatedly levied on the same product as it passes through all the stages that lie between the raw material and what the consumer buys, a complicated taxation system provides fertile ground for tax evasion (some might refer to it as ‘terrorism’) by manufacturers and traders and higher prices for consumers.
The GST is designed to address these distortions. Streamlining exemptions, unifying ‘goods’ and ‘services’ so that the latter can be taxed by the State as well, and applying the rate universally will widen the country’s tax base, ease procedure and increase compliance and revenues.
Implementation: Constitutional Amendment, GST Council, GST Network
Understandably, an overhaul of this scale is a gigantic proposal, as has also been discussed at length. To begin with, pursuant to the fact that it alters the division of taxation powers between the Centre and State set down in the Constitution, it requires no less than a Constitutional Amendment passed in the Lok Sabha and the Rajya Sabha by a special majority and ratified by at least half the State legislatures (i.e. 15). Both hurdles have been crossed.
The next step is the constitution of the GST Council, to be chaired by the Union Finance Minister and comprised of the Union Minister of State for Finance and the Finance or Revenue Ministers of all the States and Union Territories. The Council is empowered to make decisions on the rates, exemptions and special provisions of the new tax system, which involves adding taxes above and beyond the ones mentioned in the draft Bill and setting the lower limit of turnover for a business to come under the GST framework. Without such a threshold in place, small industries would be exposed to the same rate of taxation as larger ones, a kind of business foeticide.
Decisions will be considered binding on the strength of a three-fourths majority subject to a quorum of half the members of the Council. The voting pattern is weighted in favour of the States: two-third weightage goes to them and only one-third to the Centre. This is because the GST relates only to indirect taxes that are included in the cost of a trade or an exchange; it does not cover the taxes that are paid directly to the government, like income tax, corporate tax, wealth tax and capital gains tax, all levied and collected by the Centre. Leaving the bulk of the Centre's revenue earnings untouched, it thus disproportionately affects the States.
The United States, which itself does not have a VAT, the IMF and the World Bank have been instrumental in popularising [VAT], which is unsurprising given that reducing taxes on trade is integral to the neoliberal project
Needless to say, the administrative machinery finds itself on the cusp of a sea change in procedure. This large-scale exercise in simplification will be enabled by the GST Network, a non-profit private company set up in 2013 on the basis of the 'IT Strategy for GST' report. The report was published in 2010 by an Empowered Group on IT Infrastructure on GST under the chairmanship of Nandan Nilekani. As per its recommendations, the GST Network will set up and manage a platform on which all traders will register and file their tax returns electronically, government authorities and banks will process digitised documents and the revenue will be transferred to the government. A software-based solution is absolutely essential for transparency and smoothness in a system that must, for instance, allow for manufacturers and traders nationwide to claim input tax credit for the CGST (the tax paid by them for the purchase of their inputs must be deducted from the tax they pay on the sale of their output to avoid the cascading effect of the same tax being levied repeatedly on a good). On April 1 this year, the Finance Ministry approved the formation of a Steering Committee to 'monitor the progress of IT preparedness of GSTN/CBEC/Tax authorities, finalisation of reports of all the Sub-Committees constituted on different aspects relating to the mechanics of GST and drafting of CGST, IGST and SGST laws/rules'.
Some Exceptions to Remain
While all of that sounds perfectly copacetic, the need for something like the turnover threshold for small industries mentioned above hints at the fact that not all goods and enterprises are actually going to fall in line. It is noteworthy that the categories exempted in the draft Bill are some of the highest revenue earners across the board: alcoholic drinks, electricity, real estate and petroleum products will remain outside the purview of GST for the time being. This is a vast assortment, given that petroleum is an intermediary in innumerable everyday commodities. In an interview with CNBC-TV18, Chief Economic Adviser Arvind Subramanian said, '[A]bout 54 percent of the consumer price index basket will be exempt from the GST ... food, essential medicines, these are all tax exempt and that is likely to remain going forward.' He asserted that this largely precluded inflation in commodity prices, although certain sectors would inevitably be affected. For example, tobacco is to be subject to both GST and Central excise duty; the cost of cigarettes can thus be expected to continue accelerating upwards.
