Politics over economy: Why the GST structure is an unfortunate compromise
Have political concerns outweighed sound economic logic when it comes to the GST structure?business Updated: Jun 25, 2017 07:10 IST
India is set to implement the goods and services tax (GST) on July 1 to replace a bunch of state and federal levies in what is being called the biggest tax reform since independence.
The best way to understand the grand federal bargain is to consider it a victory of immediate political concerns over potential economic gains that could have been possible in the future. In other words, political optics have overpowered economic logic.
The tax rates that have been approved by the finance ministers in the GST Council are clearly a reflection of three political economy concerns. First, the impact of the new tax regime on the prices citizens will pay. Second, the impact on government budgets through changes in tax collections. Third, maintaining an element of progressivity on what is essentially a regressive tax, as all indirect taxes are. The overarching goals of the negotiations thus seem to have been to ensure that the inflationary impact is minimal, government revenue is protected, and the new tax system explicitly appears to be pro-poor.
The problem is that these dominant political economy concerns have led to a complicated tax structure with multiple rates, exemptions and even cesses—a far cry from the clean goods and services tax that had been proposed initially more than a decade ago. The multiple rates on services are beyond belief. Fears of a flawed GST structure have now been confirmed.
Why should this be a worry? The complicated tax structure that has now been decided in many ways is a copy of the current tangle of excise duties. Consider some examples. There are separate GST rates for roasted coffee and instant coffee. The tax rates on restaurants have been decided in a way that would do the interventionist Indian bureaucracy proud. The sheer complexity of the GST structure will result in tax disputes, lobbying and corruption in the future.
The second problem with a complicated tax structure is that it will lead to distortions. The GST, even in its current form, will lead to efficiency gains in the Indian economy—and hence lead to higher growth. But the growth dividend is likely to be far lower than what a better structure would have delivered. HSBC India chief economist Pranjul Bhandari has estimated that the addition to economic growth in the medium term will be 0.4 percentage points, rather than 0.8 percentage points from an ideal GST structure.
The GST council has taken a static rather than a dynamic view of the transition to GST. On the one hand, a more complicated tax structure will actually increase business costs, while on the other, exemptions will mean cascading of costs because of the absence of input tax credits. Higher economic growth as well as a bigger tax base would also have ensured revenue neutrality despite lower tax rates. The optimality in a tax system should be judged on elasticity.
A simple GST structure, with zero taxes on a few essentials, a high tax rate for a few sin goods and almost everything else taxed at a single rate would have added clarity, transparency and boosted growth.
The GST structure that has been decided on is too complicated and distortionary for India to reap the benefits of the national value-added tax.
Economic reformers will now have to push for a simpler GST structure in the years ahead. There are two ways to do this. First, governments should gradually remove exemptions, on the one hand and equally gradually, bring taxes on most goods and services to a standard rate on the other hand. Second, there is now a strong case to push ahead with the direct taxes code so that higher collections of income and corporate taxes create fiscal space for a rationalization of indirect taxes. That is easier said than done, because the GST council could present classic collective action challenges.
India will now begin with a flawed GST structure. There is no doubt at all that it is an improvement over the messy system of national, state and local taxes that it will replace. GST will integrate the Indian market, promote economic efficiency by taxing final consumption rather than intermediate goods, encourage voluntary compliance and create a new architecture for cooperative federalism.
However, it is unfortunate that we will have a complicated tax structure that may seem politically less risky at this point in time but is most likely to compromise on the growth and efficiency gains that a simpler GST would have delivered over the long run.
The original GST crusaders now have another important battle on their hands.
1. What is GST?
GST is a value-added tax at each stage of the supply of goods and services precisely on the amount of value addition achieved. It seeks to eliminate inefficiencies in the tax system that results in ‘tax on tax’ known as cascading of taxes. GST is a destination-based tax on consumption, as per which the state’s share of taxes on inter-state commerce goes to the one that is home to the final consumer, rather than to the exporting state. GST has two equal components of central and state GST.
2. What is input tax credit?
To make sure that tax is levied only on the amount of value addition at each stage of the supply chain, credit for the taxes paid at the previous stage is granted. For example, a garment manufacturer gets credit for the taxes paid on the materials purchased while computing the final indirect tax liability on his product that is collected from the consumer. Similarly, a service provider, say a telecom company, gets credits for the taxes paid on the goods and services used in his business.
3.Who is liable to pay GST?
Businesses and traders with annual sales above Rs 20 lakh are liable to pay GST. The threshold for paying GST is Rs 10 lakh in the case of north eastern and special category states. GST is applicable on inter-state trade irrespective of this threshold.
4.What are the existing taxes that are subsumed into GST?
Taxes on production such as central excise duty and additional excise duty, import duties such as additional customs duty known as countervailing duty and special additional customs duty, service tax, central cesses and surcharges, state taxes like value added tax (VAT), central sales tax on inter-state trade of goods, luxury tax, entertainment tax except those levied by local bodies, taxes on advertisements, taxes on betting and gambling and state cesses and surcharges on supply of goods and services are subsumed into GST. Basic customs duty, which the tariff barrier on imports, is not part of GST.
5. What are the benefits of GST?
GST brings transparency on the taxes levied on the supply of goods and services. At present, when an item is purchased, the common man sees only the state taxes on the product label, not the various embedded tax components. GST will improve the ease of doing business as entry barriers along state borders will be dismantled. The new indirect tax system is expected to improve tax compliance, boost revenue receipts of central and state governments and accelerate GDP growth rate by an estimated 1.5-2 percentage points. Elimination of cascading of taxes will result in reduced tax burden on many items.
6. What are the products not part of GST?
Crude oil, diesel, petrol, natural gas and jet fuel are temporarily kept out of GST. The GST Council, the federal indirect tax body of state finance ministers chaired by union finance minister, will decide when to bring these items into GST. Liquor is kept out of GST as a constitutional provision and hence it would require an amendment to Constitution if it is to be brought into GST net.
7. What is integrated GST or IGST?
IGST is the tax on inter-state supply of goods and services with central and state GST components.
8. How are imports treated?
Imports are treated as interstate supplies and will attract IGST. Exports do not attract any tax. Taxes paid on the raw materials and services used in export of goods and services are refunded to the business.
9. What is the anti-profiteering mechanism?
To prevent the possibility of prices going up and to make sure that the reduced tax burden on products and services are passed on to consumers, the government introduced an anti-profiteering clause in GST law. The anti-profiteering authority to be set up will act on complaints of profiteering and direct a profiteering supplier to cut price, return the benefit of reduced tax burden to the buyer with 18% interest or recover such amount if the buyer cannot be identified or doesn’t make a claim. A profiteering business could lose its GST registration too.
10. How are decisions taken at the GST Council?
No decision can be taken in the Council without the concurrence of both the union or the state governments. Decisions will be taken by a 75% majority of the weighted votes of members present and voting. Union government’s vote has a weightage of one third of the votes cast, while all states together will have a weightage of two third of the votes cast.