July 6, 2017 12:29:20 am
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.
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