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Good And Simple Tax
October, 09th 2017

Three months after its introduction on July 1, 2017, it is time to take stock of the Goods and Services Tax (GST). Tax collections are running ahead of estimates. By pulling in large chunks of the informal sector into the formal economy, the long-term benefits of GST will be a game changer.

In the earlier regime of a plethora of state-level taxes – octroi, VAT, sales and excise – many SMEs operated beneath the radar. Small traders almost never paid any taxes. Now most do. The GST will, in the months and years ahead, dramatically broaden India’s tax base.

Where GST has failed the test, however, is in its architecture and implementation. The architecture is needlessly complex. There are too many tax slabs, too many exemptions, and too many anomalies. Implementation has inevitably suffered with tortuous paperwork to decipher which tax slab applies to which product.

As Einstein said apocryphally: “The clever simplify the complicated; the rest complicate the simple.” The GST would have intrigued Einstein. Here’s a great idea, replacing a complex web of state taxes with one national tax. Simplifying the complicated?

In principle, yes. In practice, no.

The first infirmity of GST is the multiplicity of tax slabs. The second is the onerous paperwork. The third is differences in tax slabs between components of the same product. A colour printer’s components, for example, have different tax slabs for each sub-product, making the paperwork a nightmare. Book publishers, to cite another example, have to deal with different tax rates for printing presses, designers and authors’ royalties.

Some of the GST tax slabs descend from the sublime to the ridiculous. Food takeaways from an air-conditioned restaurant are taxed at 18 per cent even if it’s a walk-in customer who takes delivery in a non-airconditioned part of the restaurant. Oddly, a sitar is exempt from GST; a guitar is not. A dhol is exempt, drums are not. This is taking economic nationalism to ludicrous lengths under the guise of encouraging Indian musical instruments at the cost of western ones.

Exporters are especially unhappy with the new system in which taxes have to be paid upfront in place of the earlier waiver. These taxes will be refunded but till then the government increases its cash flow by an estimated Rs 1.50 lakh crore while exporters have an equivalent sum locked up and pay high interest on it. The new Commerce Minister, Suresh Prabhu, will need to sort out this problem in an environment where exports are already under pressure.

The GST has five rate slabs: 0 per cent, 5 per cent, 12 per cent, 18 per cent and 28 per cent. But that climbs to seven rates when you add cess on luxury goods (cars, for instance) of different sizes and types. Finance Minister Arun Jaitley and his team of bureaucrats in the ministry of finance (MoF) say there will eventually be one GST rate: 18 per cent. But even here there are conflicting views in the MoF which believes there should be at least two rates – 12 per cent and 18 per cent. That actually makes it three rates since the 0 per cent rate on household essentials like food will remain. And if cess on luxury and “sin” goods also remains, that will take a “simplified” GST back to at least four tax slabs.

The MoF’s intention to move to a single GST rate is therefore clearly utopian. The only sensible way forward is to focus on three rates: 0 per cent for household essentials, 18 per cent for almost everything else, and 28 per cent for a small range of “sin” goods.

Exemptions are a bureaucrat’s delight. They give babus discretionary power and a sense of self-importance. Tinkering with tax rates is a time-honoured practice in Union Budgets. The habit has seeped into GST – unsurprisingly because the same set of people write the Budget. The GST should simplify paperwork. This can happen only with a single GST rate for almost all goods and services bar household essentials like food and luxury/sin goods.

The larger problem that stares the government in the face is that tax revenue is not keeping up with the country’s expenditure. India requires more funds for defence, education, healthcare, railways and infrastructure.

With private investment moribund and banks shunning new corporate lending due to high NPAs, the burden falls on public spending. Transport Minister Nitin Gadkari plans to issue a series of innovative bonds totalling Rs10 lakh crore to raise resources for infrastructure development. Similar creative ideas are needed to attract FDI and domestic investors in healthcare and education.

India spends Rs 5.23 lakh crore – equal to the entire fiscal deficit – on just servicing interest on old loans. Compare this to the allocation in the 2017-18 Union Budget on agriculture (Rs 0.57 lakh crore), health and family welfare (Rs 0.49 lakh crore), education (Rs 0.80 lakh crore) and energy (Rs 0.37 lakh crore). That adds up to Rs 2.23 lakh crore in four key sectors – less than half the money spent on paying interest on old loans.

Subsidies (Rs 2.40 lakh crore) and pensions (Rs 1.31 lakh crore) underscore the parlous state of India’s public finances. There is little left over in the Budget for productive investment to boost economic development after salaries are paid (to an over-staffed government), subsidies handed out and interest debited. The United States spends twice as much on just defence (over $600 billion – Rs 38 lakh crore) than India’s entire annual Union Budget of Rs 21.47 lakh crore.

Part of the reason of course, is that agricultural income (on which 50 per cent of the country’s population lives) is tax-exempt. No political party has the courage to tax agriculture – it is deemed political suicide. But there is a case for taxing rich “farmers” with an annual taxable income (after expenses) of over Rs 10 lakh. When half the country is exempt from paying tax, government revenues will always struggle to keep up with expenditure and investment.

The GST is a good start. Bolder thinking will be needed in future to fix India’s real problem: too few resources to make a difference to the lives of the country’s teeming millions.

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