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GST, an old new tax
June, 27th 2017

Sixteen years in the making, India is finally set to roll out the Goods and Services Tax (GST) from July 1. Prime Minister Narendra Modi will inaugurate the new indirect tax at the stroke of midnight in Parliament, taking a leaf out of Jawaharlal Nehru’s book. “A moment comes, which comes but rarely in history, when we step out from the old to new,” Nehru had said while ringing in India’s independence. The two events are obviously not comparable — nonetheless, the GST’s introduction could have been a rare transition, but is not.

The GST, to be collected on everything from matchboxes to gold, will touch everyone. A modern tax system should be fair, uncomplicated, transparent and easy to administer. It must yield revenues sufficient to cover the cost of government services and public goods. India’s GST does not pass these tests convincingly. It is too complex. We must collect it at fewer and lower rates, and on more items.

The GST has been fixed for more than 1,200 categories of goods and services consumed in the country at 0.25%, 3%, 5%, 12%, 18% and 28%, along with cesses to be imposed additionally in some cases. The present taxation system has not been given the boot yet. Electricity, real estate and alcohol will remain in it, exempt from the GST. Petroleum products will be in both systems, old and new, but with zero-rate GST. Over half the items will be taxed at 18% or 28% GST, the steepest rates in the multi-rate structure. This skew violates the basic principle of revenue collection: the lower the taxation rate, the higher the compliance. An opportunity is lost to collect more tax revenues, while at the same time, taking a little load off the consumer’s pocket.

More than sound economic, or political, logic, the GST seems driven by the deciding authorities’ discretion. The GST rate for gold, a luxury good, is lower than that for matchboxes. The tax incidence is the same in the GST on environment-friendly hybrid vehicles and fossil fuel-guzzling SUVs. In the extant system, the effective rate for guzzlers is significantly higher than that for hybrids. This ‘carbon tax’ on SUVs, popular with politicians, is being withdrawn.

The GST will be imposed at 18% on soaps and washing soaps, but at 28% on detergents. Some moviegoers will pay 18% GST and, others, on the same movie, 28%, depending on the price of cinema ticket — not exactly the promised ‘One nation, one tax’.

The GST, as it’s being rolled out, is an outcome of a political process in which 29 States and seven Union Territories agreed to give up their right to impose sales tax on goods (VAT) and the Centre gave up its right to impose excise and services taxes. In the amended federal arrangement, they will each receive a share of the GST collected nationally. Instead of every State imposing a tax, they will sit together and decide what that tax rate should be. Individually, States see this as an erosion of their financial autonomy, even if Union Finance Minister Arun Jaitley, the chief architect of the consensus, described it as, “the states and Centre pooling their powers and sovereignty”.

The constitutional guarantee that the Centre will fully reimburse the transitional losses did not fully address the States’ insecurities. The States insisted on keeping the GST’s rate structure as close as possible to the old system. A GST regime resembling the old tax system cannot be a low, single-rate GST. The options narrowing to a delayed or an imperfect GST, the Centre chose to defer to the States’ collective opinion. The result: far from simple or neat, the new indirect tax is a multitude of rates, cesses and exemptions.

So, politicians, not tax experts, devised the GST. The GST Council, made up of Ministers from State and Central governments, scrambled elements from the current indirect taxation system into the GST, tinging the new with the old, guided by old habits, not healthy appetite for reform.

“Status quo has strong appeal in real life,” Prime Minister Manmohan Singh had said of the resistance to 1991’s economic reforms. Chief Economic Advisor Arvind Subramanian’s summation of the process that delivered the GST suggests that decades later, attitudes have not changed: “On the GST, the political pressures from the States to keep rates low and simple were minimal. The general desire is for the structure to mimic the complicated status quo. There was insufficient concern for the implied consequences for efficiency and simplification.”

The lingering imperfections, and disregard for economic principles, will limit the GST’s transformational potential. Small firms, unlike industry chambers and lobbies, are not vocal, and therefore not easily heard. They are concerned about the number of man hours the new reporting requirements will extort. These should be taken on board. The GST Council must show sensitivity to transitional challenges. A hotline among its members, as an instantaneous problem-solving mechanism, may smoothen the transition. Increasing simplicity and reducing the complexities remains a promise made, not kept.

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