It might be useful to begin by quickly summarising the business case for GST.
The GST is a tax reform that has been on the cards for more than a decade. In principle, it is the same as the Value-added Tax (VAT) — already adopted by all Indian States — but with a wider base. While the VAT — which replaced the sales tax — was imposed only on goods, the GST will be a VAT on goods and services.
In the current tax regime, States tax sale of goods but not services. The Centre taxes manufacturing and services but not wholesale/retail trade. The GST is expected to usher in a uniform tax regime across India through an expansion of the base of each into the other’s territory. This is why a constitutional amendment was necessary — to give concurrent powers to both the States and the Centre to make laws on the taxation of goods as well as services.
Not surprisingly, the economic arguments trotted out in favour of the GST are basically the same as were given two decades ago for the introduction of VAT. These are twofold.
First, the GST, by subsuming an array of indirect taxes under one rubric, will simplify tax administration, improve compliance, and eliminate economic distortions in production, trade, and consumption. Second, by giving credit for taxes paid on inputs at every stage of the supply chain and taxing only the final consumer, it avoids the ‘cascading’ of taxes, thereby cutting production costs, and making exports more competitive. According to the Union Finance Minister Arun Jaitley, thanks to these efficiencies, the GST will add 2 per cent to the national GDP.
Only time will tell whether the GST will have a positive impact on the GDP. But there is one thing the GST will not have a positive impact on: the States’ fiscal, and therefore, political autonomy.
A losing proposition for the States?
Things don’t look all that dire on paper. As per what’s being referred to as the GST Bill – which is actually the Constitution (122 amendment) Bill, 2014 — passed in the Lok Sabha last month, India will have not a single federal GST but a dual GST, levied and managed by different administrations. The Centre will administer the central GST (CGST) and the States, the SGST. The monitoring of compliance will also be done independently at the two levels.
However, as Kavita Rao, professor at the National Institute of Public Finance and Policy (NIPFP) and member of one of the Working Groups constituted on GST by the Empowered Committee of State Finance Ministers, points out, when you move to a GST regime in a federal set-up, some curtailment of the State’s freedom is inevitable. “All goods and services will be divided into certain categories. The rates will be fixed by category, and if I am a state, I cannot shift a commodity from a lower to a higher rate, or put it in the exempt category.”
This is not the only limitation. The rates for both, the CGST and the SGST, will be fixed by the GST Council, whose members will be State finance/revenue ministers and chairman will be the Union finance minister. Once the rates are set by the GST Council, individual States will lose their right to tax whichever commodities they want at the rates they want.
This development needs to be viewed in the context of a steady erosion in the states’ freedom to decide on taxes and tax rates. The economist Prabhat Patnaik points out, “According to the Constitution, the States have complete autonomy over levy of sales taxes, which, on average, accounted for 80 per cent of their revenue. An attempt was made to curtail this autonomy with the introduction of VAT. But it did not totally succeed because the VAT still had four different rates that states could play with. But with the GST, which mandates a uniform rate, even this limited autonomy would be gone.”
In other words, while the loss in revenue of the States may well be compensated by the Centre (as provided for in the GST Bill), how does one make good a State’s loss of the political right to fix its own tax rates?
Ms. Rao believes this is not necessarily a bad thing. “Individual States are always catering to some interest group or another. By placing limits on what they can do, we are effectively empowering them to resist interest group politics, where someone or other is always lobbying for concessions or exemptions.”
But this is a problematic argument. “The underlying assumption here,” says Mr. Patnaik, “is that political representative bodies are irresponsible. So give them less power, less discretion. This is a fundamentally anti-democratic vision of development.”
Moreover, the restrictions imposed by a uniform tax regime could adversely impact States that may be more committed to welfare expenditures. “The AIADMK or the Left Front or Mamata Banerjee may have their own development philosophies,” says Mr. Patnaik. “In order to express these philosophies, you have to be able to control your tax revenue. Why should I give up this right which I already have — and be sitting in some Council where I will be outvoted by other states or the Centre telling me what I can or cannot do?”
Perhaps it is to allay this concern that the draft GST bill speaks of the GST Council fixing not just rates but “rates including floor rates with bands”. A band would, at least on paper, give some room for states to vary their rates depending on their need.
A floor-rate-with-band model (as opposed to a uniform rate) of GST is also what Ms. Rao is rooting for. “To my mind, it is the procedures, definitions, and credit rules that should be uniform for a harmonised tax regime. We should let the States figure out what rates they want.”
However, a GST regime where each State has a different tax rate for different goods and services doesn’t sit well with the industry demand for a single national market with a uniform tax regime. Besides, if rates will be different, the taxes will be dual, and the dual taxes will be administered independently by the States and the Centre, why not just streamline the existing tax architecture instead of erecting a new one?