Meanwhile, tax exemptions currently in place for small industries and for industrially underdeveloped states must remain in place. If the GST is to be set at a revenue-neutral rate (RNR) that shields individual states from revenue loss after their fiscal autonomy is compromised, the ensuing tax burden will prove heavier for fledgling businesses and businesses in states like Uttarakhand or those of the north-east. It is incumbent upon the Centre to protect their interests.
A Short History
The Bagchi Reportof 1994 was the foundation for what ultimately took shape in 2005 as the Value-Added Tax, imported with a stamp of approval from countries at the vanguard of the global market. The origins of the VAT lie in post-WWII Western Europe; it was introduced in the French manufacturing sector in 1954 and spread across the continent over the next three decades after it was made a precondition for membership in the European Economic Community. The momentum picked up in the 1980s as it was adopted in other parts of the world, including Africa and Asia. The United States, which itself does not have a VAT, the IMF and the World Bank have been instrumental in popularising it, which is unsurprising given that reducing taxes on trade is integral to the neoliberal project.
How can a tax contribute to the citizenry's purchasing power? By taking from the rich and giving to the poor; this is the basic principle underlying progressive taxation, whereby the wealthy are taxed more to fund state welfare schemes like farmer credit, public education and healthcare. Since 1991, the Indian state has steadily withdrawn from all three
India joined the fray in 1986, when the government introduced MODVAT (which later became CENVAT) on Central excise duty. The basic purpose was the same back then as the GST's today: to solve the problem of cascading taxes, i.e. to pay sales tax on only your contribution (what you add), as part of the supply chain from first input (for e.g. wood) to final output (furniture retail), to the market value of the good. If the rate of sales tax is 10%, a tax of Rs 10 will be levied on the sale of a good worth Rs 100 and you will buy it at Rs 110. If you then process that good and raise its value to Rs 160, your economic contribution is Rs 50; ergo the good will now be taxed Rs 5 and sell at Rs 165. Were this value-addition clause to not exist (as was the case before 2005), your sale would be taxed on its total value of Rs 160 rather than the value you added, meaning that the consumer would have to pay Rs 176 for the good.
It was admitted in the Bagchi Report that the state VAT system would not miraculously address all the failings of a tax regime that it described as 'archaic, irrational, and complex - according to knowledgeable experts, the most complex in the world.' The division of powers in the Constitution held the Centre and State back from creating a broad tax base of all goods and services, but VAT was a step in the direction of a solution. The GST purports to be that solution - so why did it take so long to fructify?
There are, of course, political reasons. Work on the GST model began under the Vajpayee government, culminating in the recommendations of the Kelkar Task Force in 2004, the formation of the empowered comittee that drew up 'A Model and Roadmap for Goods and Services Tax (GST) in India' in 2008, and the introduction in 2011 of the Constitution (115th Amendment) Bill by the UPA government. The Bill was, however, defeated by the BJP, with then-Gujarat CM Narendra Modi leading from the front, which began to look suspicious when they reintroduced it in 2014. But the Constitution (122nd Amendment) Bill was a modified version of the original and now it was the Congress' turn to oppose it.
Reservations: Federalism, Manufacturing, Inflation, Direct Taxes Code
The conditions set by the Congress for acceptance of the Bill were: 1) a Constitutional cap on the GST, preferrably at 18%, was necessary to protect the consumer from high commodity prices, 2) scrapping the 1% levy on inter-state trade that will accrue to the State of origin, because this amounts to a retention of sales tax, and 3) the institution of an Independent Dispute Resolution Mechanism to settle disputes that arise between States in the GST Council, checking the potential for majoritarianism in decision-making.
These conditions touch upon all the main fears arising from the prospect of the GST. The exact rate of the tax is crucial; a high rate would mean an increase in commodity prices and a low one would mean a loss of revenue for the States. The rate, not mentioned in the Bill, will be fixed by the Council, but will the Council adequately represent the interests of all the States? A simple-majority voting pattern could lead to the interests of the few being sacrificed and one cannot ignore the possibility of the will of the ruling party at the Centre being exercised through the one-third weightage given to its votes and the votes of its State governments. The AIADMK, which has staged a number of walkouts over and continues to oppose the Bill, has been pushing for the weightage of the Centre's vote to be reduced to one-fourth of the total votes.
