Should we have gone ahead with the GST, warts and all?

The Finance Minister has used the “short-term pain for long-term gain” argument to justify the go-ahead. That sends a chill down many spines, given the experience with demonetisation.

Written by Rahul Khullar | Published:July 6, 2017 12:29 am
gst, gst opinion, goods and services tax, gst review, indian express opinion The tacit grand plan was to do this through a two-step process. First, the States would have to move to a State VAT regime. Second, Central and State VAT would be integrated into a national VAT, or the GST. (Source: PTI)

The Goods and Services Tax (GST) is finally here. It has been 25 years in the making. The idea of moving to a National Value Added Tax (VAT) was mooted in1992-93. But first, some background.

The problems of the prevailing indirect taxation regime were well known. There were multiple taxes levied by the Centre and the States: Excise (Centre); Services tax (Centre and States); Sales Tax (States); Electricity duties (States); Octroi (States); Entry taxes (States). Producers and consumers paid taxes on taxes, meaning, excise duties were paid on a good and consumers then paid sales tax on the value of the good as well as excise levy.

There were many excise rates as also sales tax rates, i.e large dispersion of rates. Worse, the same good sometimes attracted different sales tax rates in the States. And the inter-state movement of goods attracted sales taxes. Finally, the Government of India and each of the State Governments were separate tax jurisdictions. All of this inhibited the emergence of a national market.

So how could one reform this regime? Simple. Subsume all taxes into a single tax (VAT) levied on a national basis. Provided the levy was on a value-added basis, cascading taxes (taxes on taxes) would be averted. The single tax would unify the national market.

Simplify the rate structure, by limiting rates to two or three, including a zero-rate. In a stroke, you would create a national market, reduce legal disputes and litigation, as well as reduce evasion of taxes on production, sales and income.

The problem: the taxation powers of the Central Government and the States were different and clearly laid out in the Constitution. How to then arrive at a single national levy?

The tacit grand plan was to do this through a two-step process. First, the States would have to move to a State VAT regime. Second, Central and State VAT would be integrated into a national VAT, or the GST.

The transition to a State VAT would achieve two main goals. It would unify tax rates across all States – that is, the levy on a good would be the same in all States. More importantly, States (and businesses) would get used to the practice of a VAT, in particular the input tax credit (ITC) regime. In a VAT regime the tax is levied on the value-add in each stage of a chain of transactions, thus averting cascading taxes.

So, at each stage a producer/trader who pays taxes on inputs, gets credit for those taxes when she sells the goods for the next phase of value addition. For example, a shirt maker who buys cloth valued at Rs 100, and pays on it a tax of 10%, or Rs 10. Now, suppose she embroiders the shirt and adds value of Rs 50 to it. When it is sold it attracts a tax of 10% on Rs 150 (the total value added), which is Rs 15.

However, the shirt maker claims an ITC of Rs 10 for the taxes she has paid and makes a net payment of Rs 5. This, then, goes on through the entire chain. The upshot is that VAT is paid only on the value-add, thus avoiding any tax-on-tax payment. The ITC regime creates a digital trail of transactions and incentivizes declaration of transactions as this is the only way to claim ITC. Thus, it becomes a self-policing taxation regime.

The GST that came into force on July 1 is an imperfect version of the ideal discussed above. There are as many as 7 rates of tax. Items like petrol, diesel, and alcohol are left outside the purview of the tax. There are multiple tax jurisdictions — Central, State and multi-State (for businesses with transactions in different States).

The first set of problems relate to compliance. Many small businesses have never used computer-based systems for business accounting. For them, the transition will be hard. And, if they are simply not ready in terms of familiarity with the software or its application, there is a serious problem.

The government has been accommodating in announcing a two-month period during which paper transactions may continue and such documents can be filed with the tax return. The lingering doubt that remains is, will two months be enough? Moreover, compliance costs for a small business will be disproportionately large with respect to turnover.

Now the ITC system ought to incentivize the declaration of all transactions, as that is the only way to claim ITC. But the incentive structure can work perversely driving entire sub-chains of transactions underground. That is, if a trader does not declare a purchase transaction, she would have no need to declare the subsequent sale. This is known to have happened in countries when a VAT regime was newly put into place. As for developed nations which have sophisticated risk-based systems, they are still sample-based. Given the Indian genius for evading taxes, even if India’s GST has the same level of sophistication, the chance of transactions going underground is very real.

The GST law says that if the net impact of taxation is reduced, then firms/traders are expected to pass on the benefit and not profit from the change in tax rates. Most businesses dread that these non-profiteering provisions of the law will be used for harassment (and avoidable litigation). In any case the provisions were not necessary; after all, completion in the market place would wipe out any windfall profits.

Compliance costs will not be insignificant. Press reports suggest that chartered accountants in the capital have already hiked fees. This will surely happen elsewhere. Moreover, there is the distinct possibility of increased litigation on valuation, applicable rates, or denied ITC. The lawyers always get rich, don’t they?

In any major change of the tax regime there will always be teething problems. So, it would be unwise to postpone implementation of a new law merely because of the fear of problems. The substantive issue is will they be simply teething problems or worse. And will they spillover into subsequent quarters?

So, should we have waited another quarter when we waited so long? Should we have given businesses the time to ramp up their accounting systems? Should we have done a dry run with the GSTN system? Only time will tell but, prima facie, there was a case for staggering implementation to October 1, 2017.

