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GST levy to replace an array of state and other indirect taxes
December, 31st 2014

Arun Jaitley is aggressively marketing the goods and services tax (GST). He told parliamentarians last week that the tax reform, meant to create an integrated countrywide market for goods and services, would benefit states from Day 1. The communication blitz is welcome now that action has begun on GST.

The government has played Santa to bring states on board and introduced the Bill to give states the right to tax services and the Centre to tax goods up to the retail stage. The reform should benefit all stakeholders, including producers, exporters and the consumers. However, the building blocks of GST provided in the Bill will make the tax system messy and render our exports uncompetitive. The flaws must be removed.

GST is meant to be a comprehensive levy to replace an array of state taxes, excise and other indirect taxes. Subsuming these levies will knock off the cascade of many taxes that many products bear. All products and services should attract the levy. The reason is simple: manufacturers will get set-offs for taxes paid on inputs, and GST will create audit trails on the value addition across the production chain.

This will help curb evasion and widen the tax base. The Bill has, however, kept alcohol out of GST. This means unlawful liquor trade will thrive. Petroleum and petro products, too, have been excluded for the time being, but can be included whenever the GST council takes a call. That, again, is a suboptimal solution.

There is no logic either to charge an extra 1% levy when goods move from one state to another. The government has defended the move saying it will help producing states worried about losing revenues when the central sales tax is scrapped. This is a weak argument since producing states such as Maharashtra, Gujarat and Tamil Nadu will, in any case, be compensated for revenue losses while moving over to GST. The Centre has guaranteed compensation. So what’s the hitch?

The Bill complicates matters by saying the extra tax “will be for a period not exceeding two years, or further such period as recommended by the GST council”. Doesn’t this make the levy open-ended and against the grain of GST? It will distort the tax system and should be withdrawn. The Constitution Amendment Bill must be flawless, without political compromises. It will not be easy to make changes once Parliament clears the Bill. So, the Centre should refer the Bill to the Standing Committee for a wider debate.

Vijay Kelkar, chairman of the 13th Finance Commission (TFC) that framed a model GST, was also unequivocal about a good GST design. “We recognise that building consensus on implementing the model GST may be an involved process, but equally appreciate that the requirement of a good design is paramount,” the commission said. The model GST had no flaws in its design and subsumed all state and central levies, bringing all products under GST.

The suggestion to include the real estate sector, where tax evasion is rampant, also made eminent sense. Exemptions spell patronage and should be kept to the bare minimum. A comprehensive GST will spur growth.

As part of a ‘grand bargain’, the TFC also recommended a Rs 50,000-crore grant to compensate states for any revenue loss when they implement the model GST. However, the grant will vanish if the states don’t agree to the model. Not surprisingly, the government’s action-taken report played down the controversial recommendation.

Nevertheless, the UPA government again asked the 14th Finance Commission (FFC), steered by Y V Reddy, to assess the impact of GST on government finances and to suggest a mechanism to compensate states for revenue losses. Unlike the previous commission, the FFC may not have gone the whole hog on GST. Moreover, in the absence of GST design, the commission would have found it tough to assess the impact on government finances. One can expect general advice by the FFC, whose core mandate is to determine the distribution of tax proceeds between the Centre and the states.

The ball is now in the GST council’s court. It will set the rates and thresholds to roll out a dual GST, comprising acentral and a state GST. A lower rate makes sense to transform a fragmented market, lower compliance costs for taxpayers and also raise the share of manufacturing in the country’s GDP.

India should adopt a clean and elegant GST that’s purely consumptionbased. It is imperative for states to cooperate if they are serious about lowering business costs, promoting enterprise and integrating markets. Contentious issues relating to the dual administration of the new levy and underdeveloped appellate mechanism at the state level must be addressed. The Budget should also provide a clear roadmap, with realistic timelines, for a flawless GST.

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