The GST is but a modified VAT, another step in a process that began with the MODVAT … there will also be bigger [reforms] to come, since it is still fraught with exemptions. … [T]he pattern it emphasises, of the Indian state's commitment to private enterprise to the negation of social welfare, is but an extension of the Faustian pact signed in July 1991
Tamil Nadu's stance is not mere petulance. It is a demand for the federal division of powers to be respected from the leading manufacturing state in the country and reflects legitimate concerns about a situation in which it stands to lose revenue and, by extension, the capacity to incentivise industry within its borders. To alleviate these fears, the draft Bill provides for the option of the loss-incurring States being compensated by the Centre for a period of 5 years. Arriving at a revenue neutral rate is also desirable. However, none of these rates or amounts have actually been finalised yet; the prevailing uncertainty does not instil confidence. In a country where the State governements are responsible for all major governance roles, their right to make independent decisions about how to raise money seems only fair.
The counter is that the GST will have an overall positive impact on business in the country, making taxation less of a headache, reducing the average tax burden by increasing the tax base, lowering production and commodity costs and making Indian goods more competitive internationally. Union Finance Minister Arun Jaitley has projected a possible boost of 1-2% to India's GDP. But these are speculative figures, contingent first and foremost upon the rates. The rhetoric of growth can be misleading when it suggests that a better environment for producers and traders is its lynchpin; in India, supply is not the problem, demand is. What is produced must be bought for there to be growth, but the per capita consumption capacity of a poor country cannot logically be high. And this brings us to the most 'signficant' oversight of the entire GST discourse: apart from the possibility that the prices of some commodities will fall (again, depending on rates), it does nothing to improve the average consumer's purchasing power. It is designed to benefit business; indirect taxes necessarily transfer the burden of taxation from the producer to the consumer. They are inherently regressive.
How can a tax contribute to the citizenry's purchasing power? By taking from the rich and giving to the poor; this is the basic principle underlying progressive taxation, whereby the wealthy are taxed more to fund state welfare schemes like farmer credit, public education and healthcare. Since 1991, the Indian state has steadily withdrawn from all three, making way for greater private investment, motivated by the pursuit of happiness as profit. To illustrate, nearly three-fourths of the expenditure on health in India is from the private sector, while the government's expenditure on public health has been hovering around 1% of the GDP for two decades in a country where medical bills are a prime cause of indebtedness among the poor. But this, too, is very much a neoliberal imperative; reduction in public health expenditure, a goal explicitly stated in the National Health Policy of 2015, is a cornerstone of the Bretton Woods makeover peddled by the IMF and the World Bank.
Meanwhile, the Finance Minister has announced, as Jaitley did earlier this year, a plan to reduce the corporate tax rate from 30% to 25% over the next four years. Government data on income tax over the last 16 years, also released a couple of months back, shows that only an infinitesimal 1% of India's population paid it in 2014-15. The share of direct taxes has fallen from 60.78% of total taxes in 2009-10 to 56.16% in 2014-2015, of which 53% is paid by Maharashtra and Delhi.
It is baffling that none of the attention lavished upon black money treasure hunts and indirect tax reform is reserved for the gaping income tax hole that reeks of non-compliance. For the base to widen and monitoring to improve, direct taxes need to be shared with the states as well, but there are no discussions on direct tax reform on the horizon, especially not after Jaitley effectively buried the topic in December 2014 by declaring that the Direct Taxes Code had lapsed with the dissolution of the of the 15th Lok Sabha. The DTC, drafted to replace the Indian Income Tax Act of 1961 and recommended for adoption by the Standing Committee on Finance after it was scrapped in last year’s budget, is aimed at bringing all direct taxes under a single code, prescribing rates such that they can be changed only by an Amendment rather than having them set in on a year-by-year basis, and basically increasing compliance and the tax-to-GDP ratio.
At a certain level, realising that the GST is but a modified VAT, another step in a process that began with the MODVAT, tempers some of the hyperbole about it being the biggest reform yet; not only has it been in the making for 30 years, but there will also be bigger ones to come, since it is still fraught with exemptions. At another, the pattern it emphasises, of the Indian state's commitment to private enterprise to the negation of social welfare, is but an extension of the Faustian pact signed in July 1991, an inevitable stage of an unfolding event. It could well be the biggest tax reform in independent India, but that is only because equally crucial ones are stalled. It also does nothing to change the lopsided, top-heavy and unsustainable narrative of growth that the Indian economy is wedded to, by the logic of which the share of indirect taxes paid by everyday consumers is increasing while the share of direct taxes on the income, wealth and property of the rich is falling.