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Finance Minister Favours Cess Over Additional Tax To Compensate States Under GST
October, 27th 2016

Finance Minister Arun Jaitley on Wednesday favoured levy of cess on tobacco and luxury products to compensate states for loss of revenue under the GST regime saying the cost of funding that through an additional tax would be "exorbitantly high and almost unbearable".

Ahead of the meeting of all powerful GST Council next week to decide on GST rates, Jaitley said the 4-slab structure of 6, 12, 18 and 26 percent was under consideration, with lower rates for essential commodities and higher bracket for luxury goods.

"Different items used by different segments of society have to be taxed differently. Otherwise the GST would be regressive. Air conditioners and hawai chappals cannot be taxed at the same rate. Total tax eventually collected has to be revenue neutral. The Government should not lose money necessary for expenditure nor make a windfall gain," he wrote in a Facebook post.

Explaining the rationale for cess, Jaitley said if the central government has to borrow money to fund states' compensation, it would add to its liability and increase cost of borrowing for the Centre, state governments and the private sector.

He said there is no rationale for increasing direct tax for this purpose and theoretically it has been argued that the compensation be funded out of an additional tax in the GST rather than by cess.

"Assuming that the compensation is Rs 50,000 crore for the first year, the total tax impact of funding the compensation through a tax would be abnormally high. A Rs 1.72 lakh crore of tax would have to be imposed for the central government to get Rs 50,000 crore in order to fund the compensation," he said.

"50 percent of the tax collected would go to the states as their GST share and of the balance 50 percent in the hands of the Central government and 42 percent more would go to the states as devolution.

"So out of every 100 rupees collected in GST only 29 percent remains with the Centre. The tax impact of this levy would be exorbitantly high and almost unbearable," he said.

Alternatively, Jaitley said cesses can be imposed which would be subsumed in the taxes after five years.

"This would include clean energy cess and cesses on luxury items and tobacco products, which in any case, presently also pay levy higher than 26 percent. This would ensure no additional burden on the tax payer and yet be able to compensate the losing states," he said.

Jaitley said if cess is levied, states which benefit out of GST rollout do not have to compensate the losing states.

The Centre, as a non-beneficiary, has to compensate and the proposal for continuing existing cesses for five years to the extent of compensation required is the more benign way of compensating the losing states without burdening the tax payer.

Arun Jaitley, Finance Minister

Jaitley said it has been proposed to the Council that there should be a 4-slab multi-rate tax structure with items constituting nearly 50 percent of the weightage in the Consumer Price Index basket (mainly food items) being exempted from the levy.

"There will be a zero tax on such items. The object of this is to ensure that the GST structure is not regressive or burdensome on the common man," he said.

In the GST Council meeting last week, some states had expressed concern over the Centre's proposal to impose cess on demerit goods over and above the higher tax bracket of 26 percent. A final decision on this is expected in the next meeting on November 3-4.

Jaitley further said that unlike developed countries, developing nations like India need more tax slabs as they have to take care of people below poverty line.

"The reality is that a multiple tax rate in India is inevitable for several reasons... The tax on some products in a narrow slab regime will substantially increase. This would be highly inflationary," he said.

A commodity being taxed by the Centre and states at 11 percent at present will be taxed at 12 percent. If its taxation is suddenly raised on standard rate of 18 percent, it would disrupt the market and would be highly inflationary.
Jaitley said presently there are several items mainly used by the more affluent which are taxed at a VAT of 14.5 percent and an excise of 12.5 percent.

"If the cascading effect of these taxes and octroi is added, then range of taxation of these products is between 27-31 percent. It has been proposed to the Council to fix the rate of these items at 26 percent.

"Some of the items which are now being used by the lower middle classes will eventually be proposed to be shifted to the 18 percent bracket. With regard to demerit and luxury goods which are taxed globally at a higher rate, no rebates are contemplated. Each good would be taxed on the basis of its own demerit," he added.

Describing the GST Council meetings as "excellent example of deliberative democracy", Jaitley said that so far all issues have been decided by a consensus.

The principal rationale behind a 6, 12, 18 and 26 percent tax structure is that items which are presently taxed at rates closer to the range of each of the slabs will be fitted into the particular rate of the slab. Those presently taxed below 3 percent as the total tax of the Centre and the States will be taxed at a zero rate. Those between 3-9 percent will be taxed at a 6 percent rate, those between 9-15 percent will be taxed at 12 percent and there would be a standard rate of 18 percent, he said.

"Some have suggested that multiple tax rate is disadvantageous to the GST and would neutralise some of the advantages of a uniform tax structure," Jaitley said.

He said the gains of GST would necessarily involve that there would be a seamless transfer of goods and services across the country.

"The biggest advantage of GST actually lies in the GST design itself which provides for seamless transfer of input tax credit across the value chain. Most commodities would be taxed at lower than present levels.

"On some cases because of the tax rate going down and cascading of tax on tax going away, higher compliance levels which would reduce the level of non-compliance," Jaitley said.

The net gains of a more efficient tax would be felt over a longer period of time once the implementation glitches are all resolved, he said.

"Hopefully with higher compliances and more revenue after the initial period, the GST Council would continue to have a look at the expenditure requirement and the tax likely to be collected and rationalise the tax rates and the structures in future," Jaitley said.

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