Use fin panel model for GST benchmarking and assessment
April, 28th 2010
Indian policy makers have set an ambitious agenda, to be completed over the next several years, for modernising Indias tax system and tax administration.
The agenda includes unified goods and services tax (GST, to be introduced in April, 2011); a new Direct Tax Code to replace the Income Tax Act, 1961; restructuring of Income Tax Department towards taxpayer service orientation, risk management based auditing systems, and enhanced functional specialisation.
Institutionalising the operations of the large taxpayer units (LTUs) (the first was set up in Bangalore in 2006), which administer income, customs, excise and other central taxes under a single-office, should also be an integral part of the agenda.
The main role of the LTUs should be to help preserve Indias overall tax base, provide valuable feedback for policy and administration, and substantially lower compliance costs while encouraging the culture of voluntary compliance.
The GST is thus only one of the vital components of Indias ambitious tax reform agenda. As the name implies, under GST, both goods and services will be uniformly taxed under one tax law. This is in contrast to taxing goods and taxing services under separate laws as is the case currently.
The tax on goods as exemplified by levying excise taxes on different commodities is inherently regressive as the share of household income spent on goods declines with rising income.
This suggests that relative excise tax burden also declines with rising incomes. Excises on goods were a significant part of the revenue of the central government at the time when the official objective was to progress towards a socialistic pattern of society. This illustrates weaknesses in the application of basic economic reasoning in different areas of public policies have led to dysfunctional, inefficient, and inequitable policies.
Public interest demands that competence in applying economic reasoning to public policies and schemes should be an integral part of training of civil servants at all levels of government, and at various stages of their career.
Thanks to Sardar Vallabhbhai Patel (1875-1950), India was able to progress towards unified All India polity at the time of independence. However, due to what in hindsight were misguided economic policies since independence till the early 1990s, the Indian market became fragmented, with high transactions costs and considerable artificial frictions in pursuing inter-state commerce.
As India becomes globally integrated, and the size of Indias gross domestic product (GDP) at current growth rates increases from $1,200 billion to $5,000 billion by 2025, just 15 years away, unified internal market spanning the country has become essential for national prosperity and broader economic security.
The Model GST recommended by the 13th Finance Commission is based on several specialised studies specifically undertaken for the commission, and wide consultation with the state and central governments.
The main elements of the Model GST are as follows: l First, a dual GST, with both central GST (CGST) and state GST (SGST) levied on the same tax base. This will require single treasury arrangement for the GST collection, and facilitate database construction for smoother administration, refund, systems, and risk-based auditing systems. Establishing a sound treasury management system should therefore be regarded as absolutely essential.
Second, all goods and services except agreed upon exceptions will be brought into the GST base. The 13th Finance Commission estimated the base to be Rs 3,100 crore; and given the wide base, the revenue - neutral rate to be 12% for both goods and services (5% by the centre (CGST) and 7% by the state (SGST)). This is substantially lower than current 12.5% value added tax (VAT) in states and 8% central VAT. The 12% rate is an ideal rate. All state GST laws should be harmonised.
The 13th Finance Commission has followed a simple, but politically difficult, principle of tax reform, i.e. wide-base-low-rate, to obtain a given level of revenue. This helps to minimise rent seeking by special interest groups, and distortions in economic behaviour arising from high marginal tax rates. GST will also permit some items, like naphtha, which are difficult to tax under the current sales tax.
Third, as GST will be consumption-based, all related indirect taxes at the centre and in the states should be subsumed into it. Among the more important ones are VAT, central sales tax, entry tax, service tax, central excise duty, additional customs duty, stamp duties, entertainment tax, and all centre and state surcharges and cesses. The exports will be zero-rated, but imports will be subject to GST, as destination principle (sales taxes are levied where goods are consumed) is applied.
Fourth, there will be no tax on inter-state sales. The tax should be collected by the consuming state, consistent with the destination principle.
Fifth, the threshold of exempted turnover should be consistent across SGST and CGST. The present area-based exemption schemes should be abolished.
Sixth, the 13th Finance Commission recommends a compensation mechanism for the states if what it calls grand bargain between the centre and the states is reached.
The above suggests that the Model GST will dilute fiscal autonomy of states. It may impact their revenue generation from certain products and affect sales tax treatment of small enterprises.
The 13th Finance Commissions arguments imply that these will be small negatives for the huge positive impact that the Model GST will generate for the country. The commission estimates that India can obtain a sustained annual increase in GDP of 0.9-1.7% if the Model GST if implemented.
The empowered committee of state finance ministers has the responsibility to ensure that the design of the GST corresponds as closely to the Model GST as possible.
There are reports that the empowered committee is leaning towards a 16% rate for GST, one-third higher than the Model GST. Greater the departure from the Model GST, lesser the realised benefits from the GST will be. The empowered committee should reach an early agreement to enable the states to prepare their staff, infrastructure and management systems for GST.
Indias GST reform has rightly been called by the 13th Finance Commission as game changing tax reform. It has set a benchmark against which the design and implementation efficiency that finally emerges will be judged. Sustained public and media pressure on the political and bureaucratic class to not fail the country in the GST design and implementation is warranted.