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Preparing for Goods and Service Tax
February, 12th 2009

In a properly unified market, taxpayers should have to deal with just one set of tax authorities, and have the same tax structures across the country. A system that gives tax credits will create incentives to pay taxes, and will help to lower costs as tax rates can be cut when the taxable base broadens. According to the former finance secretary, Vijay Kelkar, currently the chairman of the 13th Finance Commission, the introduction of an all-India Goods and Service Tax (GST) in place of the current plethora of central and state-level indirect taxes will result in an efficiency gain of 1.5 per cent of GDP each year, or Rs 75,000 crore. Put a modest discount rate to this and, Dr Kelkar estimates, the net present value of the savings could be as much as half of Indias GDP. In other words, after Manmohan Singhs initial burst of economic reforms in 1991-93, this is the biggest reform measure that India could witness. Experts will quibble on the value of the savings, on the discount rate, and more, but that would be to miss the point Dr Kelkars numbers are directional, and that is why the GST is being attempted.

Whether the country will be able to switch to a GST by April 1, 2010, as the agreed schedule says, is however a different matter altogether. The fact is that there is a great deal of ground still to cover. For starters, there is no clarity as yet on what the single GST rate should be the National Institute of Public Finance and Policy had done some initial analysis last year which suggested that 10 per cent (with a 7 per cent non-rebatable excise on items like cars, petroleum products and tobacco) would be a revenue-neutral rate, but major states would need to get separate studies done. The central government too needs to move towards a uniform GST rate; the cenvat rate is largely 10 per cent, but there is a plethora of exemptions, and the service tax rate is different. These need to be rationalised.

At the level of states, as this newspaper reported a few days ago, alcohol is likely to be kept out of GST; petroleum products are already out of it, and it is likely that tobacco will be slipped into the same special category. Keeping such big revenue sources outside the purview of GST will clearly weaken it, so another possibility being discussed is to bring all these products into the GST with moderate tax rates, and leaving a sin-element outside the net. Thus, there could be a low GST on tobacco and a larger non-vattable sin-tax on tobacco. Similarly, the large difference between the VAT rates for raw materials (4 per cent) and final goods (12.5 per cent) has ensured that the state VAT is still not designed to encourage compliance. Nor has there been any meaningful progress in setting up an information system for keeping track of taxes on goods that move across state borders. In short, there are several vital links that are still missing, such as a transition system to the dual-GST on all goods and services.

As should be expected, these were pretty much the same issues that delayed the introduction of a uniform VAT across all states. Given this, it may not be a bad idea to spend some more time to iron out operational problems instead of trying to rush things through because of a deadline. Also, there can be little doubt that the success of VAT had a lot to do with the fact that the economy was on an upswing so, it was easier to convince states that the buoyancy in revenues which they were witnessing was the result of VAT. Delaying the introduction of the GST till the economy is on a rebound would help its acceptance.

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