The social dimension
The answer to this question leads us to the other aspect of the GST, to do with why it started to get widely adopted (as VAT) from the 1970s, paralleling the rise to global dominance of neo-liberal economic thought.
The GST, even in the diluted version proposed in the GST Bill, would still accomplish one thing: widen the tax base and make it identical for both the Centre and the States. That is because, unlike, say, an excise duty (whose base consists of manufacturers) the GST is paid only by the final consumer. The seller of the good or service remits this GST to the State after deducting the taxes already paid by him earlier in the supply chain.
In other words, while the GST, like all indirect taxes, is a tax on consumption, in seeking to institute a uniform rate on all forms of consumption, it tightens the tax net — currently riddled with numerous holes in the form of multiple rates and exemptions and classifications — in addition to widening it.
Many countries that have embraced the GST have also exempted essential commodities from it, or kept lower rates for select goods. But the very logic of GST is such that it works best when the exemptions are zero or minimal. New Zealand comes closest to the GST purist’s dream — with very few exemptions. Once implemented — in however compromised a form — this is the direction GST regimes gravitate toward: fewer exemptions, higher rates. New Zealand introduced GST at 10 per cent — today it is 15 per cent. In the countries where the GST rate was reduced over time, it was made possible by a broadening of the base by minimising exemptions.
This brings us finally to the question that has monopolised the GST debate of late: what should be the taxation rate? The report of the 13th Finance Commission’s Task Force on GST recommended 12 per cent (7 per cent for SGST and 5 per cent for CGST). That was in 2010. In 2014, a panel of State government representatives mooted a revenue-neutral rate or RNR (rate at which tax revenues for states and the Centre will remain the same as before GST) of 27 per cent ( 12.77 per cent and 13.91 for CGST and SGST respectively.
Both these rates might be unrealistic. A 12 per cent GST will most definitely mean substantial revenue losses for states, as the general VAT rate for many states hovers around the 13-14 per cent mark. And from this week, the service tax (levied by the Centre) has gone up from 12.36 per cent to 14 per cent, a move, ironically enough, intended to smoothen the transition to a GST regime.
A GST rate of 27 per cent, on the other hand, would impose an enormous tax burden on the wage-earning classes, and could prove fatal for any elected government. Understandably, Mr. Jaitley has been quick to clarify that the GST rate would be much lower than 27 per cent.
In fact, the ideal way to bring down the GST rate without incurring revenue losses is to widen the base by including as many goods and services under its purview as possible. But this could mean that some essential goods currently taxed at a lower rate could end up being taxed at a higher rate under a GST, but it would hit the lower income groups harder.
This might explain why in some developed countries, including Canada and Australia, the introduction of the GST was opposed fiercely by the local working classes, especially the trade unions. The resistance to it was so strong in Canada that the then Prime Minister Brian Mulroney had to invoke an obsolete, colonial era provision of the Constitution — drawing on special powers of the Queen — to get the law passed in the Senate.
At any rate (pun unintended), the GST can only be implemented, believes Ms. Rao, by “a leap of faith”. She elaborates, “You can’t do a calculation to the last penny and say only at this revenue-neutral rate will I implement GST. It has to be acceptable to the masses, because at the end of the day, it is the average citizen who has to cough up the money.”
The shift towards indirect taxation
Around the world, governments, faced with declining tax revenues, and too fearful that higher corporate taxes will lead to capital flight (or capital slumber), have been turning their attention to indirect taxes, which have a wider base than direct taxes, are more difficult to evade, easier to administer, and not income-dependant beyond a point.
It’s because the poor and the working classes spend a greater proportion of their income on essential consumption compared to the classes that are better off, that indirect taxes are considered regressive compared to direct taxes, which are typically proportional to the ability-to-pay. India isn’t immune to this global shift in favour of indirect taxation, accompanied by lower taxes on capital and reduced social spending.
The National Democratic Alliance government has already ticked two of those boxes. The 2015-16 budget, which fixed a roll-out date for GST (April 1, 2016), also abolished the wealth tax, and announced a lowering of corporate tax rate from 30 per cent to 25 per cent over a four-year period. According to Mr. Patnaik, the same budget also grants direct tax concessions to the tune of Rs. 8,315 crore, while planning to raise Rs. 23,38 crores through indirect taxes.
This is despite that fact that India’s direct taxes contribute only 37.7 per cent of total tax revenue, according to a 2013 study by the Center for Budget and Governance Accountability — which makes India’s taxation regime already more regressive than that of other emerging markets such as South Africa (57.5 per cent from direct taxes) or Indonesia (55.85 per cent). When the third box, the GST, is ticked, it could become even more so.
Keywords: GST, Goods and Services Tax
