The Congress party, in its objection to the proposed design of GST, has raised three important concerns. The first and the most important is the levy of 1% tax on inter-state transactions in goods and services. There is merit in the argument and, hopefully, the government will accede to this, as this is against the very grain of the destination-based GST. It will violate the principle of common market and result in inequitable export of tax burden from the rich states to consumers in less advanced states. Furthermore, it will bring in enormous complications in both law and administration when dealing with inter-state transactions in services and e-commerce.
While compromises in the design of the tax are unavoidable in a federation with 29 states, two Union Territories and the Union government, it is nevertheless important to get the fundamentals right. The economically-advanced states do not really have a case for demanding the inter-state tax, even if it is 1%. The argument that the levy is meant to compensate these states for the spending on infrastructure is fallacious because infrastructure is created to accelerate growth in output and employment. Indeed, many states, in addition, give generous incentives to attract investments. Ironically, while exports to other countries are zero-rated from GST, tax is sought to be levied on inter-state trade!
The second bone of contention is the need to cap the rate of tax at 18% in the Constitution Amendment Bill. While it is important to ensure that we levy the tax with a broad base, low rate and less differentiated rates, to put a ceiling rate in the Constitutional Amendment is both undesirable and impractical. It is undesirable because it does not allow the Union and states to vary the rates as and when needed. This will erode the autonomy of the states further, and even the states ruled by the Congress party will not agree to this. It is impractical because if the revenue-neutral rate is higher than the ceiling rate, then both the Union and states will lose revenue. With total tax-GDP ratio of just about 16.5%, under-recovery on account of this reform will either aggravate fiscal imbalance or will eat into the capital expenditure, which is clearly undesirable.
On the issue of revenue-neutral rate, there is considerable confusion. Indeed, the earlier study by the NIPFP for the Empowered Committee of State Finance Ministers estimated the revenue-neutral rate at 18% (9% each of the Union and states) if the tax is levied at one rate at both the Union and states levels and when the revenue loss on account of abolition of central sales tax is taken at 2%. However, when the tax is proposed to be levied in two rates—one lower rate for essentials (5%)—the general rate goes up. Furthermore, the Empowered Committee is unwilling to include the value of transactions in immovable properties in the tax base. Under these assumptions, the estimated general rate will go up to 13.5% each for the Union and states and, therefore, the discussion has revolved around 27% as the revenue-neutral rate. This is only an estimate and does not factor in improvement in tax compliance. More importantly, when the GST is introduced, if the technology is properly harnessed, the seeding of GST registration numbers with PAN could improve the compliance of income tax.
In view of these, the decision could be taken to peg the general tax rate of 10% leviable by the Union and states. The Union government should take the risk, and if it results in revenue shortfall, the GST Council should go back to the drawing board after 2-3 years and rework the rates. In any case, this cannot be and should not be an issue for the Constitutional Amendment.
The third issue of disagreement relates to the dispute resolution mechanism. Given that the interests of the Union and states do not always coincide, leading to conflicts, it may not be possible to resolve the conflicts among them in the GST Council. Therefore, it may be worthwhile providing for a conflict resolution mechanism in the Bill. The modalities of having an acceptable mechanism can be left to the GST Council.
The new situation has raised the hopes of an early resolution of the issue. However, it is important to note that this is only the first step and there is considerable work to do before the tax is introduced. Once the Bill is passed—and it has to be ratified from half the number of states—the next task is to constitute the GST Council and set the business in motion. The Council should draw up a clear time-table and put out a detailed work plan to conform to it. Each of the states, besides the Union government, will have to pass its own GST legislation. There is considerable bargaining to do before the final decisions are taken on the list of exemptions, the structure of rates, the place of supply rules, training of tax collectors, mechanism to deal with the issues of transition when the VAT is replaced by GST and taxpayer services.
There has been too much of brouhaha about the reform and it is necessary to exercise prudence and caution. The Union finance minister has termed it as the reform of the century and a game-changer, and this has been echoed by the champions of industry and much of the media. While the reform is extremely important, too much optimism could lead to disappointments and it should only be considered as the next stage of consumption tax reform. There is no acceptable empirical evidence to show that this will be a game-changer. The study done for the Thirteenth Finance Commission assumes a “flawless” GST and estimates potential gains in incomes and exports using the 2003-04 input-output table. In subsequent years, there have been several developments including the induction of technology in tax administration and the replacement of the cascading type sales tax with multiple rates with VAT at two rates. It is time the industry and trade also play a more proactive role in the architecture, engineering and management of the tax, rather than simply acting as cheerleaders to ensure that the fundamentals of the reform are in place.
The author is emeritus professor, NIPFP; non-resident senior fellow at NCAER; and adviser to the Takshashila Institution
