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Carving-out GST exemptions will break up input tax credit chain
November, 21st 2013

States want to keep petroleum products and liquor out of the goods and services tax (GST). This is a bad idea and inimical to GST, meant to replace a multitude of state taxes, excise and other indirect levies. Subsuming many levies in GST will cut out the cascade of multiple taxes that these products bear, lower retail prices, and lead to efficiency gains and faster growth. More important, GST captures value addition in the production chain, and across sectors, as a manufacturer can claim credit for all the taxes paid on inputs.

However, exemptions will break up the input tax credit chain. Today, state taxes on petro products are steep and cascading. Petro-products attract heavy taxes in Europe too, but an integrated GST that provides credit for taxes already paid, offsets the burden. An integrated tax regime for oil products, with tax payable on the value added at each stage of production, distribution and sale brooks no delay. States must see reason. They must also agree to scrapping entry taxes as well as the central sales tax, a tax on interstate sales collected and appropriated by the state where the sale originates, to remove barriers for seamless movement of goods and services.

Many states find petroleum and liquor easy revenue sources and tax them heavily — collections in petroleum products alone account for over a third of the consolidated tax revenue. The Centre should compensate states for any revenue shortfall during the transition for GST just as it did when states switched to the value added tax ( VAT) system from the inefficient sales tax system.

States apparently want a formal constitutional mechanism for compensation. That's not a good idea as compensation has to be for a short transition period. GST will see revenues, including income tax, grow faster: the incentive to pay tax is built in because only then will a manufacturer be able to claim credit for the taxes already paid. The audit trail so generated would make evasion of income tax difficult as well. So, devolutions from the Centre would have to be taken into account to compute loss to state revenues, if any.

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