There are two macro-economic issues of concern. First, it is recognized that economic activity will be disrupted. The question is by how much and for how long. We can ill afford any disruption; there is a huge banking problem and the economy’s growth rate is decelerating with no revival of investment on the horizon. The short-term impact of the disruption is not in doubt. The real question is how long will it last and its impact on expectations.

Second, how will revenue realizations behave? This is important because it has a direct bearing on the fiscal deficit. Any contraction or disruption to economic activity will adversely impact revenues. Further, submergence of transactions (going underground) will also impact revenue collections.

So, should we have gone ahead with the GST, warts and all? Well, even an imperfect GST is way better than the extant indirect taxation regime. Further, there is no denying the long-term benefits: an integrated Indian market, a simpler tax regime, greater transparency, and buoyancy of revenues. Moreover, the State VAT was in place by 2004. It has taken us over 12 years getting this far. And, given our politicians’ ability to procrastinate, better to go with the good rather than wait for the best. The niggling doubts are about timing and the potentially adverse macroeconomic impact.

Should we have waited another quarter?

The Finance Minister has used the “short-term pain for long-term gain” argument to justify the go-ahead. That sends a chill down many spines, given the experience with demonetisation. And, that is what worries most people. We are in uncharted waters and the fear of the unknown is truly terrifying.

Most people – the common men and women – simply do not understand what the GST is and how it will work. But they are all deeply suspicious of what the Government does. The accountants and the lawyers may be salivating, but they too are trying to come to grips with the law.

Rahul Khullar is a former Commerce Secretary and former chairman of the Telecom Regulatory Authority of India (TRAI)

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  1. S
    Sanjeev
    Jul 6, 2017 at 8:53 pm
    Once it had to be done. Thanks to Time that we have a resolute PM.
    Reply
    1. R
      Ramani Lakshmanan
      Jul 6, 2017 at 7:38 pm
      The author rightly said that we Indians have ingenious ways of evading taxes. A big majority of indian business men have a system of fulfilling statutory requirements only at the 11th hour!! No one can deny this. So waiting for one quarter or 10 quarters make no difference. It is better to start and evolve. With a proactive IT and ED most will fall in line sooner. Regarding having a computer knowledge of software applications do not have any merit. Most of the states long time back implemented online filing of VAT mandatory. Besides all these business men have been filing IT returns only online. Most of them take the help of some tax consultants not necessarily CAs for this and pay only a small fee. When it is already in practice don't know why there is so much of fuss on this and scarring the business men. I am sure how demonetization fear was broken this one will also be successful. May be some initial hitches but surely will be a great success in couple of months.
      Reply
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        Al S
        Jul 6, 2017 at 4:41 pm
        If the former commerce secretary has punched holes in the naive assertions made by Government, we should welcome them. The powers that be still have an opportunity to incorporate some of the valuable suggestions, particularly the one that pertains to small businesses.
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        1. P
          Parth Garg
          Jul 6, 2017 at 2:19 pm
          The GST Help Desk is flooded with lacs of anxious queries and the help is scarce. This itself shows that GST was thrust on the people without adequate preparations and without educating the stakeholders about the intricacies of this so called tax reform.
          Reply
          1. S
            SC
            Jul 6, 2017 at 1:41 pm
            The author of this article is the former Secretary to the Government of India The question is whether he had made any representation before the GST council on the points he is making now. The problem is that the GST council and also Mr. Rahul Khullar both do not have email ids.
            Reply
            1. K
              Kautilya
              Jul 6, 2017 at 6:50 pm
              GST Council Email ID: contact.gstcouncil gov Also take the time to peruse through the GST accusing this government of lack of transperancy has often backfired. Can't say anything for Rahul Khullar don't trust the Babus, especially those closer to the UPA regime.
              Reply
              1. K
                Kautilya
                Jul 6, 2017 at 6:51 pm
                contact.gstcouncil(attherate)gov
            2. A
              Anirudh
              Jul 6, 2017 at 1:16 pm
              After merely seeing the tone and tenor of the topic, and the Author, I was curious to know whether he is still in service, and scrolled down quickly. Yes, I got my doubt cleared after coming to know that he has become former Chairman TRAI! That explains his stance in the article! Thank GOD he is no more in the service. Such doubting Thomases hinder the reforms.
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                Bijay Kumar Poddar
                Jul 6, 2017 at 12:51 pm
                All the sweet shops used to sell their sweets at a fixed price. for example a sandesh sold for Rs 20 and it used to include Vat if it was there.They used to issue cash memo which was back calculated. for example Rs 19 for sandesh and Rs 1 for Vat. with the introduction of GST they have simply started taxing GST on Rs 20 without giving benefit of prior to GST Regime. Courier companies used to charge Rs 10 service Tax now they have fixed new price Rs 15 Today is 6th July 2017 Eastern Coalfields Ltd has failed to start loading of trucks from their various Area namely Kunustoria, Kajora, Sripur, Kenda etc. In kolkata customs till yesterday Bills of Entries are not getting printed hence all clearances stopped. Private parties are waiting and watching to issue GST invoice. If any invoices issued it is issued prior to 1st July 2017. In any case Indians are familiar to such problems and things will be ok in next 2-3 months but must acknowledge courage of Our P.M and F.M
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                  Anmol
                  Jul 6, 2017 at 12:39 pm
                  Modi govt was more interested in tamasha and self promotion, and less on the seamless planned GST implementation.
                  Reply
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