Flaws in India's GST defeats its purpose

There is much work to be done to design a good GST, notes Parthasarathi Shome.

In the last mile, many essential components of a robust goods and services tax India is rushing towards a so-termed GST replacing service tax and excises (or CENVAT) at the Centre and VAT and small consumption taxes of the states.

In a decade-long process of replacement, major successes were occurring to meaningfully consolidate the nation’s domestic consumption tax structure.

But in the last mile, many essential elements of a robust GST have been shaved off; so the current version of GST is neither sufficiently aligned to easing the way of doing business nor internationally benchmarked.

I write today because I care about this tax, having assisted some 30 countries in its reform or introduction, becoming involved in India since 1995.

Neither will I be shy in revealing that as chairman of the task force on tax policy and administration for India’s Tenth Five-Year Plan, in 2001 that report recommended a seamless tax on goods and services with parallel channels for the Centre and states.

I made presentations to K C Pant, the stalwart Deputy Chairman, Planning Commission. After an early presentation, I confessed that some of the recommendations might seem idealistic but asserted, albeit apologetically, that they nevertheless were optimal.

Addressing me as professor, Pant replied solemnly that I should present the best and not think of downsizing for which others would be readily available. Technocratic Yashwant Sinha, then finance minister, mentioned the report in his 2002 Union Budget speech, indicating he would streamline tax incentives following the report’s recommendations.

Today that seems long ago. A decade later, Mr Sinha, then chairman, Parliamentary Finance Committee, invited me to provide views on GST which are on record. The 2015 Parliamentary Select Committee on GST also invited me for my views. 

If constructed appropriately, GST makes transparent the tax administration and is revenue productive. It removes distortions in businesses’ production decisions by effectively taxing only consumption (not production).

It does not differentiate goods from services, or within goods or services streams. Following his GST announcement in Union Budget 2006, a comprehensive report was convened by P Chidambaram, then finance minister.

As permanent invitee to the Empowered Committee (EC) of state-level finance ministers, I co-authored that first report and submitted GST’s best achievable structure on December 31, 2007. It hopefully occupies a place in the annals of EC.

The current GST proposals fail essential tests including Mr Sinha’s Parliamentary Committee recommendations. The shedding occurred reflecting individual states’ interests.

They bypassed national concerns while the Centre, appearing to be in a hurry, accommodated this watering down process. I wonder what Pant would have to say were he to witness these developments.  

First, presuming that GST will occur on April 1, 2016, India is the first country I have experienced with considerably less clarity regarding the intricacies in its proposed structure, transitional arrangements, administration and procedures, and framework to contain inflationary ramifications. In other countries, consultation on the actual proposals would have taken place in an open manner.

Second, one major characteristic of GST is that it should not distinguish between a good and a service. Yet, in its GST, India is likely to continue with a distinction.

The argument put forward is that services are currently being taxed at only 14 per cent at the level of the Centre; hence any equality of rates between goods and services would raise the tax rate on services too much. But the solution is not to keep a separate lower rate for services, rather to consult, educate and arrive at understandings with business chambers and traders. 

Third, states have been allowed to have bands in their GST rates. This debate started with states initially pleading they should be given some flexibility with rates in periods of emergency for temporary extra revenue. That then snowballed into full-fledged bands that even their prevailing VAT does not allow.

Theoretically a band being a continuous line, the SGST could have infinite rates. I cannot imagine the impending impossible life of an interstate dealer. Thus GST could potentially go back to the future, reinventing the sales taxes era that prevailed prior to VAT.

Fourth, excluding petroleum products will rob GST of comprehensive input tax credit (ITC). Relatedly, capital goods would continue to be given ITC only over two years and not in one year.

Both these would result in considerable cascading or ‘tax on tax’ for businesses and, since they will certainly attempt to pass this downstream to consumers, the latter will face an array of prices that would not reflect market demands accurately.

Instead, the relative prices among all goods and services will reflect different cascading elements in them, reducing GST to a hybrid production/consumption tax. (Exemption of alcohol for domestic consumption will also suffer from, and contribute to, similar limitations).

Given that one state that would considerably enjoy protection of revenue from petroleum production is the Prime Minister’s own, this is the moment to rise above state specific interests and, in the national interest, include petroleum fully in GST, just as he displayed acumen by retracting from his 2015 Land Acquisition Bill to reincorporate social impact analysis and states’ views (see my 14.07.15 BS Opinion).

Fifth, a one per cent interstate trade tax will be retained and later reviewed by GST Council. This tax will cascade since exporting states will retain its revenue without allowing ITC.

Again, this will favour exporting states that are richer. Fiscal federalism comprises not just Centre-state but also inter-state equity. The finance minister could boldly remove this tax from GST framework, declaring it will not only be inefficient due to cascading but inequitable among rich versus poor states, just as he has accepted not to impose MAT on FIIs.

In sum, there remains much work to design a good GST. Otherwise, it can be called GST but neither will price distortions reduce, nor business decisions or consumption reflect demand-driven prices, nor administration and compliance be simplified, nor GDP be impacted positively, nor revenue excel, nor the world accept it in a global pantheon of GSTs.