As adviser to then Finance Minister P Chidambaram, Parthasarathi Shome had played a crucial role in the introduction of state-level VAT, and prepared the first report on goods and services tax (GST). Shome, who is now the director and chief executive of economic think tank ICRIER, however, tells Indivjal Dhasmana and Dilasha Seth that the new GST structure is far more complex and distortive than what he had suggested. Edited interview:

The country has missed two deadlines of the introduction for the GST because of differences between states and the Centre. What went wrong?
The GST structure, as was proposed in the first (pertinent) report that I wrote for the empowered committee and submitted to (then finance minister) P Chidambaram, had a seamless structure. But the structure that has evolved has become much more complex. Talking about the hurdles, they have to decide that goods and services cannot have different rates. If you say goods will have 10 per cent and services will have eight per cent, then immediately you have to decide if it is a good or a service. The whole point for a goods and services tax is that you do not differentiate among what you are purchasing or define what you are purchasing. That leads to litigation, something that happens between excise duty and service tax today.

Different rates for goods and services suggested by the finance ministry was for the first year and all rates are proposed to be converged in the third year.

The case should be rather the reverse. In the first two years, when the system is nascent, they should go for same rates. Later, when administration has gained enough maturity to handle the GST, one can afford to think of different rates. I am not advocating different rates. All that Im stating is that it is much wiser to have different rates in later years than in the beginning.
States and the Centre have agreed on the negative list of services with some conditions. What is your take?
Some countries will exempt, say, primary education. One is the lower rate and the other is exemption. The exemption is, you buy your inputs, you pay the GST but since your tax is zero, you dont get credit for what you have paid. So, you absorb your tax. If in certain services they are so needed as they are consumed by poor people, then the government will give you back the taxes you paid. That is called zero rating. Zero rating is very difficult because all these zero-rated entities will have to file returns for getting the refund. To avoid this, for lower income groups certain goods and services are simply exempt. Most countries do that say, for municipal schools. But does that mean nursery schools? Some of the most luxurious nursery schools are run in the country and Delhi is replete with them. Why should they not pay the GST? They should.

How big should the list of exempted items be?
It should not be a long list. The problem is if you have a long list, others also want to get in and make it longer. The best thing, therefore, is like (what they have in) New Zealand or Chile to have one rate. Everything is covered. That allows you to have as low a rate as possible. In India, another problem today is the base. In New Zealand, the VAT covers everything from birth to death; even funeral services are covered. But here, we are keeping out two large items alcoholic beverages and petroleum products from the scope of GST. That will have many deleterious effects, and does not resemble international practice.

After some state finance ministers visited Europe, they advocated a band for GST rates instead of specified rates. Which of the two will you advocate?
That (a band) is not impossible to design, but the structure will become very difficult to administer. Think of one dealer, say, an importer who imports and exports from Bihar. He is importing from Maharashtra at eight per cent, but the Bihar rate is 10 per cent. So this information has to go through a banking system, a clearing house between Bihar and Maharashtra. Expand his business and think of him as importing from 33 entities (ST and UT) and exporting to 33 entities. Can you imagine the complexity? For another individual, yet another pattern may emerge.

So, you need to have a very finely defined IT-specific clearing house system, which will develop an algorithm, and be able to implement it smoothly. If not achieved, the next day after it is implemented, there will be commotion and chaos. The compliance cost of taxpayers will also increase, with taxpayers having to keep extensive records. Thus, conceptually you can have a beautiful clearing-house mechanism if you have proper recording systems. But, essentially you need an advanced IT-based mechanism to create that clearing house. And that has to function pretty much flawlessly.

However, if you cannot make it work, it will create distortions for the taxpayer. A tax system with its administration is not only for the government. It has to function well for the taxpayer in particular. We need to see if it makes sense for the taxpayer in terms of compliance costs. But, theoretically, of course, you can create a mega structure. We should be cautious with such an approach.