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Eco-tax should not spoil simplicity of GST
April, 27th 2010

The environmentalists are doing genuinely good work to promote more favourable situation for the earth to survive the rampaging attack on ecology. But in the process one has to look for the correct method. The environmentalists advocate eco-tax and eco-subsidy to cope with pollution. I am writing this treatise to examine this proposition.

The point of view of the environmentalists is that environment tax provides an effective instrument for incentive base for pollution control while generating revenue though revenue is not the main purpose. What they argue is that those goods which are either imported or manufactured in the country that increase pollution should be taxed more and vice versa.

The generic name for such taxes levied to correct negative externalities of a market activity is Pigovian tax. This tax is named after the economist Arthur Pigou who also developed the concept of econ-omic externalities. Pollution tax is one such kind of ini-tiative which can be moun-ted with the levy of sin tax.

With a sin tax (Pigovian tax) there is always an incentive to reduce pollution, wher-eas with direct regulation a polluting company has no incentive to pollute any less than what is allowable.

Here I am not discussing measures such as carbon tax which are directly effective and are not part of indirect tax set up. In India, there is presently some provision for exemptions to machinery that help control pollution. But when the GST comes with a consolidated single rate of duty, the issue that would be relevant is whether we should make higher or lower rate of duty to allow for betterment of environment.

Carbon taxes are now common in all countries and the report of the Green Fiscal Commission (2009) shows how many countries such as Finland, Norway, Denmark, Sweden, Germany, UK have effectively reduced CO2 emission with the help of carbon tax.

It is also operative in India. Carbon tax surely is useful but it is not a part of GST since it is not an indirect tax but a direct impost. What I am writing here is about the GST and eco-tax which means I am trying to reply to the question "is it necessary to imbibe eco-tax which may be higher or lower than the general GST rate?". The Pigovian tax was alright when there was no GST.

We are going to introduce GST for simplification which will vastly improve administration of tax. GST is a broad based consumption tax and the beauty of it is its simplicity, that is to say, one rate or maximum two rates with no exemptions. New Zealand, Japan, Canada, Australia, UK, Thailand etc. (altogether 54 per cent of the countries in the world) have one rate of GST and very few exemptions. For controlling pollution, there is no separately higher or lower rate of duty within the GST regime. Actually speaking slightly higher rate or lower rate would not effect the major polluting industries in the Country.

In India the major polluting industries are iron & steel, oil refinery, sugar, fertiliser, power, cement, etc., If we give them little tax benefit, it will make no difference to the huge investment that are necessary to change the basic nature of the machinery which are outdated. Huge subsidies can only serve the purpose and not tax incentive or disincentive which can only be marginal in nature.

The moment we give such exemptions or impetus for environment, others in line who will ask for the same will be infrastructure and power industry who are already campaigning for lower rate in seminars on GST. GST structure will be completely messed up if exemptions for promoting or discouraging this or that cause is accommodated.

The conclusion is that eco-tax should be limited to direct taxes such as carbon tax and it should not be an element in GST.

GST is a broad-based consumption tax which will improve performance of industry and service if only it is a simple tax with one or two rates and no exemptions. Direct subsidy and direct eco-tax would be a much better combination than incorporating eco tax in GST which is an indirect tax.

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